Hedge Fund Strategies: Emerging Markets

Last time we noted that some hedge funds are defined by the geographic markets in which they invest, rather than the specific strategies they follow. We looked at regional funds, country-specific, and emerging markets hedge funds.

An emerging markets hedge fund manager invests in the equity or debt of less mature markets, which have the potential for significant growth but also tend to have higher levels of inflation, volatility, currency, political and liquidity risks. In addition, many emerging markets do not allow short-selling, nor do they offer futures or other derivative products with which to hedge risk. This removes a critical tool from the hedge fund manager’s arsenal.

Emerging markets hedge funds began to gain popularity in the mid-1980s when International Finance Corporation (IFC) set up the first mutual fund that invested solely in securities from emerging markets with seed capital of around $50 million. Since that time, they have grown to approximately US $110 billion under management, according to Hedge Fund Research.

Although they are defined by the geography in which they invest, emerging market hedge funds are really quite diverse, and employ a variety of strategies within the 28 emerging countries including: equity long, event-driven, global macro and fixed income arbitrage.

As Richard Wilson of HedgeFundBlogger.com points out, the nature of emerging markets has changed substantially in the past 10 years. Once, many of these countries were net importers of capital; today, many governments in emerging markets have become international investors themselves, through the creation of sovereign wealth funds. These sovereign wealth funds wield considerable influence in today’s markets.

Emerging markets hedge funds reportedly took in over $9 billion in new assets in early 2008. Before the current crisis, many emerging market hedge funds were delivering returns in excess of 25% annually, well above the hedge fund industry average, which led to their growing popularity. However, inflows and returns have dropped off precipitously in the wake of the financial crisis. Emerging market economies have been hit just as hard by deteriorating economic conditions.

Emerging market hedge fund investing remains a volatile and high risk strategy, heavily dependent on a manager’s research and expertise in that country or region of the world.






The Hedge Fund Association

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