Ricardo Maxit outlines Copernico's approach to exploiting volatility in Latin America, where a potential decrease in liquidity remains the biggest challenge.
Ricardo Maxit is a Director of Copernico Capital Partners (Bermuda) Ltd.
From June 1997 until August 1998 Ricardo worked as a representative of Banco Pactual, one of Brazil's leading investment banks, in Argentina. Prior to that and since September 1996 he managed his own Buenos Aires-based investment advisory firm. From 1994, Ricardo worked as Head of Asset Management for Merchant Bankers Asociados, an Argentine investment bank in which Salomon Brothers had a significant stake. Prior to this, he was a Vice President of MG Emerging Markets in New York where he was responsible for fixed income and equity trading for Argentina, Peru and Panama. Ricardo has a bachelor degree in Economics from the Universidad de Buenos Aires and an MBA from the George Washington University.
HW: What is the background to the fund?
RM: The Copernico Latin American Strategic Fund ('CLAS') was launched in August 1999. It currently has USD 180m of assets under management. Copernico Capital Partners (Copernico), the CLAS' investment advisor, manages a total of USD 301m. The company was founded by Mariano Caillet Bois, its CEO; Ricardo Maxit (myself), its CIO; and Thomas Keesee, a non-executive director. The fund is managed by myself alongside a group of three other portfolio managers, while Mr. Caillet-Bois and his team are in charge of the risk management functions. Copernico's investment strategy has primarily three components: event driven, market momentum and current income; using additionally, elements from long/short equities, fixed income relative value and distressed securities strategies. Its geographical focus is Latin American using sovereign debt and credit related investments.
HW: How and where do you distribute the fund? What is your current and targeted client base?
RM: The fund's marketing is done both directly and through a small number of strategic relationships with third party marketing and advisory firms with specific segment and / or geographical expertise.
Copernico has a well diversified investor base, including high net worth individuals, family offices, funds of hedge funds, private banks, fund platforms, pension funds and insurance companies, particularly in the Americas and Europe.
HW: What is the investment philosophy of your fund?
RM: Our investment philosophy is based on the continuous search for consistent, positive returns. While Latin American markets are known for their historic volatility, we believe that it is possible to produce consistent, positive returns by pursuing a three-pronged strategy. The three central elements of this strategy are:
- An event driven, short to medium term gain component, by means of which we focus on identifying and investing in relatively liquid securities, both debt and equity, that have an identifiable and relatively short term (1 month to 6 month) catalyst that will cause a repricing;
- A momentum component, whereby on an opportunistic basis, we seek to identify and take advantage of overbought and oversold conditions, which are typically very short term in nature (1 day to 1 month), focusing on extremely liquid securities, typically sovereign debt, currencies or tradable indices, to generate short term gains, and;
- A current income component, through which by investing in high coupon fixed income instruments with relatively short dated maturities and of relatively high credit quality, we can generate a base return for the portfolio without much volatility.
Most of our time and effort, and most of the P&L generated, are devoted to and derived from the first element of this strategy - the event driven component. As such, our approach is research intensive, and we believe that our local Latin American presence, combined with the extensive experience of the Firm's three partners and management team, provides the Firm with a big advantage, not only in terms access to data, but also the ability to interpret it correctly.
We also place a high degree of importance on risk control to limit downside volatility, employing such techniques as tight stop loss rules, portfolio diversification, maximum position size and limited use of leverage.
HW: How do you generate ideas for your fund?
RM: The investment process is research intensive relying on information from multiple sources including issuers (when appropriate), broker-dealers (both local and international), banks (both local and international), other hedge funds or investment funds, consultants, lawyers, accountants or other relevant specialists, as well as information services, newspapers, magazines, newsletters and information supplied by local regulatory bodies. In all cases, we seek to get a variety of viewpoints and speak directly to the relevant parties involved with the transaction.
First approach is to identify what we call investment themes. Based on those investment themes, which is usually combined with our selection criteria, we then scout for individual stories using a bottom up approach. Making sure that the combination between value and catalyst is there will make the following step. Copernico, as an asset manager focused on event-driven situations, is essentially an investor with a bottom-up approach.
Departing from an eligible universe made up of virtually every financial instrument available on Latin American issuers, portfolio managers try to detect mispriced securities - those in which there are potential reasons for an upward or downward repricing. In general, the selection criteria will include countries, sectors or companies whose fortunes are about to reverse, or which we foresee that are on the verge of being affected by an event that the market has not yet priced, or which are being inefficiently priced vis-à-vis its peer group.
The portfolio managers will elaborate on these ideas and, upon reaching a favorable conclusion to proceed will write down a fact sheet explaining the merits and risks of carrying out the investment. The fact sheet will be discussed with other portfolio managers at the weekly meeting. The fact sheet will include not only the rationale of any proposed investment, including price target, liquidity conditions, suggested amount of the investment and risks involved in the investment, in addition to an overview of the impact of the proposed investment on the portfolio.
HW: What is your approach to managing risk?
RM: In the specific issue of risk management, we try to continuously monitor all different risks to which we are exposed. The principal responsible for managing the portfolio's risk is Mariano Caillet Bois.
Our four basic principles in order to manage risk consists of: 1) determining at every moment the maximum risk level to be assumed in each fund managed by the investment manager; 2) once the risk has been determined, deciding about the investment strategy, in accordance with the mentioned risk level; 3) once the investment strategy is executed, the continuous rebalancing and monitoring of risk; and 4) reviewing on a regular basis whether the risk levels taken are in line with the established parameters and policies. In brief, the Risk Manager will decide about the market risk level to be assumed and how it should be allocated and controlled.
We have identified four main risks: Market risk, liquidity risk, credit risk and operational risk. The first three of these are quantifiable with relatively standardized techniques. Briefly, we measure market risk through a series of measures including a VaR system, Stress Testing, Back Testing and Sharpe ratio. In connection to market risk limits, Copernico Capital Partners considers that a market risk in line with the investment strategy of the Fund is able to be assumed. In absolute terms, a certain Value at Risk is not considered as maximum limit to be assumed. In this regard, the maximum potential loss to which the entity is exposed to will be evaluated given the particular situation at each moment and making an assessment on the future possible scenarios, it will be decided whether to continue with the existing investments or to modify the investment portfolio with the purpose of reducing the market risk to which the Fund is exposed.
Regarding liquidity risk, Copernico continually applies risk measurement techniques according to market circumstances and to the fund's size, as well as it constantly evaluates that the net cash requirements fit the investment strategy. Historically, the Fund has not suffered substantial redemptions and has thus not been subject to a stress situation in which it was forced to liquidate assets. However, it is a policy of the Fund to always keep a portion of its assets in cash format in 'A' or higher rated financial institutions and a substantial portion of its investments in situations that are subject to quick liquidation. This adds to the prior notice period requested from investors when deciding upon redemption. Nevertheless, it is worth mentioning that the event-driven strategy of the fund in general leads a significant proportion of assets to be invested in relatively illiquid assets.
Credit risk is essentially referred to counterparty risk and issuer risk. Regarding counterparty risk, we generally trade with highly-rated banks and always evaluate the credit merits of our counterparts. The issuer risk comes from negotiating the assets of an issuer in primary and secondary markets and it is defined as the eventuality of an issuer not facing its obligations assumed in the securities issue. In this respect, we stress the importance of portfolio diversification. The portfolio is diversified at a number of levels with countries, sectors, and type of assets acting as the starting point in the whole process. Respecting those limits and analyzing the correlation among the different investments is the next step. The risks we take are essentially event risk and systemic risk. We also have the risk - the main one in our judgement - that the events we are targeting do not occur. Position limits are also an important tool when it comes to controlling credit risk.
Finally, Copernico considers explicitly as an internal definition for operational risk, the risk of losses due to the improper processing of operations because of human or equipment causes. The Risk Manager has set up policies to ensure that functions are separated in order to permit crosschecking, to minimize errors and to prevent fraud.
HW: How/against what do you benchmark the performance of your fund?
RM: As a total return fund we do not have a benchmark. We aim for constant positive returns associated with low volatility.
HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?
RM: Our performance since inception has been quite encouraging. Since inception, October 2003, our biggest class of shares, the class B, has an annualized return of 15.42% with an annualized standard deviation of 3.64%. We do not expect to change our style in the future.
HW: What opportunities are you looking at right now?
RM: There is an interesting flow of stories coming our way, mainly as a result of dynamic mergers and acquisitions market and the continued firmness in the prices of most of the commodities the region supplies. We are placing special attention to equity stories where there is a catalyst that will allow for re-pricing, in order to take advantage of these opportunities. Additionally, we are to maintain meaningful positions in local markets instruments, particularly in Brazil and Argentina, in the former case as a result of our expectations for a continued aggressive rate cut policy and in the latter as a result of an undervalued currency and high inflation readings. On the tactical front, we have increased our net exposure to the higher end of our range. This move is based on a growing perception we had that we were heading into a period of status quo, typical for this time of the year, with no one particularly interested in making waves before year-end, unless a drastic or unexpected negative event takes place.
HW: What events do you expect to see in your sector in the year ahead?
RM: Main events in our market will be presidential elections in most of the region's countries (including three of the largest four), the likelihood of commodity prices reversing the uptrend they have been in for the last couple of years, and finally, the possibility of liquidity drying up, if only marginally, as a result of the hiking process being conducted by some of the world s largest central banks.
HW: How will these changes/future events impact on your own portfolio?
RM: We are well positioned to take advantage of the above-mentioned events, in particular an important decrease in liquidity, which we think remains today's biggest challenge. Having said this, we continue to have a constructive view on our markets, while fully aware that spikes in volatility will be very likely during most of 2006 (and politics will play a big role in it).
HW: What differentiates you from other managers in your sector?
RM: We are based in the region, so we tend to see opportunities before most other market participants do, and we believe that we tend to understand them better.
There are very few truly event driven managers focused on Latin America, so we are in a relatively un-crowded sector understanding that our strategy is the best fit for a market like Latin America, as inefficiencies are ever present.
Most of other investors in the region are long only benchmark investors, so they tend to be victims of the region's volatility, rather than knowing how to exploit it to their advantage. Since we are total return investors, we are often in the position to efficiently take advantage of the opportunities brought up by volatility.
HW: Do you have any plans for similar/other product launches in the near future?
RM: We are constantly analyzing new investment opportunities and changes in the existing strategies in the region. New investment vehicles will result from this research process.
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