The Brazilian firm’s move into the UCITS space has come via Morgan Stanley’s FundLogic platform. The MS Claritas Long Short Market Neutral UCITS Fund aims to entice European investors who are seeking a tightly risk controlled way to tap into Brazilian equities. Net exposure is typically about 10%, but it can vary from +20% to -20%.
The portfolio managers, led by Helder Soares, the chief investment officer, have targeted an investment universe of about 155 listed Brazilian companies with high liquidity. This includes all the companies in Brazil’s benchmark Ibovespa Index. The portfolio is comprised of 40-60 stocks.
Scale of complete investment group
What sets Claritas apart from most Brazilian firms is that it has the scale of a complete investment group. It has 27 people on the investment side either as analysts or portfolio managers focusing completely on opportunities in Brazil. Alignment is strong with most of the wealth of principals and partners invested in the group’s range of funds. Soares oversaw the launch of the Claritas Offshore Fund, its first Brazilian long/short fund equity fund in 2001. By 2004, it had become one of the firm’s fastest growing funds and is now a well recognised strategy among Brazilian investors. The UCITS and offshore fund follow a similar investment process. This features top down and bottom up analysis as well as catalysts.
“We try to balance these features in each investment decision,” says Marcelo Karvelis, co-founder and head of the institutional client advisory group. “We are looking for stocks where those three things are aligned.”
The investment team is stable with a low turnover. Two members have worked on the strategy since inception with an additional two members having eight and ten years of tenure. Strict portfolio construction rules and risk control are used to preserve alpha. The focus on alpha preservation also means that portfolio risk is calculated on a stress scenario basis rather than on Value at Risk.
The fund uses a screening process composed of a number of filters. The liquidity filter for stocks to qualify for inclusion in the fund is daily trading volume of 1 million Brazil reais ($600,000). Other filters include valuation screening of price/earnings ratios, enterprise value to EBITDA, dividend yield and price-to-book value. The top-down scenario is built through the interaction of macro, equities and derivatives investment teams as well as economists and senior management on the investment committee. This defines the level of risk appetite, target beta and sector focus.
Variable sector weightings
Different weightings of the quantitative or qualitative part of the analysis vary for each stock sector. Utilities, for example, currently have greater weight put on valuation and less weight on the more qualitative analysis of business fundamentals.
In contrast, financials have more weight put on fundamentals than on valuation, while with telecoms more weight is put on triggers than either fundamentals or valuation. Bank stocks provide an interesting example of how the process works. Though the portfolio mangers would likely reject investing in a bank whose shares are on a P/E of 15, they wouldn’t necessarily buy the stock just because it was cheap at, say a P/E of 5.
“In some sectors, like banks, the qualitative part is the most important,” says Soares. Thus to invest in a bank, the stock would need to be passed on the qualitative business fundamentals before the analysts would even look at the valuation in terms of P/E or cash flow. But with utilities, the process would be valuation, not fundamentals, led. The aim of the long/short strategy is to deliver some 600-700 basis points of alpha in a risk adverse fund with volatility of 4%. The maximum position size is capped at 10% on the long side and 8% on the short side.
Stop losses are used on each position. For the entire fund, if all positions hit their stop loss in one day the maximum loss would be 12%. In reality, the worst loss that has occurred was in the 3-4% range. Around 10-20% of the portfolio is in short term oriented positions lasting from one week to one month, leaving 60-80% of the book in a six month investment timeframe with a further 10-15% being a year or more. The latter focuses on ‘value’ stocks that are the firm’s best ideas and are undervalued but without an identified catalyst.
Interest rates have fallen in Brazil since 2011 from 12% to 8.5%. Still, the risk free rate is very high compared with rates in developed economies with LIBOR almost at 0%.
“If overseas investors want to invest in Brazil they want a higher rate of return,” says Soares. “That is why the UCITS has more risk than the offshore fund with 33% greater exposure. I target slightly higher alpha, around 10% returns, and slightly higher volatility, around 5-6%, as well.”
Investors in the UCITS get currency exposure hedged out. In May, when the Ibovespa fell 11.9% in local currency terms and 17.5% in dollar terms, the UCITS rose +0.22%. “When investors allocate to the long/short fund they don’t need to worry about currency exposure and the net exposure is very low,” says Soares. “They are buying my stock picking ability. It is like buying exclusive alpha.”