2011 Key Trends in Latin American Hedge Funds

Introduction

The Latin American hedge fund space has seen remarkable growth over the past decade. As of July 2011, the number of funds was nearly four times that as of end-2000, while assets over the same period recorded an increase over 23-fold. There are currently 442 operational hedge funds, managing over US$64 billion in assets.

After seeing phenomenal growth from 2000 to 2007, Latin American hedge funds witnessed significant challenges in 2008 and early 2009 amid the global financial crisis. Managers witnessed significant redemptions as panicked investors withdrew large amounts of their capital, which further resulted in performance-based losses due to forced liquidations. Despite heighted redemption pressure and falling underlying markets, the Eurekahedge Latin American Hedge Fund Index lost only 5.08% in 2008.

Figure 1: Industry growth since 2000

Progressing into 2009, the Latin American hedge fund industry bottomed out in the first quarter of the year and resumed its asset growth path through the remaining months of 2009 and into 2010. As at April 2011, industry assets reached a historic high of US$64.2 billion, representing a 63.3% increase since March 2009. This was made possible through a series of positive inflows and strong performance from regional managers.

Asset flows

The following table lists details of the gains in assets under management (AuM) on a monthly basis. In 2009, the Latin American hedge fund industry attracted US$5.9 billion of investment capital while strong performance contributed to US$6.6 billion of asset growth. The Eurekahedge Latin American Hedge Fund Index witnessed one of the best annual performances on record with a 28.83% gain. The following year, AuM climbed to US$60.0 billion due to prior good performance and fresh flows from investors. Latin American hedge funds posted an average gain of 9.63% in 2010. The trend of positive net flows picked up pace through 2011, with the first seven months of the year recording a total net flow of US$2.7 billion, exceeding total net flows for the whole of 2010. Industry assets reached an all time high of US$64.2 billion in April 2011 before settling down to US$64.1 billion in July 2011.

Table 1: Monthly asset flows in 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
Jan-11	(0.1)	0.2	60.1
Feb-11	0.4	0.8	61.3
Mar-11	0.5	0.6	62.5
Apr-11	0.8	0.9	64.2
May-11	(0.1)	(0.2)	63.9
Jun-11	(0.3)	0.1	63.7
Jul-11	0.1	0.3	64.1

Note: all figures are in US$ billion                           Source: Eurekahedge

Figure 2: AuM growth of Latin American hedge funds vs. global hedge funds

Figure 2 compares the percentage asset growth in Latin American hedge funds and global hedge funds since January 2008. During the financial crisis, Latin American managers lost capital at almost the same pace as global hedge funds, however since April 2009, when the industry started to recover, Latin American hedge fund assets started growing at a much faster rate than global hedge funds. The substantial difference in the growth rate between the Latin American hedge funds and their global counterparts carried through from 2009 to 2011. By the end of July 2011, the size of the Latin American hedge fund industry was 15.3% larger than what it was in January 2008 while the global hedge fund industry declined by 1.8%.     

Figure 3: Industry growth of onshore and offshore funds

Both onshore and offshore hedge funds delivered remarkable growth in terms of assets and fund population from 2000 to 2007 with offshore funds displaying a stronger growth pattern. By the end of 2007, the offshore Latin American hedge fund industry stood at US$43.8 billion while their counterparts managed US$12.6 billion of capital. In the following years however, the pace of offshore fund growth slowed while onshore funds continued to attract more capital. After 2008, there was a vigorous demand for more transparency and better hedge fund regulation from investors, which turned the tables in favour of onshore Latin American hedge funds. The interest for onshore hedge funds followed on at an exponential rate and continued on into 2011 to the extent that the industry size has most recently exceeded the offshore industry in July this year.    

Head office locations and fund domiciles

Figure 4a-4c: Head office locations by number of funds

Most Latin American hedge funds have head offices in Brazil with 66.2% of the fund population having representatives in the country. Brazil is the most popular place to set up an office in Latin America as the country has enjoyed an economic boom in recent years, making it both the largest economy in the Latin American region and the most developed in terms of liquidity and sophistication of its financial services industry. The growing population of high net worth individuals in Brazil has also provided hedge fund managers with a pool of investors who are familiar with the markets.

Figure 5a-5b: Fund domiciles by number of funds

Figures 5a–5b show where most Latin American hedge funds chose to register their funds by locations. The registration of a fund involves a common fund structure to enlist the master fund in an offshore location, followed by developing various currency classes from the mother fund to be registered in various Latin American regions. There are many factors to choosing a fund domicile but offshore locations tend to have a greater advantage over local domiciles as they are often exempted from taxes and are less restricted for managers and directors of the funds. An important factor in the choice of fund domiciles is reputable jurisdiction and excellent court systems, which are evident in the locations listed above. The offshore industry continues to be dominated by Cayman Islands-domiciled funds while Brazil unsurprisingly, is the domicile of choice for more than 80% of the onshore funds.

Geographic mandates

Figure 6a-6c: Geographic mandates by AuM

The change in investment allocation of Latin American hedge fund investors over the years as seen in figures 6a-6c, indicate clients’ preference of choosing to invest more in the developing markets. Allocations to Brazilian and Latin American geographical mandates increased from 34.9% in July 2007 to 49.1% in July 2009 and to 53.7% in July 2011. This steady increase reflects the confidence people have in Latin America investing funds. With the troubles in Europe and in the US, it seems natural that assets of Latin American or emerging market focused funds would continue to grow in future, as the regions offer more attractive opportunities to investors.     

Strategic mandates

Figure 7a-7c: Strategic mandates by AuM

The breakdown of Latin American funds by strategies in figures 7a-7c show that the most notable difference over the years is the increase in percentage of assets managed by macro hedge funds. Macro-investing Latin American hedge funds grew their AuM from US$5.2 billion in July 2007 to US$12.8 billion; a 146% increase in short span of four years. The percentage of onshore multi-strategy Latin American funds fell from 52.1% in July 2007 to 45.9% in July 2011 even as the market share of all multi-strategy funds was almost unchanged in the same period, due to a greater competition for capital and better performance of other onshore strategic mandates in the recent years. 

Fund sizes

Figures 8a-8c: Industry breakdown of hedge funds by fund size (US$ million)

Population changes in the Latin American hedge fund industry for the last four years according to their fund sizes can be seen in figures 8a-8c. The most significant change is the increase in the percentage of small funds with less than US$20 million of AuM; from 15% in 2007 to 29% in 2011. The bigger pool of financial talent has also contributed to the proliferation of small hedge funds as a number of professionals who used to work in investment banks have moved into the fund management business. The largest funds with managers’ managing more than US$500 million of capital saw the largest drop in market share from 10% to 5% between July 2007 to July 2009, primarily due to the heavy redemption pressure during the financial crisis. However, given the strong asset flows to the region since 2Q 2009, the population of large hedge funds has increased to account for 8% of the total industry,

Funds above high watermark

Table 2: Percentage of funds above December 2008 high watermark as of July 2011

	All	Arbitrage	Distressed debt	Event driven	Fixed income	Long/short equity	CTA	Macro	Multi-strategy	Relative value
Average hedge fund worldwide	51	56	56	55	59	53	42	47	53	52
Latin America-investing	64	83	NA	75	63	66	NA	71	63	50
Onshore Latin America-investing	69	83	NA	100	78	71	NA	69	67	50
Offshore Latin America-investing	53	NA	NA	60	43	53	NA	75	50	NA

Source: Eurekahedge

Table 2 displays the percentage of Latin American and global hedge funds that have exceeded their December 2008 net asset values (NAV) as of July 2011. Since the high watermark differs from investor to investor, depending on the NAV level at the time of capital allocation, we are taking the NAV of funds at December 2008 as the starting point for this analysis to determine if they are above their high watermarks or not. This is because hedge funds witnessed significant outflows at that time, and since then they raised new capital.

Most managers have a high watermark mechanism which ensures that the general partner or manager does not take a performance fee when the fund has a negative performance over the previous performance fee period. Arguably this might encourage the manager to take more risk when performance is below the high watermark and less risk when the fund is above the high watermark. Still, the high watermark is one of the assessments of manager skill as an investor is more likely to invest in a fund that continually exceeds its high watermark. The data shows that the percentage of Latin American hedge funds that have surpassed their December 2008 NAV is higher than the global average, showing that a greater proportion of Latin American managers would have earned their performance fees in 2011 as opposed to the global hedge fund managers.

Performance review

Figure 9: Performance of Latin American hedge funds vs. underlying markets

Figure 9 illustrates the performance of Latin American hedge funds and the MSCI Latin American Index from 2000 to July 2011. Over this period Latin American hedge funds outperformed underlying equities by a massive 230.69% while the difference for onshore Latin American hedge funds is even larger at more than 352%. Not only did Latin American managers beat the MSCI Index with a higher return, they also had lower volatility. The annualised volatility for the Eurekahedge Latin American Hedge Fund Index was 5.86%; less than a third of the volatility of the MSCI Latin American Index which was 19.74%. Another distinguishing statistic is the drawdown figures for hedge funds and Latin American stocks as the latter fell by as much as 47% during the recent 2008 crisis while hedge funds only shed 10.8% on average.

Figure 10: Performance of onshore and offshore Latin American hedge funds

Table 3: Performance of onshore and offshore Latin American hedge funds

	EH Latin American Hedge Fund Index	EH Latin American Offshore Hedge Fund Index	EH Latin American Onshore Hedge Fund Index
2011 YTD returns	2.39%	0.83%	3.05%
2010 returns	9.63%	7.99%	10.34%
3 year annualised returns	10.00%	5.27%	11.92%

Source: Eurekahedge

Table 3 and figure 10 display the performance of Latin American hedge funds across domiciles which show broad and healthy gains across all three time frames. Onshore funds recorded the greatest return in all time periods with three year annualised returns of 11.92%, 2010 returns of 10.34% and a 2011 gain of 3.05%. Most of the onshore funds invest in local assets and the strength of the Brazilian real along with very high interest rates have helped to boost the performance of managers. Another reason why onshore funds have done particularly well is the performance of multi-strategy funds, which form the bulk of the onshore fund population. Multi-strategy managers are able to diversify the risks and navigate through volatile markets through the use of various investment styles. Offshore Latin American hedge funds on the other hand, are mostly focused on the long/short equity strategy which tends to be more correlated with stock market betas. Even though offshore managers may enjoy a tax advantage over onshore funds, the Eurekahedge Latin American Offshore Hedge Fund Index was only up 5.27% on an annual basis for the last three years, less than half the gain recorded for Latin American onshore funds.      

       

Figure 11: Performance of new vs. existing Latin American hedge funds

Table 4: Performance of new vs existing Latin American hedge funds

	Recent Latin American start-ups	Large and experienced LAHF (>500M, at least 3 year track record before Dec 2007, incepted pre 2008)
2011 YTD returns	-0.08%	3.88%
2010 returns	12.38%	14.25%
3 year annualised returns (July 2008 to July 2011)	9.80%	7.91%

Source: Eurekahedge

Figure 11 and table 4 compare the returns of Latin American start-ups and hedge funds that have been around for a few years. We define start-ups as funds incepted from January 2008 onwards and veterans as managers who have a three year track record as of December 2007 and managed more than US$500 million of AuM. The average performances of these funds are plotted starting from January 2008. As shown in figure 11, Latin American start-ups outperformed experienced managers by 24.97% from January 2008 to July 2011, but fell behind the latter in the last one and a half years. Start-ups registered a 0.08% decline in 2011 and a 12.38% gain in 2010, both of which fell short of the 3.88% and 14.25% from experienced hedge funds. Another interesting point is that start-ups had better risk management during the nine month period market turmoil from July 2008. It is clear from figure 11 that newer funds had a lower drawdown compared to larger and more experienced hedge funds, seeming to imply that hedge funds incepted in the last two and a half years tried harder to preserve capital during the 2008 to 2009 market fallout but underperformed experienced and larger managers when market recovery was underway. 

Figure 12: Performance of strategic mandates

Table 5: Performance of strategic mandates

	Arbitrage	Event Driven	Fixed Income	Long/Short Equities	Macro	Multi-Strategy
2011 YTD returns	5.69%	-4.95%	6.44%	0.06%	5.38%	2.98%
2010 returns	8.07%	8.79%	9.65%	10.86%	4.72%	9.76%
3 year annualised returns	10.00%	12.58%	11.30%	9.81%	9.23%	9.62%

Source: Eurekahedge

As seen in figure 12, fixed income hedge funds benefited the most from the volatile market environment in 2011; the Eurekahedge Latin American Fixed Income Hedge Fund Index was up 6.44% for the year and 9.65% in 2010. When compared against fixed income managers in other regions, Latin American fixed income funds delivered significantly better results. The index gained 381.64% since inception whereas the average fixed income hedge fund rose by only 174.35%. Even the second best performing sector North American fixed income funds delivered a 226.96% return.

The strongest performance over the past three years has been event driven Latin American funds which saw a total return over this period at an excellent 42.68%, thanks to robust corporate activities in 2009. In that year, the Eurekahedge Latin American Event Driven Hedge Fund Index soared 58.58% with 12 months of positive monthly gains from January 2009 to December 2009.