Charlemange Capital

Growing up with emerging markets

Philip Coggan
Originally published in the June 2006 issue

Any hedge funds playing the stock of Charlemagne Capital, the emerging market specialists, will have done better playing the short side. Having floated on the UK's Alternative Investment Market in April, the group's shares only briefly hovered above the flotation price of 100p. As emerging markets suffered a big sell-off in May, so did shares in Charlemagne. By late May, they were trading at just 72p, 28 per cent below the issue price. Some £83.5m had been wiped off the group's initial £298m market capitalisation.

The group was established in June 2000 following its demerger from Hong-Kong based Regent Pacific Group. Regent alumnus Jim Mellon, best known today for his apocalyptic views on the global outlook (see his book, 'Wake Up! Survive and Prosper in the Coming Economic Turmoil'), was one of the founding shareholders.

The float saw Mellon sell half his stake and the managers, such as Jayne Sutcliffe, Chief Executive, and David Curl, Finance Director, sell 30% of their stake. Sutcliffe says management is not going to sell any more stock for at least 12 months and other investors including Mellon and the Templeton Foundation are committed not to sell any more stock for the next six months.

Given the share price, they are hardly likely to be willing sellers (indeed, Mellon stepped into the market to buy back some shares in May). And Sutcliffe says "there is no reason to believe that the major institutional shareholders are anything other than long-term holders."

The float gave investors a chance to realise part of their holding. "Most of our shareholders came out of a quoted company and needed a liquidity mechanism" says Sutcliffe. She admits that: "We looked at the option of a strategic sale". But they found plenty of reasons against the idea. "A lot of people who work here came out of institutional businesses and didn't want to go back" she adds. "Our shareholders wanted liquidity but not a complete exit".

And Curl says that, in any case, there were few large fund management houses looking to add an emerging markets capability. "Anybody big enough to buy us, already does what we do."

Of course, a stock market quote allows companies to go out and make acquisitions on their own.

But Sutcliffe says that "We have never made an acquisition. We work in a fairly specialised area and all our growth has been organic. Acquiring other businesses can be a distraction for a small management team."

Getting away from Eastern Europe Charlemagne hasn't needed an acquisition to generate growth. Revenues have risen from $9.9m in 2001 to $90.8m last year, while operating profits have risen from $1.8m to $49.6m over the same period. The pre-tax profits in 2005 were $43.1m. The five years have seen the group distribute some $120m to shareholders. The key has been shifting away from the company's original area of expertise in Eastern Europe. "We have really expanded in the last three years as we have developed our GEMs [Global Emerging Markets] capability" says Sutcliffe.

"We now only have 50% of assets in Russia/ Eastern Europe, 50% in GEMs," says Curl.

"We would not like to have too much financial commitment to one region" says Sutcliffe. "The global emerging markets category is much bigger than eastern Europe."

To date, Curl says that most of the group's institutional assets are in Russian and East European funds. That's partly because the company is still relatively new to the GEMs arena. "It will not be that until July we have a three year record in global emerging markets" says Curl, "whereas we already have a five year record in eastern Europe."

"Once we get a three year record, we can start seeing the consultants" says Sutcliffe, referring to the key actuaries such as Watson Wyatt and Mercer who control access to the UK pension funds industry. At the moment, the company has no pension mandates; but Curl says there has been one encouraging development – Charlemagne is part of a multi-manager institutional programme that Nomura put together, where Gartmore manages Latin America, and Charlemagne manages EMEA (Europe, Middle East and Africa). Thegroup operates hedge funds under the Occo brand name, with four absolute return funds. It describes their aim as "to exploit the inefficiencies of the equity markets in global emerging markets, Asia, Eastern Europe and Latin America in order to generate consistent positive returns with low volatility, regardless of market direction."


The main long-only brand is Magna, where the company operates eight geographically focused sub-funds under the UCITS III regulations (which give fund managers more flexibility, including the opportunity to use derivatives). A new Magna fund is due to be set up in June. "The Asia fund will be another spoke in the range" says Curl (the group already have a Greater China and an India fund). In addition, the company runs white label funds for US Global Investors, Manulife, Julius Baer, and HSBC Louvre Gestion. On top of that, there are specialist offshore funds and structured products.

There are performance fees on both the long-only and the long-short products. On long-only, there is a 10% hurdle and then the fund manager gets 20% of the excess return. On the long/short funds, there is no hurdle before performance fees are earned.

The potential loss of performance fees on group revenues, as emerging markets declined in May, probably explains why Charlemagne shares took such a big hit. "Accrued performance fees are like options" says Curl, alluding to their geared effect on revenues. "The market downfall may have a short-term financial impact. But we don't think events now will have made much of a difference in two years' time."

From a starting pool of assets of $250m five years ago, the group's funds have grown dramatically. The company has just started to report assets under management on a monthly basis. "Our assets under management were $5.8bn at end of April and peaked at just over $6bn in early May" says Curl. By the time of the interview in late May, this had fallen to $5.2bn.

There is scope, Charlemagne believes, to expand its reach. Geographically, its coverage is patchy. "Historically we haven't done a lot of distribution in the UK," says Curl, "because UK investors have not been big on investing in Russia. We haven't ever actually sold hedge funds in the US, but we have good depth in the Swiss and UK hedge fund markets. On the long-only side, we haven't really marketed in Asia or the US."

"The hedge fund business will always be smaller in absolute size than the long-only business but it's growing fast" says Sutcliffe. Around 93% of assets are long-only and Charlemagne would like to get the hedge fund proportion up to 10%. At the start of April, there was $1.2bn in the Magna funds, $2.7bn in the institutional business, $950m in specialist funds and just $366m in the hedge funds.

Expansion may require some further recruitment. "We have grown assets under management very rapidly and headcount only slowly." says Curl. The company currently employs 50-55 staff, and Sutcliffe thinks it may need to hire a few more people on the sales side.

Regent Pacific alumni

Sutcliffe and Curl are both veterans of Regent Pacific, where the former ran the European operations and the latter specialised in Eastern Europe. Other Regent alumni are Anderson Whammond, Executive Director of Operations and David McMahon, the Company Secretary. But Stefan Bottcher, the Head of Portfolio Management, is one of the few members of the management team not to have joined from Regent. He was an executive director and Head of Emerging Markets at Schroders Investment Management, having previously worked at Flemings and WI Carr.

Bottcher is proud of his fund management team, saying there is no-one with less than 10 years' experience. "We want a team but we want ownership as well. Fund managers have to have their own franchise, they have to run their own funds."

Onthe GEMS side, Bottcher is backed up by a team of seven, with experience ranging from James Hanson and Yvonne Yeoh, each with 11 years, to Roger Platford, with 25. Andrew Wiles is Bottcher's main back-up on Eastern Europe while the Asian team is headed by KC Reddy and Sangita Uberoi, each with over a decade's experience, and Latin America by Stefan Hertz.

All this adds up, Bottcher believes to a "relatively established team with a consistent style, combining bottom-up and top-down views."

While he says the team has "definitely a value bias" he adds that you "don't want to complicate matters too much in emerging markets." Opportunities are created by some "unsophisticated local investors", he says.

Bottcher likes his fund managers to get their hands dirty. "Research is done by the fund managers themselves. At some places, the senior fund manager sends the junior graduates to see the companies. Not here. We are all both analysts and fund managers." That narrows the field of potential managers. "It is not easy to find fund managers with 15 years experience who will visit companies and do their own spread sheets" he admits.

To help cover the investment universe, each manager has an area of sector expertise. "Andy Wiles covers commodities, KC Reddy technology, and I do banks" says Bottcher. And there are no short cuts. When it comes to analysing insurance companies, Bottcher says he calculates his own appraisal value. But valuation models are not the only guide. "It's no good focusing on the minutiae of discounted cash flow valuations 20 years out" he says. "You have to watch the short-term risks over 1-2 years." And some common sense rules apply. "We don't touch what we don't understand. Teva, it's a big pharmaceutical company in Israel and I don't understand it" he says.

"We want the fund managers to be as little involved in marketing as possible," says Bottcher, "but we still want the fund managers to speak to clients for 15 minutes, to answer the questions that can't be answered by the sales guys. Listening to the clients helps to put together a good investment process, and helps managers understand about risk management."

Allowing the managers their own franchises is more satisfying for the individuals concerned but can create some inconsistencies across the whole group; big bets on one sector, for example, or two fund managers running completely offsetting positions.

Bottcher says the group takes steps to avoid such problems. "We have one investment process, and when we identify opportunities, they should be in the long-only and in the long/short funds. We also employ a chap in charge of portfolio implementation. He is there to ensure there is a consistent relationship between the regional and global funds. If the regional fund manager is taking a bet with a 600-700 basis points overweight, that's a big position and should be in the global portfolio." In addition, Bottcher says that the risk manager has a front office position at Charlemagne, not a back office position as occurs at many other fund management companies.

Bottcher himself performed many of these roles when the business was in its early days, but the company has steadily expanded its back-up team, and now he won't need to. "When we started, we just had one dealer, now we have three. We have tripled the staff in the back office" he says.

An informal style

Bottcher still likes the fund management team to have an informal style. "I am very keen on having no meetings" he says. "Seems a waste of time when you have a small team. You can talk to each other whenever you like."

When interviewed in late May, in the middle of the emerging market sell-off, Bottcher said that "recent trading have been just dreadful out there". But Curl added that:"The underlying economic position of emerging markets is reasonably robust. They comprise 7% of market capitalisation but are contributing 50% of global growth."

Curl said that it was "very positive that merging markets are now correlated with developed markets rather than with each other. We don't have the same contagion as we did in 1997-98. It means the emerging markets have grown up, and as they grow up, it is inevitable they will become increasingly correlated with the US. We would be worried about across-the-board profit warnings but we haven't seen them and we haven't seen earnings downgrades."

Charlemagne's track record suggests the group is a pretty good judge of the prospects for emerging markets. As of May 26, the Magna Latin America fund was the second best fund in its sector out of 83, with a 16.5% year-to-date gain while Magna India was fourth (out of 29) over the same period with a 17% return. Since launch in July 2003, the Magna GEMS fund has delivered 131.4%, placing it 20th out of 400 funds (all figures denominated in euros).

On the hedge fund side, the OCCO global emerging markets fund has delivered an annualised return of 16.4% launch (in may 2004) with a share ratio of 1.85. The Eastern European fund has doubled investors' money since launch at the end of 2001, with a share ratio of 1.96.

If Charlemagne can keep delivering those kinds of returns to investors, then its own shares should start disappointing the short sellers.

Philip Coggan is the Investment Editor of the Financial Times