Carrhae Capital

Global long/short equity investing in emerging markets

Originally published in the June 2012 issue

In an earlier time, investors were urged to go west. In the 21st century, the dash is on for investors to profit from exposure to emerging markets. A novel approach to this is Carrhae Capital’s liquid global long/short equity fund which targets what the firm calls ‘an emerging markets information angle’.

Ali Akay is the chief investment officer of Carrhae Capital. He and two others on the six-strong investment team are veterans of the respected hedge fund SAC Capital Advisors. The lineage is notable as is Carrhae’s seed backing from leading fund of fund investor Blackstone Group.

As such, Carrhae has quickly attracted capital since launching in mid-2011. Following inflows on June 1 the fund is up to $465 million and expects to close with around $500 million in July. Depending on market conditions the fund may open again in 2013 with a view to raising further capital to around $1.0-1.5 billion.

Having been conceived and delivered during a period of historically high market volatility, Akay’s approach to tapping returns from emerging economies features tight control of net exposure. Net market exposure is kept to +/- 25% with low target correlation to emerging market indices and other hedge funds operating in the area. Indeed, in 11 years of being a portfolio manager, Akay says the biggest net exposure he has ever run is 15%. For investors weary from market volatility that sounds reassuring.

Flows out of emerging markets
“With the uncertainties in Europe and economic data showing a euro zone slowdowns, there has been a fear that emerging markets would be severely hit,” says Akay. “It is something that investors have thought about since last year, especially with weak data coming out of China. It convinced investors that emerging markets can’t grow on their own and will be severely hit by a tail risk scenario from Europe. With increasing risk, investors have sought refuge in US dollar denominated assets and there were tremendous outflows out of all emerging asset classes, particularly equities.”

Carrhae’s investment focus on global equities, which have substantial exposure to emerging markets growth, means that it has been liquid enough to quickly pare back exposure when that was needed. Its low net exposure provided a further dampener on the volatility feeding into global equities markets.

Though it suffered a -2.8% loss in May, the strategy remains up +1% for 2012. The May outturn showed just how well the low net exposure strategy functioned and the quality of Carrhae’s hedging against the backdrop of a greater than -12% fall in the MSCI Emerging Markets Index.

Akay and his five fellow analysts focus on a handful of sectors that are driven by emerging markets: metals and mining; consumer goods; energy; financials as well as industrial and cyclical stocks. There is additional research provided by an outsource analyst based in India who supports the team in London. Each analyst looks at 100-120 companies to find the best opportunities.

Information edge
The investment approach is generally sourced from across Carrhae’s network and is expected to provide a competitive advantage. The firm uses a network of local brokers for execution as well as to tap into trading information. These relationships and the knowledge they provide are considered an important way to differentiate Carrhae from other managers as is the broad research capability of having such a relatively large team so early in the firm’s development. All of this is redolent of the business model of SAC Capital where Akay was the only London portfolio manager to focus on emerging markets.

The portfolio is constructed to combine fundamental, bottom-up security analysis with a macro overlay and is expected to maintain a structurally long volatility bias. In addition to keeping net exposure low, the strategy is diversified across over 60 long and short positions, using a relative value approach and a catalyst for exiting positions. “Over a longer period of time that’s hundreds of ideas,” says Akay. “In the alpha there is a great deal of information content.”

End of the super cycle?
As commodities prices have dipped, speculation has mounted about whether the commodities super cycle may be ending. Akay doesn’t have an opinion on that, but does believe that the market has got ahead of itself in terms of its bearishness on commodities stocks. Much of the fund’s geographic exposure is to multi-nationals based in Europe and North America (See Fig. 1).

“If there is an end to the commodity super cycle, there are a lot of emerging market countries that depend on commodity trade with China and would have a much weaker current account and a lower growth rate,” he says. “But there are countries that are net importers of energy like Turkey and India that would benefit from lower commodity prices. We don’t look so much at the macro thesis of the commodity super cycle, but at the corporate performance. But the market is much more focused on the macro features and corporate themes are not so prominent.”

Carrhae trades in a variety of ways. It can put on a pair trade or a short position with a basket as a hedge, or it might go outright long or short. The aim is to have a diverse series of strategies that function as independent pools of risk.

“In emerging markets, the good thing is that most investors prefer a long only approach,” says Akay. “I think it will stay that way and that provides a niche for us.”