Fed Leaves Hedge Fund Bears Waiting on Emerging-Markets Bet

Ray Bakhramov has been waiting almost two years for his hedge fund’s bet against emerging markets to pay off, which spurred a 20 percent loss in 2012 and cost him clients. Even with a slump from bonds to currencies over the last five months, he’s still waiting.

Bakhramov, whose $180 million Forum Global Opportunities Fund posted gains this year after shorting South Korean and Turkish government debt and wagering against mining and steel companies reliant on developing economies, remains in the red on his bearish outlook. He says his best returns will come once central banks unwind their record stimulus, something the U.S. Federal Reserve unexpectedly refrained from doing yesterday.

“What we’ve seen so far is just a preview,” Bakhramov, 45, said in a telephone interview from New York this week. “A slowdown in any asset class is not a two-month or even a one-quarter phenomenon. When you go through a major repricing, the process of bottoming out typically takes about four years.”

Fed Chairman Ben S. Bernanke triggered the emerging-markets slump when he signaled May 22 that the Fed may curtail its bond buying, luring capital away from nations that offered higher yields and relatively low risk as long as central banks were backing the global economy. More than $47 billion has been pulled from global funds investing in emerging-market stocks and bonds since May, according to EPFR Global, a Cambridge, Massachusetts-based data provider.

‘Bit Disappointing’

Hedge funds haven’t reaped the benefits of the emerging-market selloff because the currencies that fell the most this year aren’t easily bet against, some managers put on the wrong trades and volatility made it hard to stay in positions, investors said. What’s more, the worst of the emerging-market selloff may have already passed, analysts at Barclays Plc and JPMorgan Chase & Co. predict.

“Performance has been a bit disappointing,” said Anthony Lawler, who oversees $6 billion invested in hedge funds at GAM in London. “Hedge-fund managers have been looking for something to break, and central banks have been trying very hard to not let anything break.”

Brevan Howard

Hedge funds focused on emerging markets, the investors who charge the highest fees to navigate developing economies, account for $155 billion of the industry’s $2.4 trillion of assets under management, according to Chicago-based Hedge Fund Research Inc. The funds slumped 0.8 percent on average through the first eight months of the year, with performance dragged down by money managers who lost money after failing to anticipate the slide for stocks, bonds and currencies, that Bernanke prompted four months ago.

The $2.7 billion emerging-markets fund at Brevan Howard Asset Management LLP, Europe’s second-largest hedge-fund firm, declined 12.7 percent this year through Sept. 13, and New York-based QFR Capital Management LP, a $3.5 billion firm that invests in developing nations based on macroeconomic trends, lost 13.4 percent in its fund through August, investors said.

Firebird Management LLC, a New York-based firm that oversees $1.1 billion in emerging-market equities and private-equity investments, restricted clients from pulling money from one of its funds in July due to “significant redemption requests coupled with the illiquid nature” of the holdings, according to a notice on the Bermuda Stock Exchange’s website.

A spokesman for London-based Brevan Howard declined to comment on the fund’s performance. Officials at QFR and Firebird didn’t return phone calls and emails seeking comment.

Fed’s Strategy

Hedge funds broadly gained 3.9 percent through August, HFRI data show, while the MSCI Emerging Markets Index lost 12 percent and the Standard & Poor’s 500 Index rose 15 percent.

While booming economies such as in China, Brazil and India have been fueled by consumer demand, the bearish case against emerging markets is based on the view that global capital flows have primarily sparked asset gains. The combination of slower growth and the Fed curtailing its monthly bond purchases will accelerate the pace of redemptions, triggering a slump for stocks, debt and currencies, Bakhramov and other hedge-fund managers predict.

The Fed said yesterday that it wants to see more evidence that the U.S. economy is improving before reducing its bond buying. Economists had forecast the central bank would dial down U.S. Treasury purchases by $5 billion to $40 billion, while maintaining its buying of mortgage-backed securities at $40 billion, according to a Bloomberg News survey.

Markets Rally

The MSCI Emerging Markets Index jumped 2.3 percent as of 9:34 a.m. today in London, the biggest gain in more than two months. A group of the 20 most-traded emerging-market currencies rose to the highest level since June, and JPMorgan’s index for dollar-denominated bonds in developing nations posted the largest rally in almost three months.

Before the Fed’s announcement emerging-market currencies were headed for their biggest annual decline against the U.S. dollar since 2008. Still, those that fell the most after Bernanke first hinted at tapering, the Indian rupee and the Indonesian rupiah, haven’t led to windfalls for hedge funds, said GAM’s Lawler.

The rupee and rupiah aren’t liquid enough to bet against in a meaningful way, leaving hedge funds to focus bearish wagers on currencies such as the South Korean won, which should fall if economic growth in China slows, Lawler said. The won trade hasn’t worked this year, as it’s gained 4 percent since May 22.

Brazilian Real

A trade that some hedge funds missed is the Brazilian real’s slide, Lawler said. Instead of betting on the currency, money managers wagered that slowing growth would lead Brazil to cut interest rates, he said.

Stephen Jen, the former global head of currency research at Morgan Stanley who now runs London-based SLJ Macro Partners LLP, was one of the earliest and most vocal hedge-fund managers predicting an emerging-markets slump. He said during a February 2011 conference at the London School of Economics that emerging-market stocks and bonds would underperform. He’s since been quoted in articles by Bloomberg News, the Economist and other publications warning that slowing growth and the reversal of capital flows will crush currencies.

‘Significant Weakness’

Jen, whose firm also helps institutions and corporations hedge their risk to currency moves, remains convinced that the worst is yet to come. In a note to investors this month, he said the International Monetary Fund estimates that investors pumped $7.7 trillion into emerging markets over the past decade. Data indicate that just 10 percent of that has been pulled, and the Fed hasn’t even started tapering, Jen said.

“We remain firmly in the camp looking for further significant weakness,” he wrote in the Sept. 4 letter obtained by Bloomberg News. “Sell-side analysts have been too bullish on emerging markets based on the demographic trends, oblivious to the emerging-twin deficits, the overextended credit cycles and extreme valuation of both the currencies and the underlying assets.”

Jen’s SLJ Macro Fund, which trades developed market and emerging-market currencies based on global macroeconomic trends, rose 13.3 percent in the first eight months of this year and is up 15.7 percent since it started trading in November 2011, the letter shows. Unlike most hedge funds, SLJ reports its performance excluding fees. The fund charges management fees ranging from 1.5 percent to 2 percent to oversee clients’ money and pockets either 15 percent or 20 percent of any investment gains it makes on trades, according to the investor note.

Jen, 47, declined to comment on his investment performance or how much money he manages at SLJ.

Bakhramov’s Performance

Russian-born Bakhramov, who previously structured asset-backed securities at Credit Suisse Group AG, outperformed peers during Forum’s first six years of trading. He never posted an annual loss, a run that included an average annual gain of about 42 percent from the start of 2007 through the end of 2010, said investors, who asked not to be identified because the returns aren’t public. The hedge-fund industry had an average annual gain of 4.2 percent over the same four years, HFRI data show.

Difficult 2012

Then came 2012. Bakhramov positioned his portfolio for an emerging-markets slump and lost 20 percent. The hedge-fund industry rose 6.4 percent last year. Bakhramov told investors in his New York-based Forum Asset Management LLC that he watched in disbelief as central banks continued to pump endless amounts of money into the global economy.

With the Fed now laying the groundwork for pulling back, he said his time has come. The jump in interest rates prompted by Bernanke just talking about tapering shows that preventing a further rout in emerging markets may be beyond central banks’ control, especially if developing nations and companies start struggling to fund themselves, Bakhramov said.

Among the trades he’s put on is a bet against the Chinese yuan and buying credit-default swaps on ArcelorMittal and Glencore Xstrata Plc, derivatives that pay out if the creditworthiness of the companies weakens, clients said. While the Forum fund was up about 6 percent this year through August, it lost money this month when emerging-markets rallied after China reported export and production figures that exceeded economists’ estimates.

Ali Akay

The September rally shows “people are still complacent that the Fed will take care of every problem,” Bakhramov said. “The mistake that people are making now is that they have accepted that emerging markets are an issue, but they don’t think it will be a big issue. We have our doubts.”

A hedge-fund manager who has successfully picked which emerging-market stocks will rise and fall this year is Ali Akay, a former SAC Capital Management LLC trader whose London-based Carrhae Capital LLP has gained about 9 percent through August, investors said. His $480 million hedge fund made money in July shorting potash companies that plunged after OAO Uralkali, the world’s largest producer of the soil nutrient, abandoned production limits that underpinned prices, a note to Carrhae’s investors shows.

Akay, 36, and Rob Kirkwood, Carrhae’s head of business development, didn’t respond to requests for comment.

In a short sale, traders bet stock prices will fall by borrowing shares from a broker and selling them. They plan to buy back the stock at a lower price, return the shares to their broker and pocket the difference as profit.

No Clarity

Investors should probably avoid hedge-fund managers wedded to either bullish or bearish views on emerging markets until there’s more clarity about the effects of the Fed curtailing its stimulus and the turmoil in the Middle East over Syria, said Alper Ince, who helps oversee $9 billion at Pacific Alternative Asset Management Co. in Irvine, California.

“You want someone who can trade these markets nimbly, going both long and short,” said Ince, whose firm invests in hedge funds on behalf of clients. “Emerging-markets underperformance looks overdone to me since May, but I’m not in the position to say now is the time to load up on exposure because there is so much uncertainty.”