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Why emerging markets hedge funds face “uneven recovery” after Covid-19 shock

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Hedge funds trading emerging markets strategies face major dispersion in their assets, as the impact of Covid-19 – and the resulting government responses – diverges sharply across different regions and countries.

New analysis by Lyxor Asset Management this week pointed to “uneven recovery prospects” across different EM countries and markets following the pandemic, stemming from various factors including differing regional responses to the crisis, business cycles, government support for economies, and reliance on oil markets, among other things.

Emerging markets-focused hedge funds lost 8.5 per cent last month, according to Lyxor stats, as the dramatic sell-off in developed markets spread further to EM.

“While market timing still dominates, managers foresee even wider EM assets differentiation after the outbreak is overcome, boding well for bottom-up alpha,” Lyxor strategists observed in a note this week.

While the outbreak appears to be past its peak in much of Asia, except India, cases in Latin America, the Middle East and Africa are only beginning to gather pace, with health infrastructures and the ability to impose lockdowns differing sharply across countries and regions.

“EM economies are unevenly leveraged to business cycles,” Lyxor strategists observed.  “Latin America and central and eastern Europe tend to be sensitive to activity in the US and EMU, respectively. In contrast, Asia is both sensitive to Chinese activity – which is recovering – and to global trade – which is in freefall.”

The cross-asset research note, by Jean-Baptiste Berthon, senior strategist, Philippe Ferreira, senior strategist, and Nicolas Quirin, hedge fund analyst, also underlined how exposure to commodities prices affects emerging market countries in different ways.

“Producers in Lat-Am and MEA are facing a steep drop in oil revenues, in part from a price war on the supply side (that the largest producers are trying to end) and above all from the collapse in demand,” Lyxor’s note observed.  “Meanwhile, oil importers – such as Asia ex-Malaysia and CEE ex-Russia – are likely to get a boost.”

Lyxor added: “Countries most vulnerable to capital outflows and/or carrying heavy external debts would be constrained or could face FX depreciation – in particular, Argentina, South Africa, Turkey, and Indonesia,” Lyxor said.

Though long/short managers trading Brazilian assets were squeezed, and the surge in coronavirus cases in the US hit Mexican positions, Asian trades proved resilient, Lyxor said. Now, EM managers are beginning to train their sights on the most dislocated areas of the market, such as credit.

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