Globalisation and Hedge Funds

Leveraging the global information advantage

Neil Rogan and Ben Walker, Lead Managers, Alphagen Aldebaran Fund, Gartmore Investment Management
Originally published in the March 2007 issue

Globalisation has become a pervasive theme, encroaching into many aspects of life. The investment world is no exception. While there is often a negative perception of the generalised trend in some quarters, especially with regard to outsourcing or ‘offshoring,’ the increase in economic interdependence seems inescapable.

New patterns are also emerging. Traditionally, developed economies have provided foreign direct investment, often into emerging economies. Now a two-way process is evolving, with developing economies changing from passive recipients of inward investment to active participants in shaping globalisation.

By way of illustration of this trend, powerful predators have come to the fore in the developing markets. India’s Tata Steel and Brazil’s CSN recently fought over Corus, the steel producer created from the 1999 merger of the UK’s British Steel and Hoogovens from the Netherlands.

Equally, a UK-listed company may have significant overseas operations, rendering the stock less of a pure domestic play. Several leading members of the FTSE 100 are global companies that happen to be listed in the UK. Investors in the ever expanding number of multinational companies must now take into account the state of the global economy rather than just the outlook for the markets where their stocks trade.

Hedge funds have been at the forefront of the move towards global investing. This is evident in the growth of international assets under management at UK-based hedge fund managers. One explanation for this trend is the strong performance that has been delivered by many equity long/short funds dedicated to overseas markets.

While there are some excellent equity long/short funds focused on geographic regions, such as Europe or emerging markets, there is a growing trend towards investment in global equity hedge funds. Global funds are proving attractive because they offer investors exposure to the full opportunity set. Notably, global fund managers can take advantage of long and short investment opportunities, as they present themselves, anywhere in the world. It seems sensible to enable fund managers to exploit profitable opportunities across continents, especially when they are able to use the knowledge and expertise that they gain in one region to make money in another.

Freedom to react

Traditionally, global investing has followed a top-down approach, starting with an asset allocation across the regions and then a drill-down to sectors and stocks. Such an approach can prove to be less dynamic, as asset allocators may be slow to spot changes that first emerge at the stock level.

In contrast, Gartmore Investment Management’s AlphaGen Aldebaran – a global equity long/short fund – takes the opposite stance: bottom-up investing with the stock specifics as the starting point but the ability to act quickly as themes emerge. As of the end of January 2007, Aldebaran had returned 16.9% annualised net of fees (since inception on 1 March 2005), with an annualised volatility of 7.6%. The Fund’s correlation to the MSCI World Index is 0.48 and the Sharpe Ratio is 2.2.

When Aldebaran’s managers research a stock idea, the focus is on the outlook for change at the industry and franchise level. This work often reveals multiple opportunities, with a cluster of stock positions resulting from the original stock idea. If the managers have conviction in the cluster, it quickly becomes a theme.

Global information advantage

One of the attractions of a global fund with genuinely global managers is the ability to identify and allocate capital proactively across themes, as they progress through regions and sectors. At Gartmore, we refer to this as ‘leveraging the global information advantage.’

The globalisation of stock markets means there is much to be gained from taking a world view. Until relatively recently, the health of a country’s economy was the major determinant for the state of its stock market. A poor national economic outlook would drastically hold back that country’s companies, and, hence, the performance of their shares. Today, more and more companies, in particular, the larger ones, reflect the performance of the global economy.

When a company in one corner of the world benefits from a positive trend, there’s a good chance that its counterparts elsewhere will also be experiencing an improvement. Once a strong idea has been identified, a global fund with an unconstrained investment remit should be able to seek out stocks in other markets that are benefiting from the same positive trends. In many cases, we will also identify ‘losers’ that become candidates for short positions.

The luxury goods sector provides insight into the mechanics of the ‘global information advantage.’ It also highlights the gradual disappearance of a bi-polar world, with its neat division between rich and poor countries.

New money

Within the luxury goods sector, US-listed auction house Sotheby’s has benefited from the year-on-year increase in art prices. While the focus of Sotheby’s has historically been on the Western art world, art from other regions, such as Russia and Asia, is increasingly commanding higher prices. This trend, in turn, reflects the increased dispersion of wealth to different centres of the world. A business elite in Russia has grown wealthy from the exploitation of its natural resources and is interested in Russian art, for example. (Sotheby’s recently held an auction of Modern and Contemporary Russian Art in London.)

Similarly, the German luxury car maker Porsche is performing well, as new wealthy customers emerge from the future economic powerhouses of India and China. Such purchasers have been keen to buy cars with all the add-ons, further enhancing Porsche’s bottom line.

While a wealthy elite may grab the attention, many of the emerging economies are experiencing the expansion of their middle classes. Domestic consumption is also providing the impetus for their economies. Hitherto, emerging economies used to focus on supplying low-cost goods and services to the developed world.

Global landscape

Last year provided strong evidence of the globalisation of capital markets. In a record year for Initial Public Offerings (IPOs) around the world, four out of the ten largest listings took place in equity markets classified as emerging. In contrast, the US and Europe were predominant in the IPO market in the 20th century. The world’s largest ever IPO (US$21.9 billion) by the Industrial and Commercial Bank of China took place in 2006. Bank of China and Russian oil group Rosneft also had major listings that year.

For those investors seeking access to a wider range of markets, funds with a truly global mandate offer a good way of gaining exposure to the investment opportunities available in emerging markets. In addition, global funds provide investors with exposure to less volatile, core international markets, such as Europe, the US and Japan; and not forgetting the UK market as well.

Of course, emerging markets are not without risk. The moves by some Latin American countries to nationalise their energy resources represent a riposte to globalisation. They serve as a warning to multinationals that local politics can undermine global ambitions.

Global equity markets now offer a wider, and more equal, distribution of investment opportunities. As a result, investors are spoilt for choice when deciding on particular regions. This is a good problem to have but creates an element of risk when choosing between regions. In the search for added value, some funds haveoften made the wrong call on certain markets, particularly in respect of the US and Japan. However, global hedge funds that can proactively allocate capital to themes, as they progress across geographical boundaries, are well placed to avoid these pitfalls.