Emerging markets hedge funds risks

[avandalen]

Emerging markets hedge funds are doing very well since 2002 (about 17% annual). What are the risks?

Here are some points for concern:

1. Before 2002 the emerging markets hedge funds performed poor. In the 1998 hedge fund crash the emerging markets drawdown was very badly, about 40% (CSFB Emerging Markets Index). The broad market CSFB Index was down only about 10%.
2. Emerging markets are less developed and less liquid. Thus vulnerable for crashes.
3. recently the Asia markets however are more hedge fund friendly such as the increasing liberalization of short selling rules.
4. Unlike stock markets bubbles, hedge funds can’t have bubbles. Only when they have a high exposure (unhedged) to equity markets.

My questions are:
1. Is the reason for the booming Emerging markets hedge funds that these markets have much more imbalances (unlike other markets) which are profitable for hedge funds?
2. Could it be that in 1998 the emerging markets hedge funds had a high exposure (unhedged) to equity markets because hedge funds could not really hedge in these markets? This could explain the 40% drawdown in 1998.
3. Now that this situation has changed, is such a drawdown unlikely in the future?

 

[nazzdack]

(1) Focus more on liquidity and momentum with the emerging market's overall performance. There is a lot of money looking for a place to go and once a trend gets established, others hop on board. (2) Most hedge funds don't "hedge" at all. Most merely have long-positions, most of the time. In a bear market, they get ripped to pieces. (3) Big drawdowns are still likely because a lot of the money invested in these markets is from outside the country. Hedge funds are profit-motivated, not patriotic. (4) Hedge funds can be in a bubble if they're overleveraged in the most overextended markets. When the bubble deflates just a little, they can implode easily. (5) Remember, when emerging markets turn into submerging markets, you have to be extremely careful not to get wet.

 

[Div_Arb]

The risk is not being 100% long in emerging makets and missing out on some spectacular gains. Shorting emerging has been a loosing bet lately, but of course now the MSCI EMF is due for a pullback. The best you can hope for now is a cash return, so it would obviously be a better bet to just leave your money in cash and not fool with the uncompensated firm risks (blowup risk).

 

[avandalen]

Hello nazzdack

About your answer (3): “Hedge funds can be in a bubble if they're overleveraged in the most overextended markets. When the bubble deflates just a little, they can implode easily.”
This is a good remark. But what I mean with a bubble is that stocks markets are often overvalued. Hedgefunds can’t be overvalued (?) But it is trough that overleveraged HF have much more volatility.

About your answer (2):
Bearmarkets normally doesn’t harm HF because they are absolute return orientated. Since 2000 the HF market had no problems even when most hedge funds don't hedge at all.They are not get ripped to pieces.

 

[nazzdack]

???.........Recently, when natural gas spreads corrected a little bit, Ameranth was ripped to pieces. When crude oil & copper came off of their all-time highs, there were some smaller hedge fund washouts. When the stock market corrected in May-06, there were some other washouts too. After the fact, you can say these funds were "overvalued" because they were overleveraged in the most overextended markets at the time. (2) The other end of the extreme is funds that don't leverage enough. They just die a slower death or suffer mediocrity from not "swinging for the fences". They can exist quietly in oblivion.

 

[aus_SPIder]

flight to quality. i distinctly recall LTCM and neiderhoffer both investing in emerging markets and having both their asses handed to them when there was a flight to quality that occurs in a large correction/fall.

The correction in shanghai a few weeks ago is a nice example of how fickle global capital flows are

 

[ThetaSpec]

Quote from aus_SPIder:


The correction in shanghai a few weeks ago is a nice example of how fickle global capital flows are [/B]

Great point ... , it was very interesting to watch Mexican Peso, Turkish Lira and S&P futures move in tandem after a drop in China. It was a very interesting week, indeed. The correlation is breaking down now...

ThetaSpec

 

[ByLoSellHi]

Emerging markets obviously have both greater risks and greater rewards.

The assumption of the greater risk is the fiat you use to purchase the opportunity of greater reward.

They are higher beta markets, naturally.

I would only invest in specific companies in such markets if I was "plugged in" with a network of competent individuals who knew the specifics of the companies, and were persuaded that their balance sheets were clean, and that everything was as proclaimed.

Needless to say, Chinese accounting standards are suspect.