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Charlemagne sticks to its
guns with market-neutral
approach to EM equities
F
or most emerging market equity managers, 2009 was a year
of stratospheric gains – with
some even posting triple-digit returns. But those eye-popping results generally came after disastrous performances in 2008, when
many funds produced losses so big
that even their huge 2009 gains
could not get them back to anywhere near their high water
marks.
But Charlemagne Capital’s longrunning OCCO Eastern European
fund did not follow that path. Although the fund enjoyed its best
year ever in 2009 with a gain of
roughly 50%, and lost money in
2008 like most of its peers, the
strategy has never put its investors on quite such a lurching rollercoaster ride as other emerging
markets funds.
This is entirely by design. The
fund is meant to be market-neutral – and manager Andy Wiles
says this approach means the
fund has generated more consistent returns over time, and with
less volatility, than typical longbiased emerging markets equity
strategies.
“There are not too many genuinely non-directional funds in our
part of the world,” says Wiles.
“Over the last five years we have
been positive greater than 50% of
the time when the MSCI Emerging
Europe index has been down. Our
volatility over the life of the fund
is in the single digits.”
The fund launched in December
2001 and has produced an annualised return since then of over
15%, with an annualised volatil-
Minimising directional exposure to emerging equity markets
enabled the OCCO Eastern European fund to limit its losses in
the crash of 2008, while fully exploiting the upside in 2009
ity of less than 9%. In the 20082009 combined period, the fund
returned 22% – and it has had
no down months in the past 14
months.
Wiles is an old hand at managing emerging markets strategies,
having previously been part of the
team that ran a long/short emerging markets fund at the now-defunct Buchanan Partners before
joining Charlemagne in 1995.
At Charlemagne, he heads up
a team of five, including portfolio adviser Pawel Szulc, assistant
Chris Coghlan, head of operations
Adrian Jones and risk manager
Pascal Khoury. Between them,
the team members have nearly 60
years of experience.
The strategy is highly fundamental. The team keeps a dynamic list
Performance: OCCO Eastern European Fund
%
250
EuroHedge Emerging Market Equity USD Index
OCCO Eastern European Fund
200
150
100
50
Source: EuroHedge
-10
Ja
n
09
nJa
08
nJa
-0
7
Ja
n
06
nJa
05
nJa
4
-0
Ja
n
Ja
n03
Ja
n-
02
0
of about 150 small, mid and largecap companies, each with its own
models and price targets. From
that list, the managers construct
a portfolio of about 30 positions,
based on exhaustive fundamental
research and numerous company
meetings.
“I consider myself an analyst
first and foremost. 90% of my
time is spent on research,” Wiles
says. “The process is resolutely
bottom up – we spend most of
our time researching individual
companies. Geographically, we sit
very close to most companies in
our opportunity set – as bottomup managers, that’s essential. You
can’t expect those inefficiencies to
accrue to you passively.”
The team also divides its universe into sectors, with the top
three sectors – financials, materials, energy – comprising about
80% of the portfolio. They account
for about 70% of the region’s total
market capitalisation.
Wiles says the team does not
just aim to cover all the big companies. Instead, they try to see
where the market is inefficient
and where they have an edge and
then allocate capital where that
information advantage exists.
For example, the team no longer
covers Gazprom because Wiles
says the analysts do not feel they
can add value on a company that
is so closely followed by the buy
and sell sides and that is so affected by top-down policymaking
in Russia.
The company used to be the
largest holding in the fund, but
Wiles says that when the world
changed, the fund had to adapt
with it.
“The point is that we are flexible
in understanding where we have
an edge,” he says. “We are always
looking to optimise the way we
allocate capital. That’s a bit of an
obsession for us.”
Once the universe of 150 companies, models and price targets has
been constructed, the fund’s portfolio construction overlay kicks
in. The overlay is highly oriented
towards risk management and is
meant to filter those 150 views
into a portfolio that hedges out
most of the common factor risks,
such as sector or country exposure.
Wiles says the overlay has
helped to keep the realised volatility of the fund to 8.8% since inception and has enabled the team to
understand where the portfolio’s
risks are coming from – and also
to keep that risk related to the underlying securities, rather than to
other factors.
“We don’t think we have expertise in forecasting macro variables, so it also ensures we aren’t
constructing a portfolio that’s
based on a different oil price or
cost of capital to the rest of the
market,” he says.
The end result is a high-conviction portfolio, with one in every
five stocks that the team covers
ending up in the portfolio. The average position size is 3%, and the
minimum position size is limited
Disclaimer: This publication is for information purposes only. It is not investment advice and any mention of a fund is in no way an offer to sell or a solicitation to buy the fund. Any information in this publication should not be the basis for an investment decision. EuroHedge does
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18 February 2010
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PERFORMANCE
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PROFILE
Andy Wiles
“
Over the last five years we have been positive greater than 50% of the time when the
MSCI Emerging Europe index has been
down. Our volatility over the life of the fund
is in the single digits
to 1%, to prevent low-conviction
tail risk from building up.
Some 80% of the portfolio is
invested in large and mid-cap
names, as Wiles and his team believe the market is still inefficient
enough to offer value in the more
liquid securities. These inefficiencies occur as a result of various
factors, such as the absence of
broker research, erroneous market research, local accounting
standards, a lack of inclusion in
indices and local or regional stock
”
market listings.
The team is organised by sector,
with a different analyst assigned
to cover each sector, and the idea
generation process is fairly competitive. “We need to convince
each other of the robustness of
our approach,” says Wiles. “Everything is challenged and that’s
the environment I want to create.
There needs to be competition for
capital.”
This goes for the short book as
well. Wiles says the short book is
OCCO Eastern European Fund: at a glance
Management company: Charlemagne Capital
Inception: December 2001
Managers: Andy Wiles
Strategy: Emerging market equity
Assets: $122 million
Prime brokers: Credit Suisse, Goldman Sachs
Administrator: PNC Global Investment Servicing
© EuroHedge
meant to add market protection as
well as generate alpha. That said,
he says the team is happy for the
short book to lose money, as long
as the fund generates more returns on the long side – as maintaining a short book prevents the
fund from some of the drastic declines suffered by its peers in the
space.
The team spends equal time on
long and short analysis. The short
book tends to be slightly higher
beta. Wiles adds that this higher
beta embedded in the short book
takes the overall portfolio –
which on the surface appears to
have a 10-15% net long position
over time – to a market-neutral
position.
On a country level, 50% of the
portfolio’s gross exposure is in
Russia, with the rest allocated to
the Czech Republic, Poland, and,
to a lesser extent, Kazakhstan and
Hungary.
Russia is the most liquid market
in the region and also fairly broad,
which accounts for its sizable allocation in the portfolio. But Wiles
says it delivers a commensurate
return.
It also offers the best shorting
opportunities. When the fund
launched in 2001, shorting was
more difficult and the Russian
markets were still embryonic.
But markets grew quickly from
that point – before stalling in
2007 – and Wiles says the market
has opened up significantly more
to short selling, with few restrictions on the practice and a host of
Russian companies that have dual
listings in Russia and New York or
London.
“It’s now categorically wrong to
say you can’t short in emerging
markets,” he says.
But while transparency and corporate governance in Russia have
improved, there is still a long way
to go – as evidenced by the chilling saga of Bill Browder’s Hermitage Capital.
Browder, a shareholder activist,
is defending the firm against tax
fraud charges levied by the Russian government. Browder claims
the government stole several Hermitage holding companies and
used them to commit the fraud.
Browder’s lawyer, Sergei Magnitsky, was sentenced to prison in
Russia and died there in November 2009.
“It has its faults, and a number
of situations that give rise to very
serious concerns about how shareholders and citizens are treated,”
says Wiles of Russia. “We go into it
with our eyes wide open – there
are obvious risks and we want to
be compensated for those.”
But he adds that Russia is still
a very attractive market for the
fund, because it demonstrates all
the classical inefficiency signs. He
adds that the benefit of having a
market-neutral strategy is that
the team does not need to have
a positive view of Russia to make
money.
“I don’t need to take a longterm directional view with regard
to Russia to generate positive returns,” he says.
For now, Wiles says the team is
trying to grow assets, which fell
from a peak of $300 million down
to a low of $65 million following
the crisis of 2008. But thanks to
performance, the return of some
redeeming investors and some
new inflows, the fund is back up
to $122 million.
The fund lost 19% in 2008,
which compares favorably to the
65% drop in the markets in which
the fund trades. The EuroHedge
Emerging Market Equity index
produced a median loss of over
45% that year, and many funds
in the space saw declines of well
over 50%.
Wiles says the team is still far
from happy with its performance
in 2008, but it has learned some
valuable lessons. “We performed
poorly,” he says. “We understand
what went wrong and restructured the portfolio in terms of
risk.”
He is also determined to stick
to the fund’s philosophy of offering market-neutral exposure to
emerging markets, regardless of
how hot they may become.
“Investors want exposure to
the rising wealth levels and demographic themes in emerging
markets; I understand that,” says
Wiles. “But we can generate very
good risk-adjusted net returns by
hedging out the market volatility
and by extracting the inefficiencies that exist in our regional markets. We tell people if they have a
positive view of our markets and
want beta exposure, then don’t
invest with us. I think people understand that.”
February 2010 19