When I started managing emerging debt funds in 1998, the manager universe was like a zoo. And a pretty diverse one I must add. A selection of most well known investment houses would reveal extreme diversity in philosophy, style, performance and even geographic origin of the management team.
Attending conferences and market events was always a pleasure due to that variety. Managers from different origins asked different questions, making such events intellectually stimulating. There was never a dull moment, including at year end, when each manager’s performance was calculated and the winner was presented with the best fund manager of the year award.
Benchmark tracking and conformists were definitely out of fashion. Managing emerging debt was a true pleasure.
Such diversity was not only good for managers butalso provided a rich hunting ground for end investors. Those who could spread their investments across a few audacious managers were able to earn above-benchmark returns while benefiting from the diversification.
From 1998 to 2007, the only game in town for investors who sought high returns was to wisely select from a few aggressive funds (usually mine at ABN AMRO, Ashmore’s and Bluebay’s) and just wait to reap above benchmark/average returns.
There were a few good quality hedge funds created during the early part of that period – Greg Coffey, Finisterre and Brevan Howard usually made up that list of attractive potential choices.
However, the game was mostly being played by large asset managers.
Shocks to the system
The collapse of Lehman Brothers in 2008 began to change the typical manager profile. But why? As we were nearing the middle of the decade (around 2005), it became ‘in-style’ in the fund management community to believe blindly in risk management models (most based on past data), a heresy for a mathematician living in the real world.
A lot of the new interest in risk models came from the growth of the hedge fund community in the asset class and its perceived wealth-creating power. When Lehman began to crumble, volatility levels shot up so high that most risk management models indicated selling everything.
Logically, prices retreated to unprecedented and generally ridiculously low levels just because ‘there were more sellers than buyers’. A lot of the selling resulted from justified fear of a financial meltdown but much also stemmed from risk management models just telling managers to sell.
In fear of the uncharted financial future, banks also reduced the amount of liquidity given to risk-taking managers and liquidity dried up.
This behaviour was a result of more conservative internal guidelines at most funds, introduced through fear of more losses. So, Lehman’s problems were the first chapter in management style change.
The Madoff surprise was the catalyst in changing the typical manager profile. The SEC’s failure to catch Madoff signalled cloudy horizons for investor safety. As a result, investors began to demand greater risk controls.
Hamstrung by red tape
In fear of losing investor assets, having a public relations nightmare and possibly being bothered by regulators, investment management firms reacted and began slowing down the speed of their fund managers.
Though their intentions were mostly well-intentioned, the changes implemented have made investing in emerging debt a bureaucratic nightmare for large firms.
Internal guidelines constrain most managers’ ability to act quickly, before opportunities are gone. Last but not least, trading desks have become the norm, essentially transferring the responsibility of trading from a knowledgeable investment manager to an execution monkey.
By definition, trading requires taking risk and feeling your gut shiver when you lose, a feeling that’s non-existent on investment management trading desks.
The view from Mars
A Martian investor landing on Earth these days is unlikely to meet knowledgeable and charming legends like Jules Green, Greg Coffey, Simon Treacher and even Raphael Kassin because under current guidelines it is more complicated for those types of investors to make money.
Instead of being able to share stories and opportunities and ultimately benefit from extra-terrestrial returns, the Martian investor is merely able to pay hefty management fees to be invested in funds that closely resemble the JP Morgan Emerging Bond index.
Which begs the question: why not just call the lovely folks at JP Morgan and buy
an index product from them at a lower fee? And another more important one: what if the investor wants more risk?
The current range of emerging debt investment funds shows a big gap for both investors and skilled investment managers. As a traditional investor looking for a standard Sicav, there is no offering from a large investment manager that promises the high-octane investing seen in the good old days.
There are a handful of hedge fund types who bring good returns on and off but at a price (high management fee, performance fee) and a lower level of comfort. Have I spotted an opportunity or should we wait for a European default before turning the risk taking button on again?
Raphael Kassin’s consultancy firm, Mirage Capital, advises on emerging market investment.
This article originally appeared in the February 2012 edition of Citywire Global magazine.