Regionally Focused Funds in Higher Demand Than Their Country-Specific Counterparts
Since May 1, the VIX, a measure of the volatility of the S&P 500, increased from 20.19 to 33.73—a 67 percent increase in just over one month. With such high volatility, investors are looking for ways to mitigate the inherent market risk present not only in the U.S. but also worldwide. Some investors have turned to short-biased funds, which can capitalize on recent slides in stock markets, while others feel that the path to a successful investment portfolio is through broadly diversified exposure.
During the month of May, BHA analysts gathered 126 mandates for long/short equity funds. In evaluating this data, a telling trend has emerged. In three of the four major regions in which BHA gathers investors’ preferences for country-specific and regionally focused funds, investors overwhelmingly favored regionally focused funds.
In Asia (including Australia), Latin America, and Europe, investors favored funds with a regional focus to those that concentrated on the equity markets of a single nation. In fact, only in North America were investors more interested in a country-specific fund (U.S. focused) than a regionally focused opportunity.
In the Middle East and Africa, BHA does not collect data on country-specific funds so a comparison is not possible here. However, it is worth noting that nearly 10 percent of all long/short equity mandates were for MENA or frontier market funds.
Of the mandates that specified some interest in pan-Asian investments, 56.5 percent were for funds with a broad focus across the region. The remaining 43.5 percent of investors specified an interest in country-specific funds within the region, mainly China, India, and Japan.
In Latin America, a similar trend was evident. 52.6 percent of mandates gathered for the region were interested in funds investing across Central and South America. The remaining 47.4 percent of investors were considering country-specific funds, predominantly funds focused on Brazil.
The comparison was stark when we examined preferences for managers within Europe (including the U.K.). Investors looking for funds in this part of the globe favored those investing across European equity markets 78.9 percent of the time. Only 21.1 percent of investors were interested in country-specific funds, predominantly U.K.-focused managers.
One possible explanation for this overwhelming trend towards regionally focused managers comes from the simple theory of portfolio diversification. With volatility rampant across global markets, many investors fear that funds concentrated on only one country’s stock market are exposing themselves to unnecessary risk.
Other investors may simply believe that country-specific funds are too focused and that the domestic market alone does not provide ample investment opportunity. Such investors would be driven to a regional fund as it can provide (in sheer quantity) more investment choices, as well as more complex arbitrage opportunities as fund managers are able to capitalize on pricing inefficiencies across international markets.
Furthermore, many investors believe that small domestic markets have few genuine shorting opportunities. In such markets, funds often short indexes as opposed to the stock of individual corporations. While this technique may accomplish a similar goal to shorting corporate stocks, many investors prefer funds that can generate alpha due to their unique understanding of individual listings and an ability to stock pick more effectively than their peers.
Whatever investors’ rationale, it is clear that there is a strong preference for long/short equity managers that are focused regionally as opposed to their country-specific counterparts.