Tapping into the latin beat

Money has flooded into hedge funds in the last few years, with industry assets estimated at close to $1trn (e760bn). As more and more money flows into this asset class, the supply of opportunities diminishes, particularly in certain strategies. It is therefore becoming difficult for many hedge fund managers to produce the returns investors have come to expect.

Confronted with this dilemma, investors eager for performance have had to seek out managers who can operate in a niche that has not yet become overcrowded. One such area is event-driven investing in Latin America, where investors can have access to managers who tend to be smaller but are also more flexible.

The opportunity set

Part of the explanation for the good performance being reported by specialist managers in these strategies is the supply-demand equation. While there are many funds in Latin America that invest on the long-only side, either in equities or fixed income, there are very few players that concentrate on “non-directional”, event-driven situations.

The events on which event-driven players focus are typically corporate situations where they can identify catalysts that will cause the re-pricing of a security, either up or down. These may include stocks of companies that are being acquired, bonds that have “put” or “call” provisions in the event of a change of control, or stocks of companies that are likely to engage in repurchase programmes.

While such opportunities in Latin America are more limited than in the more developed markets of the US and Europe, so are the number of participants that can spot them and have the know-how to successfully exploit them.

As one local portfolio manager puts it: “The big merger arbitrage guys don’t look at Latin America, and the Latin American funds typically don’t know how to do merger arbitrage. So, when an opportunity comes up, there are very few organisations that can take advantage of it, and that is where the spread comes in.”

In order to identify opportunities, as well as to do the homework necessary to evaluate the risks involved, the fund managers in the region will typically talk to other managers, both in the local markets as well as with the international houses, and occasionally, to the international brokers based in New York or London.

For the moment, there is limited competition locally. As another local portfolio manager points out: “There are a handful of players who are very good at this, but it is not a market that lends itself easily to waves of new entrants.”

For new participants, there are several barriers to entry. These include: knowledge of the local languages, local contacts, trading experience and familiarity with specialist exotic instruments and specialist research teams capable of analysing and understanding local contracts, regulations and corporate documents. “Even if other hedge fund managers could put together this expertise”, it’s just not worth it for most of them since the market capacity is relatively limited,” the same manager explains.

Therefore, while many hedge fund managers are becoming increasingly frustrated with overcrowding in their own markets, local hedge fund managers are able to focus on the relatively uncrowded niche of event-driven opportunities in Latin America. For the moment, the returns seem to justify their attention.

Ricardo Maxit is chief investment officer and founder of Copernico Capital Partners

Maxit: hedge fund managers in developed markets complain of overcrowding