Tue, 19/02/2008 - 15:57
The foundations of Latin America's hedge fund industry were largely built by managers emerging from traditional investment firms and the proprietary trading desks of investment banks establishing unconstrained vehicles, many of them running long/short equity strategies alongside long-only vehicles, for a domestic client base.
But as managers have built up solid track records of performance over the past decade or so, many firms have started to offer offshore vehicles, often with appreciable differences in strategy, to appeal to a small but growing group of investors from North America and Europe keen to tap into the economic transformation of a region that still carries a significant degree of risk.
Today, with other markets faltering, the Latin American growth story now a familiar one to global investors and the search for uncorrelated strategies more insistent than ever, the universe of offshore Latin American funds has grown to a significant size. 'Many managers have created offshore funds to diversify their business away from local investors,' says Luis Javier Echave, who monitors alternative managers in the Americas for Optimal Investment Services, a Swiss-based fund of funds subsidiary of Spain's Santander Group.
Over the past two years the growth of the offshore fund sector has also encouraged the establishment of funds of hedge funds by managers such as Optimal, the Geneva-based but Latin America-oriented Safdié private banking group, Harcourt Investment Consulting, another Swiss fund of funds manager, and Rio de Janeiro-based Gávea Investimentos, headed by Brazil's most celebrated hedge fund manager, former central bank president Arminio Fraga Neto.
The growth of the industry is also bringing new opportunities to offshore jurisdictions such as the Bahamas, a long-time hedge fund domicile that is actively marketing itself to Latin American managers following the introduction of a revamped regulatory regime and new fund structures over the past few years.
Wendy Warren, executive director and chief executive of the Bahamas Financial Services Board, says the jurisdiction has taken a series of steps over the past decade to differentiate itself from competitor domiciles, with the overriding aim of compliance with the standards set by the International Organisation of Securities Commissions. 'Close attention is paid to the need for a strong corporate governance environment while maintaining a regulatory framework that is appropriately responsive and vigilant for funds and clients investing in them,' she says.
The changes in the Bahamas have given rise to a dual licensing regime, under which unrestricted fund administrators are authorised to license Professional and Smart funds that are offered only to accredited investors, while the regulator, the Securities Commission of the Bahamas, may license all classes of funds, including standard funds. Smart Funds, a flexible structure introduced under the 2003 Investment Funds Act, can be authorised on a same-day basis if the fund uses a template already approved by the regulator. Professional Funds are reserved to banks, insurers, broker-dealers, trusts and sophisticated individual investors with a net worth of at least USD1m.
Warren notes that the Bahamian fund industry has enjoyed steady growth thanks both to funds that are domiciled in the country and a large number of vehicles that are domiciled elsewhere but use Bahamian administrators. The fund services industry, she says, has benefited from access to a large talent pool of experienced professionals, the vast majority of whom are local people.
Although it is not the only kind of structure available to Latin American managers in creating Bahamas-domiciled offshore funds, the SMART Fund concept was specifically formulated with the requirements of the region in mind. Located off the Florida coast, the jurisdiction has developed a network of relationships with Latin American clients for whom Miami is a key cultural and business hub, as well as through the asset management activities of the Bahamas' wealth management industry.
'SMART Funds provide an excellent tool for families that utilise trusts, foundations or family offices to access the alternative investment world,' Warren says. 'Where the fund has a limited number of qualified investors such as a single or multi-family office, families can access best in class managers while implementing estate planning arrangements. Where the investors of record are accredited investors, the fund can be launched and licensed by an unrestricted fund administrator.
'There is also a SMART Fund template for an incubator fund structure, allowing the fund to generate performance history prior to upgrading to a third-party fund. This recognises the requirements of funds established to create a track record or allow institutional investors to test a particular strategy. An incubator fund can receive seed capital from a limited number of professional investors on the basis of a term sheet and an investor-approved waiver of a statutory audit, providing a streamlined, cost-efficient fund structure.'
There are a total of around 130 offshore Latin American hedge funds, according to Otávio de Magalhães Coutinho Vieira, director of asset management and head of fund advisory services at Safdié Group; the Latin American hedge fund index compiled by Singapore-based emerging markets specialist Eurekahedge has 115 constituents. Vieira notes that offshore funds tend to have relatively short track records, so investors should examine domestic funds from the same manager that offer longer performance history - and thanks to daily net asset value requirements in Brazil and elsewhere, where investment in hedge funds has trickled down to the level of retail investors, are easy to analyse.
Domestic hedge funds in Brazil have always been open to foreign investors, although tax considerations - as well as currency risk - have usually dictated the choice of an offshore structure. However, locally-domiciled funds are seeing greater inflows from domestic institutions as countries such as Argentina, Brazil, Chile and Mexico relax the investment restrictions governing pension schemes and insurance companies.
However, the growing capital inflows from home and abroad may pose performance problems for at least some managers, Vieira cautions. 'Investors need to pay attention to the size of the funds,' he says. 'Even though the liquidity situation is improving, it's sometime difficult for a very big fund to move its investments. One sometimes sees funds that are initially very successful starting to struggle as their assets under management grow.'
This is exacerbated, he says, by the dominant role in distribution played by a small number of big local banking institutions: 'The industry is very concentrated in terms of money flow. For instance, when Banco Itaú or Bradesco want to put money in one or other fund, the tickets are very big. Sometimes there may be an unwelcome impact on the hedge fund's performance.'
Perhaps the biggest issue facing investors looking to diversify into the Latin American market is a preponderance of Brazilian managers that far outweighs its admittedly dominant position in the region's economic hierarchy. 'The biggest question we face from institutional clients is how you play in Latin America beyond Brazil,' Echave says. 'Most of the managers are Brazilian and based in Brazil, and it is still the biggest market in terms of liquidity and availability of financial instruments. That is the most difficult thing to work around.'
According to Merrill Lynch, Brazil is home to up to 95 per cent of the region's hedge funds, although its estimate - up to 250 funds with assets of some USD24bn - is deliberately broad. Other analysts put the number of onshore and offshore funds investing mainly or exclusively in the region at as many as 300.
The Optimal Latin America Fund is 'very Brazil-centric in terms of allocation,' Echave says, with other countries accounting for just 10 per cent of the portfolio. 'We have one New York-based manager who runs a more diversified Latin American portfolio, but because of the depth of the market Brazil and Mexico are the two dominant markets, followed by Chile and Argentina.'
However, he notes that some of the fund's existing managers are starting to establish a track record of investment in other countries, notably Argentina. 'This year we expect to add an increasing number of positions with managers outside Brazil, in some cases managers based outside the region who have Latin American mandates.'
Vieira says the Safdié Latin American fund of funds has USD150m in assets placed with 14 underlying managers, mostly based in Brazil but also including managers who invest in the region from New York, San Francisco or London. He says: 'Brazil has a competitive advantage over other markets in the region because of its degree of liquidity and the availability of investment instruments.' The Brazilian Mercantile & Futures Exchange in São Paulo is the fifth biggest futures exchange in the world, he notes, while the Bovespa, the São Paulo Stock Exchange, is by far Latin America's largest exchange, accounting for more than two-thirds of the region's total trading volume.
Brazil also stands out as a centre for hedge fund management, say market participants, because of the country's years of high inflation, whose legacy of high interest rates long made equity investment relatively uncompetitive. 'In the other big countries in the region like Argentina, Chile and Mexico, the asset management industry is more geared to active long-only funds or fixed-income funds,' Vieira says. 'There are few onshore hedge funds, and not many more offshore.'
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