Of THE 148 hedge funds based in Latin America, only nine are outside Brazil, according to figures from Eurekahedge. Over the past two years, the hedge-fund market in Brazil has become increasingly mature. Multi-mercado funds, which are essentially mutual funds for domestic retail investors that can invest in several asset classes, and predominantly run a Brazil-only macro strategy, number more than 4,000. Onshore hedge funds that have structures similar to those in the US and Europe for high-net-worth clients and institutions number 139, up more than 30% on two years ago.
Peter Douglas, founder of hedge fund consulting firm GFIA in Singapore, runs the first fund of hedge funds to go into Latin America, which launched in 2005. He holds the market in high regard. "Brazil is by far the most sophisticated domestic hedge fund market in the world. It is well-regulated and transparent," he says. Douglas says his firm’s Latin American fund of hedge funds has outperformed the global fund of hedge funds sector by a couple of percentage points. According to Eurekahedge, Brazilian onshore funds are outperforming the Latin America hedge fund index and the global hedge fund index this year (see chart).
For outsiders, it is easy to assume that managers have been performing simply by riding the Brazilian wave. However, those familiar with the industry say this is not the case. "There are some excellent managers there and, given economic history, managers are extremely considerate of liquidity and risk management," says Douglas.
Long/short equity has been emerging as a close contender to the multi-strategy funds, which invest predominantly in fixed income. As domestic investors become more comfortable with hedge funds, and as Brazil’s capital market develops, the growth of the local industry shows no signs of abating.
The growth of long/short funds
It is only over the past three years that Brazil has begun to have a sizeable equity market. When interest rates were up above 20%, there was little incentive for investors to look to the riskier equity market for returns. Investors would keep their money in the bank, or would invest in fixed-income funds. Indeed, many of the multi-strategy funds were investing mainly in fixed income. The interest rate is now 11.5%. Fabio Alperowitch, partner at Fama Investimentos, says: "For the last five years, hedge funds in Brazil have been investing in currency and fixed income, and it was easy to have high returns. But now there is little upside left so we are seeing investors turn to equities." Fama is one of the longest-standing equity investors in Brazil, having launched a long-only small-cap fund in 1993, and a long-only mid-cap and large-cap fund in 1998. In 2002, it launched a long/short equity fund in response to investor demand.
Investor demand, as well as Brazil’s growing domestic wealth, has spurred rapid growth in the equity market. In July 2005, there were 349 companies listed on Bovespa; there are now around 430. Market capitalization of the exchange has risen from $584 billion in July 2006 to more than $1 trillion over the past year, and there have been 46 IPOs this year alone.
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Brazil dominates global Latin American hedge fund market |
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Country-by-country distribution |
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Brazilian Onshore funds outperform |
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Returns of Brazils onshore funds vs indices |
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Long/short and Multi-strategy funds dominate |
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Strategies being run out of Latin America |
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Source: Eurekahedge |
A larger equity market and, in turn, greater liquidity have provided conditions for long/short funds to be created to meet investor demand. There are now about 40 long/short Brazilian funds onshore and a similar number offshore. Most managers replicate their onshore strategies for offshore investors.
Shorting the equity market is not as straightforward as in more developed countries, however, and funds need to run their own repo desks. However, liquidity has been improving. Renato Abucham, partner at Claritas Investimentos, which runs a macro fund and a long/short equity fund, says: "Two years ago, there were perhaps five to 10 easy stocks to short, now there are between 50 and 60."
One of the big obstacles to shorting has been the lack of a stock lending market. In Brazil, stock is not held in street name and therefore the end investor has to agree to its being lent out. Andre Jakurski of multi-strategy fund group JGP says: "There is still a perception here of holding stocks, and that people worry about lending stock as it will result in that stock being sold, which could have a negative effect on the price." Furthermore, lenders of stock have been trigger-happy, lending stock and recalling it at will, making it hard for long/short funds to manage portfolios.
But managers say this is changing. Ricardo de Campos is a partner at Hedging Griffo, an asset management house especially recognized for its hedge funds and equity funds. "There are more lenders of stock now," he says. "It used to cost about 6% to borrow a stock, and now that rate is about 1% to 2% – that has probably increased over the past few weeks, however, due to market conditions and would be much more for some single names, but there is a growing stock lending pool." One manager says that he is seeing investment banks trying to go into the stock loan market.
The growth in long/short equity funds in Brazil is met by some with cynicism. Given the growth in the domestic equity market, critics question whether some managers have simply been net long and riding the wave, rather than truly adding alpha. The lack of experienced equity players also raises concerns. Although returns were positive up to end of July, the fall in the stock market in August is likely to highlight those managers that have been adding alpha, and those that have simply been buying the market.
Alperowitch says: "The equity market is still new here, and there are very few funds in Brazil with experience in trading equities. It is not easy to pick stocks. In August there were certainly losses. The market devalued at one point by 8% and some names by as much as 20% – especially the recent IPOs. A lot of managers went with the mainstream and would have had the same positions, so everyone would have had to sell some stocks." Many of the managers that have produced solid returns and that have been in the industry for some time have closed their funds, awaiting further liquidity and opportunities, and banks offering long/short funds to retail clients are believed to have been forced to put customers into funds run by managers with little or no experience of a bear market. "Some of the new IPOs this year have come at crazy prices. You have to be careful how you select managers. At the moment, it is not difficult to find assets but more difficult to find investment opportunities," says Neil Steifel, co-head at UBS Pactual in Rio.