In the real estate world the mantra is “position, position, position”. The same may be said for hedge funds based in Latin America. Proximity to the real action gives local managers an advantage over funds managed at a distance. We would not have said this in the mid-1990s when Latin America was an intense focus of investor interest in major financial centers and there was a proliferation of emerging markets mutual funds. It was perceived that the best perspective was achieved from a distance (on high?) looking towards the region from the northern hemisphere where one could observe matters without all the baggage that local investors and naysayers brought to the process.History ultimately came along to mug this school of thought, firstly in the mid-1990’s Tequila Crisis and then later on with the traumas of the globalised emerging market crisis of 1998 (ironically triggered elsewhere in Thailand and Russia) and then with the Argentina crisis of late 2001. The people on the ground had been right and those “at a distance” had been caught wrong-footed. It was out of these debacles that the local hedge fund industry arose paralleling the rest of the world in what came to be known as the Decade of the Hedge Fund.
One can get too glib though on this subject for in reality the Latin “Decade of the Hedge Fund” was really more like half a decade (2003-2008) and it was overwhelmingly Brazil with little more than a token sprouting of hedge fund structures in other countries in the region. Nevertheless it can still be said that non-local LatAm hedge funds were almost as scarce. This is surprising for if there one industry that likes jumping on a bandwagon it is the hedge fund industry. Largely the outside players stayed away form region specific funds and the dabbling in the larger markets of the continent was by the very largest momentum funds from Greenwich who shoveled money in and out of Brazil and Mexico powered by the yen-carry trade. As we all know that practice came to grief in late-2008. Being closer to the action may have saved the locally based funds from annihilation as they were smaller and could trade more nimbly but still when the elevator cable is cut, all those in the elevator go down.
So the storm has now largely past and the questions arise as to whether the locally based funds will recover, whether they will retain their advantage over non-locally managed funds and how they might do this.
For us the main advantages that locally based funds have are:
We shall address some of these advantages. Firstly it undeniable that the local managers are closer to the action and have better intelligence sources. It has now been 18 years since Wall Street “discovered” LatAm and if anything the learning curve appears to be more of a parabola than anything else. In 1991 it was exotic and unknown with bets being placed upon hunches (and some filtered local gossip). By the mid-1990s there was intense study of the region as everyone piled into the analytical game. By 1998 this wave had passed and the interest since then has been cherry-picking of stories that provide some excitement. This led to a situation where the distant observer could not see the wood for the trees. The debacle of 2008 showed that the momentum players from afar did not know what they were doing, particularly in Mexico and Brazil. This was a “faith-based” investment style. The local funds may have played the same stock stories but generally knew the dangers, gossip and flaws or a particular corporate name and steeled themselves to dive overboard. This was a game of chicken in which they hoped that their nimbleness would help them escape before the bigger momentum funds even knew there was a problem. The locals also rarely read the baby food served up by the foreign correspondents in the region as news. They had all the local sources at their disposal and, for better or worse, knew the real story of the political world and were cognizant of the latest corruption scandal or its perpetrators.
This closeness to the action also meant that they were privy to the up and coming stories whereas those dependent upon Street research were usually only getting into nascent go-go stories after they had “got up and gone”. The boom in Brazilian REITs in 2007 was a particularly poignant example as was the very poor quality MercadoLibre that was dished up as an Argentine ADR and later plunged in value when its true value was divined by the marketplace. Likewise the Grupo Clarin listing in London promptly went over a cliff when it was realized that it was on the wrong side of the government of the day in Argentina. If anything ADR trading by local hedge funds was a means of trading against the foreign tendency, a variation on “taking candy from babies”. The foreign investors were obsessed by their liquidity and jurisdiction mantras and clung to their ADR ciphers even when they were one of the worst ways of accessing the real economy in the markets they professed to be interested in.
If we need a reason for the spectacular success of the hedge fund model in the LatAm markets where they have sprung up we need look no further than their “tax efficiency” for local HNWs. Hiding funds from the government has made LatAm economies what they are today. Light-fingered governments have been countered by the tight-fisted wealthy. Hedge funds have become the latest tool in this battle. It is possibly that Mexico and Argentina have the most history at hiding the wealth of the HNWs that hedge funds have not taken off there in their onshore version. In Brazil though a combination of some savvy regulation and a certain realism in dealing with the problem of evasion meant that it was better for the Brazilian economy to have local money stashed in local hedge funds than having it whisked away to Switzerland to be recycled into Madoff-style investment scams.
Likewise the latest crackdown on offshore havens by Western governments makes life somewhat tougher for LatAm HNWs who live in fear of having their assets exposed to public view even if they are not avoiding the taxes of the jurisdictions that are conducting these witch hunts. Onshore solutions (read home-grown hedge fund industries) for the tens of billions of flight capital would mobilize capital for domestic advancement (and infrastructure) much the same as has occurred in Asia.
The hedge fund industry around the world has only had a few windows of connection between the savings pools of the masses and that of the hedge funds. Primarily this has been the participation of public employee retirement schemes in allocating a rising percentage of AUM to “alternative investment” categories. LatAm is way behind on this score. In Mexico the public equities market has been held back by the failure to even approve equity investments for pension funds, let alone anything so exotic as a hedge fund. However, if locally based hedge funds were empowered to collect investments from individuals who were not HNWs or from pension funds then there could be an exponential democratization of the hedge fund industry in the region. Finally, legislation to create and supervise hedge funds in the region has been relatively light-touch thus far. Brazil again has the best legislation and should serve as a model for the rest of the region. As usual though ridiculous nationalist pride considerations have held back others from following this lead. As a result the others have been retarded in their growth in this category and have missed out on developing the skillsets that come from having a nascent industry and from the retained (dare we say “trapped”) investment funds that can be mobilized from the general evolution of local capital markets.
Thus in conclusion we would posit that locally-based hedge funds have a “smarts” advantage over the foreign based funds. Certainly they don’t have the ability to mobilize the type of money that Greenwich can, but then again the region does not need brainless money flooding in and out in tsunami tides as we saw in Brazil and Mexico in 2007 and the first part of 2008. Like any tsunami they do more damage than good. Governments can harvest the industry for good or dissipate themselves in struggling against the sheer Darwinian destiny of hedge funds. It is probably better to join them than fight them.
Christopher Ecclestone - Portfolio Manager: since 2003 has been a principal at Hallgarten & Company where he has had the roles of equity strategist, analyst and asset manager. Prior to that he was the head of research at an economic think-tank in New Jersey which he had joined in 2001. He was the head of research at the esteemed Argentine equity research house, Buenos Aires Trust Company, from 1991 until 2001. This latter firm pioneered in-depth locally-generated investment analysis in this hitherto undiscovered market. The reputation of the firm spread through fund management circles and the firm became allied with Banamex, the leading bank in Latin America in 1993 and eventually Buenos Aires Trust Co formed an alliance with Interacciones Global in 1994.
As part of the IGI structure he assembled the London sales team of the firm and built up the analytical team in Peru, Chile and Brazil. By 1997, IGI was the leading independent broking firm serving institutions investing Latin America. Prior to his arrival in Argentina, he worked in London beginning in 1985 as a corporate finance and equities analyst and later as a freelance consultant on the restructuring of the securities industry. He is a native of Melbourne, Australia. Hegraduated in 1981 from the Royal Melbourne Institute of Technology and is fluent in English and Spanish. Most recently he has been engaged on behalf of Hallgarten in conduct- ing due diligence and deal sourcing for two mining investment bank boutiques in New York.
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