Introduction
The Latin American hedge fund sector is one of the fast growing segments of the global hedge fund industry. Over the last decade, the total number of hedge funds in the region has increased four-fold while the assets under management has grown by nearly 25 times. Currently, the size of the Latin American hedge fund industry stands at US$60 billion.
Industry assets witnessed incremental growth in the 2004–2007 period, registering a three-fold increase over these three years. This tremendous growth was underscored by the performance of the Eurekahedge Latin American Hedge Fund Index, which gained 103.23%[1] over the period. The industry witnessed a downturn during the credit crunch and the subsequent financial crisis; however, managers delivered admirable downturn protection throughout this period with an average loss of only 4.93% at a time when the average global hedge fund was down 10.78%. Assets under management fell to US$39.3 billion by March 2009 before posting a strong recovery in the last three quarters of 2009.
Figure 1 shows the growth in the Latin American hedge fund industry since 2000.
Figure 1a: Industry growth over the years
Throughout 2010, Latin American hedge funds maintained the trend of growth established in the last three quarters – the Eurekahedge Latin American Hedge Fund Index delivered a gain of 9.84% in 2010. As at December 2010, industry assets stood at a historical high of US$60 billion, which represents a 52.7% increase since March 2009. While most of the growth was generated through performance-based gains, the industry also attracted net positive asset flows during the year.
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Figure 1b: AuM growth in recent months
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Asset Flows
In 2008 and 1Q2009, Latin American hedge funds suffered from a significant loss in capital, primarily through net outflows due to redemptions from panicked investors. Total assets in the industry declined by 32.7% from a high of US$58.4 billion in June 2008 to US$39.3 billion in March. However, in the subsequent recovery through 2009, regional managers registered excellent performance-based gains while also attracting assets to the tune of US$9.2 billion. Increased interest in emerging markets, as well as excellent performance-based gains posted by managers, resulted in heightened investor interest in the region’s hedge funds – the Eurekahedge Latin American Hedge Fund Index gained a massive 28.54% in 2009. More tellingly, in the 26 months since October 2008, the industry has seen only two months of marginally negative performance-based declines in assets.
The trend of positive net asset flows continued through the first quarter of 2010; however, the second and third quarters of the year saw some outflows from the industry, primarily because of the heightened risk aversion in the markets due to the European debt crisis and concerns over the global economic recovery. Table 1 shows the monthly asset flows and performance-based growth/decline since January 2009.
Table 1: Monthly asset flows across Latin American hedge funds
Month
|
Net growth (performance)
|
Net flows
|
Assets at end
|
Jan-09
|
0.5
|
(2.2)
|
40.2
|
Feb-09
|
0.1
|
(0.9)
|
39.4
|
Mar-09
|
0.2
|
(0.3)
|
39.3
|
Apr-09
|
0.9
|
0.6
|
40.8
|
May-09
|
1.2
|
1.9
|
43.9
|
Jun-09
|
0.1
|
0.6
|
44.7
|
Jul-09
|
0.8
|
1.5
|
47.0
|
Aug-09
|
0.6
|
1.7
|
49.3
|
Sep-09
|
0.9
|
1.3
|
51.5
|
Oct-09
|
0.2
|
0.8
|
52.5
|
Nov-09
|
0.7
|
0.5
|
53.8
|
Dec-09
|
0.4
|
0.3
|
54.5
|
2009
|
6.6
|
5.9
|
54.5
|
Jan-10
|
0.1
|
0.1
|
54.6
|
Feb-10
|
0.1
|
0.8
|
55.5
|
Mar-10
|
0.6
|
0.3
|
56.4
|
Apr-10
|
0.2
|
(0.3)
|
56.3
|
May-10
|
(0.5)
|
(0.6)
|
55.2
|
Jun-10
|
0.3
|
(0.2)
|
55.3
|
Jul-10
|
0.6
|
(0.2)
|
55.8
|
Aug-10
|
0.5
|
(0.5)
|
55.8
|
Sep-10
|
1.0
|
1.0
|
57.7
|
Oct-10
|
0.9
|
0.0
|
58.7
|
Nov-10
|
(0.0)
|
(0.7)
|
57.9
|
Dec-10
|
1.1
|
1.0
|
60.0
|
2010
|
4.9
|
0.7
|
60.0
|
Source: Eurekahedge
Among all major regions in the global hedge fund industry, Latin America has been the most consistent in terms of performance and growth. Although the sector witnessed a significant drawdown in assets, along with the rest of the industry, during the financial crisis, it delivered the most downturn protection to investors and registered the strongest recovery. In fact, Latin America was the only region that attracted net positive asset flows for the full calendar year of 2009, gaining US$5.9 billion. Compared with global hedge funds, the rate of growth in Latin American funds has been nearly 18% greater as investors looked to diversify from traditional hedge fund regions in the wake of the financial crisis. Figure 2 illustrates the percentage growth of assets in Latin American hedge funds and global hedge funds since January 2008.
Figure 2: Assets under management growth of Latin American hedge funds vs global hedge funds
In the 2000–2007 period, both onshore and offshore Latin American hedge funds witnessed considerable growth in terms of assets and fund population, with offshore vehicles displaying stronger growth patterns. Before the financial crisis, high-net-worth individuals in Latin America had a strong preference for offshore fund structures due to tax incentives. However, due to the increasing focus on greater regulations, onshore hedge funds have started to generate greater demand. However, while offshore Latin American hedge funds make up a larger proportion of assets under management, the growth rate of onshore vehicles has been higher in recent times. Not only have onshore managers recovered all of their assets that were withdrawn in 2008, the current size of the industry stands at US$23.9 billion, which is the all-time high. Given this trend, we expect the AuM of onshore Latin American hedge funds to overtake that of their offshore counterparts in 2011.
Figure 3: Industry growth of onshore and offshore funds
Head Office Location and Fund Domiciles
In terms of head office locations, nearly 90% of onshore Latin American hedge funds are located in Brazil, which corresponds with the country’s large economic base and its status as a recipient of a large portion of the region’s hedge fund investments. Brazil is also home to a large upwardly mobile middle class, which offers hedge fund managers a growing investor base of affluent individuals. Furthermore, the country boasts a rapidly developing financial service sector with talented managers, comprehensive service provider industry and an expanding universe of financial instruments.
The head office location dispersion among offshore Latin American hedge funds shows greater diversity as displayed in Figure 4. Interestingly, Brazil still accounts for the largest share of the pie, with 32% of offshore domiciled funds which are primarily denominated in US dollars, having their head offices in Brazil. Moreover, geographical proximity to investment regions offers hedge fund managers several advantages as they are able to better monitor the markets while also giving them the ability to meet executives and retrieve on the ground information about their target companies. United Kingdom and the United States collectively account for 46% of offshore Latin American funds, primarily because of larger hedge fund investor base in these regions and the fact that most of the large hedge fund management companies are located in these countries. It should be noted that a similar breakdown in terms of assets under management shows that hedge funds located in the UK and the US manage almost 60% of offshore Latin American hedge fund assets.
Figure 4: Head office location by number of offshore funds
In terms of fund domicile, the offshore industry continues to be dominated by Cayman Islands-domiciled funds while Brazil, unsurprisingly, is the domicile of choice for more than 90% of onshore funds.
Figure 5: Fund domicile by number of funds
Geographic Mandates
Over the last five years, the breakdown by geographical mandates has also seen some prominent trends. Assets allocated to Brazil and Latin America have witnessed a significant increase – the main reasons for this trend include the following:
a) Rapid development in the region’s financial sector, leading to greater number of regional hedge fund launches – over the last five years, 65% of Latin America-investing fund launches invested with a regional or Brazil mandate.
b) Increased investor interest in funds focused specifically on the region – previously, investors would allocate to emerging market or global-mandated funds for their exposure to the region.
c) Better performance of Latin American hedge funds – while global- and emerging markets-focused funds witnessed sharp losses in 2008, Latin American funds were down only by 4.93%. As such, they did not suffer performance-based declines to the same extent. This further prompted investors who had earlier been allocating to the region through broad-mandated funds to invest directly into funds focused specifically on the region. Additionally, the recovery in Latin American markets in 2009 and 2010 has outpaced recoveries in other global market, hence, not only supported performance but also built up investor interest in the region.
d) The increasing population of high-net-worth individuals in Latin America has also provided regional managers with a new pool of investors who are familiar with the markets and prefer to invest in the region.
Figures 6a and 6b show the changes in the geographical mandate mix of Latin American hedge funds over the last five years.
Figures 6a–6b: Changes in the geographical allocations of Latin American hedge funds
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Strategic Mandates
Looking at the breakdown of the changes in onshore Latin American hedge fund strategic mandates over the last five years, the most prominent trend is the reduction in the proportion of assets within multi-strategy funds. In December 2005, multi-strategy funds accounted for 78% of the total onshore hedge fund assets; however, by the end of 2010, this share had fallen to 49%. The main reasons for this change are the following:
a) increased availability of new financial products which would enable managers to employ different hedge fund strategies;
b) increased risk aversion – investors re-allocated substantial capital to fixed income hedge funds during the financial crisis in 2008, a move that proved beneficial as funds posted a return of 7.47% in 2008; and
c) the impressive gains posted by fixed income and event driven Latin American funds which resulted in greater growth in assets as opposed to other strategies.
Figures 7a–7b: Changes in the strategic mix of onshore Latin American hedge funds by assets under management
 |  |
The distribution of assets by strategy is more equitable and has remained more stable among offshore funds. However, similar to onshore funds, the trend of increased assets in fixed income and event driven funds has been witnessed in the offshore industry. Multi-strategy and long/short equity funds lost significant share due to the decline in equity markets globally in the 2008–1Q2009 period.
Figures 8a–8b: Changes in the strategic mix of offshore Latin American hedge funds by assets under management
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Fund Sizes
The composition of the Latin American hedge fund sector in terms of fund sizes has varied according to the total industry assets. Although the current breakdown of funds is similar to that in 2005, it represents a remarkable recovery from the financial crisis, during which the industry suffered from substantial redemptions and performance-based losses. The number of small hedge funds, managing less than US$20 million had increased to nearly 37% by the end of 2008; however, over the last two years, these funds have grown their assets through performance and as capital inflows ‘graduate’ into larger AuM categories. Interestingly, before the financial crisis, the share of smaller hedge funds had fallen to 22%.
Similarly, during the 2005 – mid-2008 period, which was marked by strong growth in the sector, the share of large hedge funds with assets more US$500 million had risen to 8% as at June 2008 before falling to 4% by end-2008. The number of large funds is now back to its historical high of 8%. Given these trends, we expect the number of large hedge funds to increase further in the next two years. Although a simultaneous decrease in the proportion of assets in smaller hedge funds seems logical, the healthy growth in fund population is expected to temper this decrease.
Figures 9a, 9b and 9c show the breakdown of Latin American hedge funds by fund sizes since 2005.
Figures 9a-9c: Fund sizes by number of funds
Fees
Tables 2a–2c show the changes in the fee structure of Latin American hedge funds as well as Asian and global hedge funds. While the trend of lowered fees has been true across all regions in 2009–2010, Latin American funds have not made drastic changes to their fee structure. It should be noted that while global and Asian hedge fund launches started to decrease their fees in 2008, the average management and performance fees of Latin American hedge fund launches increased during the year. Although in 2009, Latin American start-up funds did lower their fees in line with investor demands, the average performance fees of funds launched in 2010 are back at 20%. Due to the excellent downturn protection delivered by managers, strong performance in 2009 and greater demand for emerging market investments, Latin American hedge funds have been able to demand greater fees from investors while hedge funds in other regions are still offering lower fee structures to attract capital.
Tables 2a–2c: Average fees of launches in Latin American, Asian and global hedge funds
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Source: Eurekahedge
Funds above High-Water Mark
Table 3 gives the percentage of global and Latin American hedge funds above their high-water marks by total sector as well as by individual strategies. Since the high-water mark differs from investor to investor, depending on the NAV level at the time of capital allocation, we are taking the NAV of hedge funds as at December 2008 as the starting point for this analysis to determine whether they are above their high-water marks or not. This is because hedge funds witnessed significant outflows at that time, and since then, they raised new capital.
The data shows that 68% of Latin American managers are above their high-water marks as opposed to 58% of global managers, meaning that a greater proportion of Latin American managers would have earned their performance fees in 2010 as opposed to global hedge fund managers.
Table 3: Global and Latin American hedge funds above high-water marks
% of Funds above HWM since December 2008
|
All
|
Arbitrage
|
Distressed debt
|
Event driven
|
Fixed income
|
Long/Short
equity
|
CTA/Managed futures
|
Macro
|
Multi-strategy
|
Relative value
|
All
|
58
|
67
|
66
|
61
|
63
|
61
|
46
|
57
|
60
|
56
|
Latin America-investing
|
68
|
71
|
NA
|
63
|
69
|
71
|
NA
|
76
|
69
|
50
|
Onshore Latin America-investing
|
75
|
83
|
NA
|
100
|
100
|
76
|
NA
|
83
|
71
|
50
|
Offshore Latin America-investing
|
65
|
NA
|
NA
|
50
|
60
|
71
|
NA
|
67
|
67
|
NA
|
Source: Eurekahedge
Performance Review
Over the last decade, Latin American hedge funds have posted the strongest gains across all major hedge fund regions while also posting significant outperformance to the underlying markets. The Eurekahedge Latin American Hedge Fund Index gained 495.8% since its inception in December 1999, while the global hedge fund index rose 222.3% and the MSCI EM Latin American Index up 311.2% over the same period. In 2010, regional managers gained 9.84% while the underlying markets registered a 12.07% gain. These results followed a massive return of 28.54% in 2009 and excellent downturn protection in 2008 while the average Latin American hedge fund manager lost only 4.93%.
The outperformance by Latin American hedge funds has been particularly pronounced during the economic downturns as managers used derivatives, short instruments and other hedging techniques to protect against losses. In early 2000, Latin American markets were impacted by a sharp devaluation of the Brazilian real as well as a debt crisis in Argentina. The regional managers weathered the storm skilfully as the Eurekahedge Latin American Hedge Fund Index posted gains of 14.7%, 16.6% and 19.4% in 2000, 2001 and 2002, respectively, while the MSCI Latin American Index sank by 18.4%, 4.3% and 24.8%, respectively, over the same periods. Additionally, the predominance of multi-strategy mandated funds means that managers also took positions in Latin American bonds and commodities outside of equities. This low correlation approach also helped Latin American funds surpass the returns of stock markets in the long run. In 2003, Latin American hedge funds registered its best ever annual gain of 36.88% after the regional economy emerged from the recession.
Furthermore, since onshore funds make up 72.6% of the Eurekahedge Latin American Hedge Fund Index, their results were the key drivers of index performance. An appreciating Brazilian real and robust inflows into onshore funds led to consistent strong returns by onshore hedge funds over the last 10 years and they outperformed offshore funds by 386.6% and underlying markets by 303.6%.
Figure 10: Performance of the Latin American hedge funds vs MSCI Latin American Index
In addition to providing better returns than underlying markets, Latin American hedge funds have also provided greater stability. Figure 11 displays the volatility of returns in Latin American hedge funds plotted against that of the MSCI EM Latin American Index. The annualised volatility of the regional hedge funds was 6.06% while the volatility of underlying markets is almost five times greater—28.27%.
Figure 11: Volatility of Latin American hedge fund monthly returns vs equity market returns
Figure 12: Performance of onshore and offshore Latin American hedge funds
Both onshore and offshore Latin American hedge funds have witnessed continuous growth over the last decade. The need to differentiate between onshore and offshore hedge funds arises from the fact that a majority of onshore hedge funds are based in Brazil and denominated in the real, which has very high interest rates, thereby generating higher returns than offshore hedge funds, which are usually denominated in US dollars or other major currencies.
In the last three years, Latin American hedge funds delivered a total return of 34.23%, beating the underlying markets and offshore Latin American hedge funds by 29.38% and 16.76%, respectively. The main driver for this outperformance was the difference between 2008 returns of onshore and offshore managers. While onshore funds returns were flat to marginally negative in 2008, offshore managers suffered losses of more than 15% during the year.
Table 4: Performance of onshore and offshore Latin American hedge funds
Latin American
hedge funds
|
Offshore hedge funds
|
Onshore hedge funds
| |
2010 Returns
|
9.84%
|
8.91%
|
10.23%
|
3-Year annualised returns
|
10.31%
|
5.51%
|
12.20%
|
2009 Returns
|
28.54%
|
28.19%
|
28.63%
|
Source: Eurekahedge
In this section, we compare Latin American hedge fund returns across the different strategies over the 3-year period ending December 2010. As shown in Figure 13, all strategic mandates registered net gains in all three performance measures, with a total 3-year return in excess of 25%. Event driven hedge funds were up by a massive 58.67% in three years as managers were able to capitalise on health corporate activity and special situations post the financial crisis. Fixed income managers also grew their assets by 37.17% as hedge funds continually added net gains to their books year-on-year. In fact, Latin American fixed income managers have not seen a negative yearly return on record since inception. Arbitrage hedge funds recorded the best risk-adjusted returns with Sharpe ratios of 5.87 (assuming a risk-free rate of 4%) and annualised standard deviation of 1.10%. Moreover, arbitrage hedge funds did not witness a single month of negative returns throughout the 3-year period.
The resilience of Latin American strategies can be seen through their performance in 2008 as half of the listed strategic mandates ended that year on a positive note. Latin American arbitrage, fixed income and macro hedge funds delivered gains of 13.53%, 7.47% and 2.36%, respectively in 2008. The demand for safe haven assets in 2008 helped the portfolios of arbitrage and fixed income hedge funds while the macro-focused hedge funds have traditionally provided excellent downturn protection.
Figure 13: Performance of strategic mandates
Table 5: Performance of strategic mandates
Arbitrage
|
Event driven
|
Fixed income
|
Long/Short equities
|
Macro
|
Multi-strategy
| |
2010 Returns
|
7.90%
|
8.98%
|
10.11%
|
10.60%
|
3.95%
|
10.38%
|
3-Year annualised returns
|
10.48%
|
16.64%
|
11.11%
|
10.37%
|
7.88%
|
9.93%
|
2009 Returns
|
10.09%
|
58.57%
|
15.92%
|
40.37%
|
17.98%
|
24.11%
|
Source: Eurekahedge
Figure 14 shows the distribution of average monthly returns of Latin American hedge funds since December 1999. The graph shows a clear negative skew as well as positive kurtosis. Table 6 gives the values of the mean, median, skew and kurtosis for Figure 14 as well as for individual strategies and the MSCI EM Latin American Index.
Figure 14: Distribution of Latin American hedge fund monthly returns
The figures in Table 6 show that almost all strategies are less negatively skewed (except multi-strategy hedge funds) than underlying markets; however, all had lower mean and median monthly returns than equities. Furthermore, the MSCI EM Latin American Index returns also display greater excess kurtosis than underlying funds (except for event driven strategy). The combination of lesser negative skew and smaller excess kurtosis show that Latin American hedge funds have lesser exposure to negative fat tail events as opposed to direct investments in the underlying markets.
Table 6: Performance of Latin American hedge funds by higher order moments
Latin American hedge funds
|
MSCI EM Latin American Index
|
Arbitrage
|
Event driven
|
Fixed income
|
Long/Short equity
|
Macro
|
Multi-strategy
| |
Median monthly return (%)
|
1.54
|
2.91
|
1.10
|
1.54
|
1.04
|
1.82
|
1.14
|
1.56
|
Mean return (%)
|
1.38
|
2.30
|
1.09
|
1.66
|
1.06
|
1.65
|
1.13
|
1.30
|
Skewness
|
-0.44
|
-1.01
|
-0.11
|
-0.01
|
-0.16
|
-0.56
|
-0.05
|
-1.02
|
Kurtosis
|
1.44
|
3.17
|
-0.28
|
3.85
|
0.95
|
1.48
|
1.22
|
2.88
|
Sources: Eurekahedge and MSCI
[1] Figures used in this report (performance and assets) are as at 25 February 2011 and would differ slightly from the numbers calculated in March 2011.
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