Brevan Howard Emerging Markets Local Fixed Income Fund

Best Performing Macro Discretionary Fund

Originally published in the February 2013 issue

Filippo Cipriani’s Brevan Howard Emerging Markets Local Fixed Income Fund and Geraldine Sundstrom’s Brevan Howard Emerging Markets fund are unique products run by independent teams operating independently.

Both have won awards, but show a relatively low correlation of returns. Cipriani does not trade external or corporate debt, or equities, which can appear in the Sundstrom fund. The two funds share access to the abundance of analytical and risk-related resources at Brevan Howard, including 14 economists, 15 quantitative analysts and a 26-strong risk team.

Cipriani has been at Brevan Howard since 2005, having formerly headed Morgan Stanley’s Local Markets desk. He applies Brevan Howard’s hallmark discretionary macro trading acumen, with the emerging markets as his asset class canvas. Various downside controls are implemented by the risk team headed by Dr Aron Landy, which includes a dedicated UCITS risk manager, Olivier Daviaud.

Cipriani’s speciality is bottom-up macroeconomic analysis, identifying the drivers of monetary policy, interest rates and exchange rates. He trades currencies and interest rates. The investment universe spans Asia, Africa, South America and Eastern Europe, but not all emerging or frontier markets have enough data quality or liquidity. Currently, over 80% of the fund’s assets are classed as Level 1 or “marked to market” under ASC 820 accounting rules. Brevan Howard’s Liquidity Committee helps decide which assets can be traded.

This liquid strategy fits into UCITS very easily. Whereas some UCITS hedge funds clone or feed into an offshore fund – often with extra costs – Cipriani’s Luxembourg UCITS is the master fund, with its own offshore Cayman feeder. Fixed costs for the fund are pretty similar to those of Brevan’s offshore funds, which always have independent administrators and custodians. Thisself-managed structure sidesteps the extra costs of index swaps or platforms.

Risk controls are tighter than UCITS limits, and the aim is to limit worst monthly losses to 5% and avoid annual losses. A 200% cap on leverage for currencies is in fact imposed by Brevan Howard’s own risk department, and not by any UCITS rules. For bonds, interest rate risk does not exceed a 10-year duration. Complementing, and potentially over-riding, those and other limits is the fund’s Murex and Risk Metrics-based VaR limit of 1.75% for daily 95% confidence, which works out at less than half of the corresponding maximum for a UCITS fund. On top of the quantitative risk limits, more than 150 stress and sensitivity tests are carried out each day for events, including Asian and Russian crises dating back to the 1990s.

Cipriani only uses the bulk of his risk budget at times of maximum conviction, which included the phase after Draghi’s “Whatever it takes” speech in July 2012. If Cipriani is willing to be opportunistic when he is confident that risk is contained, at other times risk can cautiously languish at subdued levels: weeks before Draghi spoke, VaR in early 2012 was running at 0.11%, or more than 90% below the ceiling, leaving plenty of dry powder to exploit the resurgence of emerging markets that followed.

While the fund can go slightly net short (up to 10% in currencies, and two-year duration interest rates), its generally long bias means that currency carry is one source of returns. But this should not be exaggerated: even at its peak, the fund’s annualised carry in December 2012 was only 4%, still less than the 5.5% yield on a typical emerging markets bond index.

In keeping with the dynamic trading approach, Cipriani has sometimes been net short of carry: shorting the Turkish Lira was his biggest winner in 2011, and 2008 was the best year of his carve-out from the Brevan Howard Master Fund. Right now Russia’s Rouble currency is an asset that Cipriani has confidence in, based on an improving macroeconomic outlook.

Fund manager: Brevan Howard
Portfolio manager: Filippo Cipriani