Thu, 15/11/2007 - 11:06
Barings' head of alternatives Paul Graham discusses the investment strategy that underpins the Baring Emerging Market Absolute Return Fund, which was launched in September.
HW: What is the background to your new fund?
PG: The latest addition to the stable of hedge fund products at Baring Asset Management is the Baring Emerging Market Absolute Return Fund, which offers investors an innovative and unique quantitative investment strategy, based on stock return forecast models developed by Marlies van Boven, head of quantitative analysis at Barings and manager of the fund.
One of the first long/short emerging market quantitative funds to be made available to investors, it invests in the 17 largest emerging markets across Asia, Latin America and Europe, the Middle East and Africa. We believe this will provide the fund with ample levels of liquidity and enable the manager to hedge out market risk while still allowing access to the alpha available from emerging markets.
The fund was launched on September 4 with USD20m in assets, and aims to deliver returns in excess of 20 per cent per annum with a maximum volatility of 20 per cent.
HW: Who are your service providers?
PG: The service providers for the fund are PricewaterhouseCoopers and Dillon Eustace on the auditing and legal side respectively. Our administrator is Northern Trust International Fund Administration Services (Ireland), and the prime broker for the fund is Merrill Lynch.
HW: How and where do you distribute the fund? What is the profile of your current and targeted client base?
PG: We are targeting funds of hedge funds in particular with this product, but have also had interest from institutional and high net worth investors. Our client base for our alternative products is international, comprises a blend of funds of hedge funds and family offices.
HW: What is the investment process of your fund?
PG: With the rapid development of many of the emerging markets in recent years, it has become difficult for fundamental managers to track the full investible universe. We believe a quantitative approach can lead to efficiency gains here.
We follow more than 900 stocks on a weekly basis - hard to achieve for traditional fundamental analysts - and our innovative multiple-factor model and optimisation process allows us to invest without any emotional bias, another advantage in these volatile markets.
From our bottom-up stock selection model we construct a portfolio with around 70 long positions and 30 short positions. We actively manage the net exposure of the fund, using the strong top-down asset allocation skills of Baring Asset Management, and seek to hedge out unwanted systematic risk through swaps, futures and exchange-traded funds, minimising transaction costs and borrowing fees.
Taken together, we believe this allows us to provide investors with an efficient risk/return trade-off and a relatively low risk profile for an emerging market fund.
HW: How do you generate ideas for your fund?
PG: Our model is a quantitative one, utilising a proprietary multi-factor model developed by Marlies and her team. The factors we use are identified by a combination of our own quantitative research, the experience of the investment managers at Barings, and the latest thinking from academic literature. The valuation, technical and growth measures we look at define a set of factors that we believe can be expected to help forecast stock returns for longs and shorts.
HW: What is your approach to managing risk?
PG: We take the monitoring and management of investment risk very seriously, and use a combination of daily exposure monitoring by the investment manager and independent monitoring by the risk management team, reporting to the chief investment officer. This includes an assessment of sector and stock restrictions, daily profit and loss, value at risk and attribution analysis.
We have formulated net country limits for the emerging markets we invest in, and have overall limits on the maximum long and short exposure that can be taken with individual stocks. We believe these allow us to maintain a suitable level of diversification in the fund while still giving us scope to deliver attractive risk-adjusted return.
HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?
PG: While the fund has only been running since September, we have conducted extensive back-testing on the strategy to ensure that we are satisfied it is robust. The indications from this paper portfolio are very encouraging.
Real performance is what counts, though, and we are pleased with the performance of the fund since launch. In this volatile period we were fairly cautious about committing the fund's capital, but even so we have been able to deliver a positive return and slowly establish the positions we want to have in the fund.
HW: What opportunities are you looking at right now?
PG: We are looking at some very attractive opportunities in some of the emerging markets we cover. Amongst our larger positions on the long side are investments in Taiwan, Malaysia, Korea and Russia. We have implemented stock short positions in a wide range of markets, too.
HW: What events do you expect to see in your sector in the year ahead?
PG: As a house, we are upbeat on the prospects for emerging markets generally. In an environment where the pace of growth in the developed markets is slowing, we believe the transformation taking place in many of the world's emerging economies will be positive for equity markets in the region for a long time to come.
However, we expect the level of volatility in these markets to remain high. In this environment we believe a model-driven strategy, complemented by careful management of the net exposure from active asset allocation, presents an attractive proposition for investors.
HW: How will these developments impact on your own portfolio?
PG: Our back-testing has shown that the model can be successful in both falling and rising markets. Volatility presents investment opportunities, and we believe this could be a very interesting environment for investors in the fund going forward as we take advantage of pricing opportunities.
HW: What differentiates you from other managers in your sector?
PG: We believe our experience as a house in investing in emerging markets and our strong top-down asset allocation skills, our robust portfolio construction and disciplined investment process, and, above all, our proprietary multi-factor investment model, developed by Marlies and her team and drawing on a database of more than 2,000 emerging market stocks since 1998, give us a strong competitive advantage.
HW: Do you have any plans for other product launches in the near future?
PG: We are always looking at new potential investment ideas in both the long-only space and in alternatives. However, we are careful to take to market only those where we believe we have a real and sustainable competitive advantage and where our research shows there is a gap in the marketplace.
We are developing one or two potential hedge fund ideas right now in areas where we have historically been very strong, but these are still in the testing stage and we are not in a position to launch them into the public domain quite yet. Watch this space.
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