Covepoint’s Ko Reaps 22% as Emerging Currencies Converge to G-10Beth Williams and Ye Xie
Melissa Ko says the blurring line between emerging markets and developed countries offers opportunities for foreign-exchange investors.
The founder of hedge fund Covepoint Capital Advisors LLC should know. Ko, who oversees the firm’s $785 million flagship Covepoint Emerging Markets Macro Fund with a team of three co- managers, has racked up gains of 22 percent a year on average from its inception in 2005 through September. She started the fund at Bear Stearns Asset Management, and after Bear Stearns Cos. was bought by JPMorgan Chase & Co. in 2008, the bank spun the fund out to Covepoint.
Since foreign exchange is a two-sided asset, Ko says she and her New York-based team look for opportunities in relationships between currencies, Bloomberg Markets magazine reports in its November issue.
“Our focus traditionally has been emerging-market currencies, but with the division between emerging markets and developed markets becoming more and more nebulous, we focus on G-10 currencies just as much,” she says.
Financial turmoil of the sort that started with the subprime-mortgage meltdown in the U.S. in 2007 and roiled other developed countries isn’t exactly new for emerging-markets veterans such as Ko.
Ko, 43, started her career as a trader on Citibank’s emerging-markets currency desk in 1994, just before the Mexican peso crisis sent Latin America into a skid. While Thailand devalued the baht in 1997, Russia defaulted in 1998 and Argentina in the late 1990s headed for a financial crisis, Ko worked as a market maker and proprietary trader in developing currencies at Citibank, Bankers Trust and Deutsche Bank AG.
Trading Off Extremes
“Many of the dynamics I learned in trading emerging-market currencies have been very helpful,” Ko says. One lesson is to try to take advantage of extreme reactions. “When other people panic, then you see it as an opportunity, and when other people are too complacent, you should start to question,” she said in a September interview at Covepoint’s midtown Manhattan office, which has a view of Central Park.
The difference this time is that it’s the U.S. and countries in Europe where government balance sheets are strained. Developing nations such as Brazil and China have some of the best finances and growth prospects in the world, she says.
As macro investors, Ko and her team make bets based on their reading of broad global economic and market trends. They invest 80 percent to 85 percent of the fund in currencies and related instruments and also trade some fixed-income and exchange-traded funds.
“We tend to be contrarian -- certainly not for the sake of being contrarian -- but we do question the prevailing themes to see if they really make sense,” Ko says.
Her willingness to move in and out of markets can create ups and downs in the fund’s monthly performance. “We tend to be aggressive,” she says. Longer-term, the performance has exceeded benchmarks.
The fund’s gain of 22 percent annually since inception through September compares with 8.7 percent for JPMorgan Chase & Co’s Emerging Local Markets ELMI Plus Index, which tracks U.S. dollar returns as investments in 24 emerging-market currencies.
Through September, the fund gained 18.4 percent in 2010 versus 5.2 percent for the benchmark.
Ko and her team seek to anticipate shifts in market sentiment that can create trading opportunities, says Karthik Sankaran, a principal at Covepoint who joined Ko at Bear Stearns in 2006.
“You have to have your mind on the fundamentals, but at the same time you also have to have a sense of what is the dominant narrative at any given moment,” Sankaran, 46, says. “The point of maximum opportunity is when that changes.”
The Covepoint fund surged almost 63 percent in 2009 after Ko and her team bet correctly on Brazil. In late 2008, they wagered that Brazil’s central bank would break with tradition and lower, not raise, interest rates in response to the global financial upheaval.
“In many of their crises before, the response was always to hike rates massively, trying to stem capital flight,” Ko says. Since the crisis didn’t originate in Brazil, Ko and her team figured the bank would act differently, she says.
The bet paid off when Brazilian central bankers cut the benchmark Selic rate five times from 13.75 percent over the course of 2009 to a low of 8.75 percent.
“Our trade didn’t start to make a lot of money right away; it wasn’t the consensus for a long time,” she says. “We had to wait for it to pan out.” The real strengthened 33 percent against the U.S. dollar in 2009, trading at 1.7445 at year-end.
Trading Their Books
Ko and her colleagues have different backgrounds, and each trades his or her own book based on a particular viewpoint and style, she says.
Ko, who was born in South Korea and moved with her family to the U.S. when she was 13, came to trading by way of Massachusetts Institute of Technology in Cambridge, where she majored in chemical engineering and minored in economics before earning a graduate degree in business at the University of Pennsylvania’s Wharton School.
Sankaran studied 19th-century European history as both an undergraduate and graduate student at Columbia University in New York. He then worked as a journalist covering emerging markets for a time before turning to finance. Sankaran met Ko in 1997 while he was working at AIG Trading, the currency-trading unit of American International Group Inc., and Ko was one of his clients.
Another Covepoint principal, Nicholas Britell, 30, is a classically trained pianist who went to Manhattan’s Juilliard School in the pre-college division before studying psychology at Harvard College. Alexander Glasser, 26, a portfolio manager at Covepoint, also went to Harvard, where he studied math and physics.
Ko says each member of the team has gravitated toward particular areas of expertise. Ko tends to make directional bets on the market, she says. Sankaran is involved more with exotic options and relative value, while Britell tends to focus on frontier markets such as Egypt and Vietnam as well as emerging markets as a whole. Glasser’s work has been more model-driven.
“The kind of relationship we have in regard to managing the portfolio book really works well,” Ko says. “We all know what one another is doing.”
These days, Ko and her team are betting that currencies of commodity-exporting nations will strengthen over time as growth in China and other developing nations fuels demand for raw materials.
The firm launched the Covepoint Commodity Currency Fund in September 2009 to invest in a basket of commodity exporters such as Chile, Norway and Peru using funds borrowed in currencies of low-yielding, slower-growing countries such as the U.S.
“In a sense, that kind of gives you our view of how the world is going to pan out,” says Sankaran, who runs the $14 million fund, which returned 4.96 percent in the last four months of 2009 and lost 1.54 percent this year through September.
“At least right now, we think there’s something to this idea that the developed world does have severe challenges.” Sankaran says developing economies such as China are exerting an increasing influence over global foreign exchange. “From a macro point of view, emerging markets are driving a lot of what’s happening in the FX market,” he says.
“Because of the importance of China as the growth driver for the world, through reserve accumulation, through the impact on global growth -- it changes the terms of trade,” Sankaran says. “If you have a more commodity-intensive pattern, it benefits commodity exporters.”
In its flagship fund, Covepoint has done more trading in the euro and other developed-market currencies lately, Ko says.
This year, the fund gained on a bet against the euro as the Greek debt crisis sent the European currency lower, she says. When the euro got to about $1.25 versus the dollar, she reversed the bet, missing out as the euro sank further. Ko says the extent of the declines didn’t make sense given the commitments made in May by Germany and other stronger economies in the region to support debt-laden peripheral countries such as Greece.
“Our tendency to question the consensus -- it’s more art than science,” Ko says. “Sometimes I am too early.”
Ko says the fund gained in early July as the euro rebounded from a four-year low it reached in early June. “While there’s still a lot of issues around many EU members, the euro wasn’t going to implode and cease to exist right away.” The euro traded at $1.2883 on Sept. 13, up from a low of $1.1877 on June
Glasser says his focus has been more on the U.S. and broader macroeconomic trends. His views on particular smaller markets were being overwhelmed by fluctuations tied to global themes such as rising government debt loads in developed economies such as the U.S., he says. Instead of focusing on whether the Colombian central bank was behind the curve in terms of inflation, for example, he says it was more profitable to zoom out.
“When monetary policy is the focus, it makes a lot of sense to pay attention to more idiosyncratic stories,” he says. “When fiscal policy becomes more important, you are in a different framework, where people are more biased to be risk averse.”
For Ko, the aversion to risk that sent investors piling into U.S. Treasuries and drove 10-year yields to as low as 2.47 percent in August may be overdone.
“A lot of the bearishness has to do with looking into the rearview mirror in terms of wanting not to repeat 2008 again,” she says. Because of that, Ko says it’s possible the market may rally in the fourth quarter. “At the end of the day, rates are zero, and people have to put their money somewhere,” she says.
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