The Hedgeweek Interview: Petek Kutucuoglu, head of research, GEM Global Equities Management: "Timeliness is fundamental"

Petek Kutucuoglu says emerging market hedge fund manager GEM relishes extracting value from complex or obscure opportunities overlooked by the market.

HW: What is the background to the company?

PK: GEM Global Equities Management is an established asset management company specialising in emerging markets worldwide. Founded in 1992, it currently manages USD450m through five emerging market funds and a number of managed accounts.

We have two main locations, so that we can cover most of the time zones worldwide on a daily basis. Our main research office is in Istanbul, Turkey, with administrative and corporate offices in Nassau, Bahamas, and we employ a total of 25 people. Our location in Istanbul is partly due to historical reasons, since we also managed the Turkish exposure for a Soros fund during 1996-2001.

We find that Istanbul is a good location for the research and investment management team, itself being an emerging market and a useful location and time zone from which to access East European and Asian emerging markets. We place a lot of stress on really understanding the companies in which we invest, so our investment committee and research team spends a lot of time meeting with companies' senior as well as operational management, and their competitors.

We are a true absolute return investment manager, generating returns in both long and short investments, and relish complex or seemingly obscure opportunities overlooked by the market and where we are confident of being able to extract significant value.

The firm's investment committee consists of four members. Senior investment advisor Philipp Haas has extensive experience in international investment management, having worked for First Boston in New York and Credit Suisse First Boston in London, as well as for Rothschild, Pictet & Cie and Sarasin. He has also acted as adviser to Soros Fund Management as well as to Sir John Templeton. Haas has an MBA from the Business School for Economics, Law and Business Administration of St. Gallen with a specialisation in banking, and is fluent in German, English, French, Spanish, Portuguese, Italian as well as speaking some Turkish.

Senior investment advisor Baki Taskiran has a degree in physics from Bogazici University in Istanbul and has been with the firm since 1998. With extensive knowledge and experience in investment management as well as trading, he has also led the firm's private equity transactions in Ukraine and Turkey.

Head of trading and portfolio manager Toby Smith joined GEM in 2004, after having been a private banking asset manager and trader at Union Bancaire Privée, and previously a derivatives and futures trader with FTC Asset Management. Smith, who has a degree in mechanical and electrical engineering from Mander College in the UK, has also held managerial and trading position with Esso and Elf Trading.

As head of research and investment advisor, my investment experience includes working for leading Turkish equity houses, including Ak Securities as a senior analyst and Is-Tim as a pricing and probability analysis specialist. I have an MBA from Koc University in Turkey as well as a BSc in industrial engineering from Bosphorus University.

HW: Who are your service providers?

PK: Our law firms are White & Case and Klonaris & Co. Our auditor is Ernst & Young and the administrator is Citco Fund Services. Our prime broker is Deutsche Bank.

HW: How and where do you distribute the funds? What is the profile of your current and targeted client base?

PK: Our investor base has grown and evolved over the years. Our style has attracted veteran emerging market investors who share our focus on in-depth knowledge of our emerging market investment universe and have included Sir John Templeton and Gavea Investimentos, the investment group headed by Arminio Fraga, the former head of the Brazilian central bank.

At present, family offices and high net worth individuals account for 46 per cent of investors, followed by institutions are 24 per cent, funds of funds 11 per cent, private banks 16 per cent and endowments and foundations 3 per cent. In the past two years we have received investment from a UK pension fund and a US university endowment. We expect continued growth to come from all our investor bases, but the fastest growing segment to be private banks, funds of hedge funds and institutional investors.

HW: What is the investment process of your funds?

PK: By applying private equity-style investment techniques and really understanding a country, a sector and its constituent companies, we achieve a high degree of conviction in our investments. Really great investment opportunities are nearly always long-term ones, and to make the right allocation we need to be confident.

Research and in-depth knowledge is therefore at the heart of our investment process. But getting the timing right is crucial in emerging markets, where price movements are much more volatile than in developed economies. Our investment process is therefore designed to act nimbly whilst maintaining a high degree of confidence.

Our investment process is twofold: a combination of bottom-up and top-down in-depth analysis together with identifying key catalyst and triggers which will drive valuations. Furthermore, we will only invest in a particular country once it fulfils certain top-down criteria.

For top-down we analyse macroeconomic and political factors, while looking beyond the country's frontiers, to analyse its relations with its main trading partners, for example. Country- and sector-specific triggers and catalysts that will drive valuations can include impending regulatory changes that will affect the sector, supply/demand imbalances, industrial restructuring themes and sector consolidation.

On the bottom-up side, we identify catalysts and triggers within companies. These can include potential management changes or liquidity issues which, if resolved, could lead to a share price revaluation. We then conduct probability analyses of the likelihood of these catalysts and triggers occurring, and how they may each impact on a company's performance.

Our modelling is not only financial. We go a step further and look at companies from a potential acquirer's as well as a competitor's point of view. The former allows us to identify M&A and consolidation opportunities, while the latter allows us to identify sector trends, opportunities, operational issues and total sector capacity. By developing long-term forecasts, we increase our conviction rate and feed this into our investment allocation process. This approach is not used widely by other firms, but has proved very useful in GEM's own stock picking.

Meeting with company management is very important to us. We meet with the companies in which we invest, at both board and operational management level, as well as their competitors, on a regular basis. We will also have a refresher meeting with a company just before we invest if we have not met with them recently. Accessing company information in some emerging countries can be difficult, sometimes requiring face-to-face meetings, but we always use direct source data in our models. We will never compromise on this, preferring to postpone or not to invest if that is the case.

Determining the triggers and catalysts at a country, sector and company level is the key to successful investments. By being on the ground and using sectorial specialists, we are close to the day-to-day nitty-gritty of what is driving a sector or a company. In emerging market economies, the pace of change is usually much quicker than in developed economies and can catch many investors unaware. We seek to capture value by being able to interpret these triggers and catalysts quickly and accurately.

HW: How do you generate ideas for your funds?

PK: By meeting on a regular basis with invested companies and their competitors, as well as sector contacts, we get a very good understanding of the factors driving the companies and the sectors in which they operate. Our analysts are sector specialists, so easily find a common language when meeting with companies in their sector.

By comparing sectors and companies with each other across the large number of emerging markets in which we invest, we identify misvaluations and opportunities, as well as likely triggers and catalysts that have already occurred in other countries or companies and may have a knock-on effect. The research team feeds ideas into the head of research, who is a member of the investment committee. With members of the research team frequently travelling, we will also hold intra-week investment committee calls as required if a research analyst puts forward a strong case.

Timeliness is fundamental at GEM. As soon as we begin to identify a catalyst or trigger, we will research it in-depth and send an analyst out to meet with the relevant company or companies. Since we have been tracking the companies we invest in for a long time, we have already carried out all the necessary legwork. We can therefore react much more quickly in taking investment decisions whilst still maintaining a high degree of confidence.

HW: What is your approach to managing risk?

PK: The fund's risk management is company-specific. As value investors, we understand what we are investing in very well, so we know the risks involved with each company. We also always look at share price volatility before determining our stop losses. Moreover, the firm's knowledge of each market, from both a macro and a company specific perspective, enables us to act quickly during market downturns.

For example, in May 2006, when the Turkish market fell by 30 per cent in dollar terms, and the MSCI Emerging Index fell 10.76 per cent, our diversified Emerging Value Opportunities Fund was still able to produce positive returns of 5.4 per cent to investors.

All funds and client portfolios are monitored daily, on an ongoing basis, by the investment committee. In addition, funds and client portfolios are also reviewed during the investment committee's weekly conference calls. Finally, all funds and client portfolios are reviewed on a monthly basis in order to prepare monthly reports for distribution to clients.

General conditions in the economy and financial markets are continuously monitored, as are changes in monetary and fiscal policy, inflation, supply and demand, and geopolitical and social factors. Factors triggering investment reviews, and perhaps also triggering investment recommendations, include changed general conditions in government stability, the economy and all markets including currency, stock and bond markets.

Our emerging market funds investing worldwide have a majority of the portfolio in highly liquid positions, with one- or two-day liquidity. Other smaller positions in other funds may be sold between three and 10 business days, which is the norm for smaller emerging market investments. We monitor our positions continuously, with the investment committee meeting weekly and a weekly call or meeting for all GEM staff.

HW: Has your performance been as per budget and expectations?

PK: We can only disclose our fund's performance to suitably qualified investors upon request, but we have handsomely outperformed the relevant indices and one of our global emerging markets funds was ranked number one in the Equity Global Emerging Markets sector (Offshore) by Standard & Poor's in 2005 over one and five year periods. The relevant hedge fund databases also contain our performance data.

As a result we are receiving increasing interest from investors seeking to access our funds. The initial target for the PharmaInvest Fund was USD100m, but strong investor interest meant we surpassed this target by raising USD120m in the two months since its launch in October 2006.

HW: What opportunities are you looking at right now?

PK: The PharmaInvest Fund launched in October 2006 focuses on the high-growth pharmaceutical sector in Turkey, the former Soviet Union, the Baltic states, and central and eastern Europe. The first market to be targeted by the fund is Turkey, one of the fastest growing pharmaceutical markets in Europe. It has the lowest drug spending per capita in the OECD at USD92 per person per annum, compared to USD110 in Mexico, USD285 in the Czech Republic and USD500 in Italy.

Growth in the Turkish pharmaceutical market was 20.3 per cent in 2005 on a year-on-year basis, and the total Turkish pharmaceutical market is forecast to grow at a compound annual growth rate of 17 per cent in the period between 2004 and 2009, compared with forecast growth for the generic pharmaceuticals' market worldwide of 10 per cent between 2005 and 2010.

HW: What events do you expect to see in your sector in the year ahead?

PK: While emerging markets do tend to follow boom and bust patterns, one must remember that these countries are developing and maturing, and as they grow the boom and bust patterns lose their intensity. A clear example of this is the Czech Republic, whose volatility has decreased dramatically over the last five years, as the country has continued to integrate with the EU.

HW: What differentiates you from other managers in your sector?

PK: Our combination of in-depth top-down and bottom-up research together with a focus on triggers and catalysts and timely investing. Our experience and long track record also means that we know our universe very well. As a firm, we have been investing in emerging markets for 14 years, and some members of the investment committee for much longer than that.

HW: Do you have any plans for similar/other product launches in the near future?

PK: We have launched specialist funds focused on Ukraine, energy in 2003 and recently the pharmaceutical sector to complement the more diversified worldwide emerging markets funds we manage. Different investors will have different requirements, so our fund range reflects this, but we seek to employ GEM's distinctive approach in all of our funds. We launch funds once we have already identified a concrete investment opportunity, be it sectorial or geographical, and, yes, we will launch more funds as investment opportunities are identified and refined.


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