 |
"We look at how the central banks of these emerging markets are handling the issue of currency and liquidity. They have to keep their currencies cheap, so need to sell a lot of it domestically" Michael Dooley, Cabezon Capital |
Michael Dooley knows a thing or two about emerging markets. For 13 years he was an economist for the division of international finance at the US Federal Reserve, where he worked on trade and current account forecasting and was an editor of the Blue Book. He then worked for nine years at the IMF, where he advised governments in the Brady bond plan agreements. Moving to Deutsche Bank in 1992, he worked on the debt restructuring team for Argentina and stayed on as chief economist for Latin America.
It’s an impressive resume, and one that has led Dooley to his latest venture – an emerging markets-themed global macro hedge fund. Last year, he and Michael Cagney, founder of Wells Fargo’s financial products group, set up Cabezon Capital, named after a hard-to-catch species of fish caught off the shores of northern California. Cagney is the portfolio manager and Dooley is head of research.
Identifying imbalances
The fund, unlike some of its macro peers, applies a straightforward philosophy: it uses Dooley’s Bretton Woods II framework to identify tradeable macroeconomic imbalances, particularly as they relate to predictive central bank behaviour. Developing nations following the Bretton Woods II framework are pursuing export-led growth supported by undervalued exchange rates. “This strategy of keeping a local currency undervalued to ensure that exports remain high, and being a lender rather than a debtor to the US, has worked extremely well,” says Dooley. “The results have been rapid economic development in these countries and we don’t see them changing.”
He continues: “These governments are no longer coming to the US to borrow, and dollar-denominated sovereign debt is decreasing. When countries have external debt to pay, it can destabilize the local financial markets. What if they default? Firms could go bankrupt. We focus on markets that have taken this element of instability away, and that are instead focusing on building a domestic market.”
Bretton Woods II policies place unique pressures on central banks, leading to macro trading opportunities created by imbalances in inflation, interest, or exchange rates. “We look at how the central banks of these emerging markets are handling the issue of currency and liquidity,” says Dooley. “They have to keep their currencies cheap, so need to sell a lot of it domestically.” Artificially keeping currencies depressed to foster export growth creates inflationary pressures on economies: Argentina, Russia and Egypt all fall into this category. “We look at the implications for interest rate moves in each country, and finally look for countries where the market has not already incorporated our view,” he says.
Cabezon runs a concentrated book of five or six core themes, investing in debt and equity denominated in local currencies, and sometimes currency outright. Cagney trades the book by emphasizing idiosyncratic risk over systemic risk and investing primarily in liquid local debt, equity and currency markets.
Key themes
On the debt side, key themes include Argentina, Egypt and Russia, as well as a CDS position in Brazil, a country on which the fund is bearish. On the equity side, key themes include China, Malaysia and Singapore. “People view China as an anomaly because it is taking an aggressive export-led growth strategy,” says Dooley. “In our view, though, China is doing this because it works, and other countries will begin to follow suit. Vietnam and Thailand are also examples of domestic markets following this approach. The idea is that as some countries become successful and join the OECD, they will be replaced in our portfolio by other poorer countries adopting this method. I would expect foreign investor participation, and hedge fund participation, to increase in these markets significantly. I would be surprised if foreign participation does not go up by 15% over the year.”
The BWII fund has been successful in its strategy, with approximately 21% in net returns for its first six months of trading. As a result, Dooley expects participation in the fund to increase. Since its inception in July, Cabezon has raised $70 million from domestic investors, including seed capital from the Getty family, and expects to soft close at $250 million, with a hard close at about $500 million to $700 million. In February, the firm is launching an offshore fund to accommodate European and Middle Eastern investors.