Ten years ago, investors worldwide were investing in Brazil, Russia, India, and China (BRIC) in order to catch the strong wave of growth and development being predicted for those markets, particularly Brazil. Many investors still are seeking such opportunities. However, there are also many investors that believe the “next Brazil” is the continent of Africa, and they are striving to find an appropriate investment plan for this complex and under-researched continent.

Recent economic data legitimizes the optimism investors are showing for Africa. As of April 2010, funds focused on both the Middle East and North Africa (MENA) gained 7.76 percent year to date.1 Even more impressive was the 9.3 percent gain during the month of March. This is the highest monthly gain for the index since the inception of Hedge Fund Research’s coverage of the region.2 Also as of March, this index had a 12-month return of 28.31 percent.

Many economists believe there are various aspects of the African economy that are under-estimated and under-researched. These include countries such as Nigeria which has a very undervalued banking sector. Additionally, economists continue to stress that there is a great deal of opportunity within the oil, gas, and telecommunications sectors of Nigeria – which is thought to be one of Africa’s economic leaders behind South Africa.3

There seems to be positive sentiment for countries other than Nigeria as well. The continent’s lack of overall infrastructure, specifically in Kenya and seven other African nations, points to opportunity for wireless providers. Such providers and businesses are either entering the region or expanding their operations. Campaigns such as “One Laptop Per Child” is also fueling the continent’s growth in technological development and awareness.4

Some investors have looked to the 20th century for lessons in sound investments that they can take into the 21st. In hindsight, it was a wise decision to invest in Japan after WW II, in Southeast Asia during the 1970’s and, during the past 15 to 20 years, in BRIC countries.5 These were all frontier markets at certain points in time. Investors who see this consider it a no-brainer to invest in what is expected to be the next profitable frontier market. Although there are many investors with this belief, there are still many who greatly underestimate the African continent or simply don’t see sustainable growth potential.

Within the last month and a half, on several occasions, BHA research analysts spoke with investors seeking African-focused hedge fund managers. They included an investment consultant in the U.K., a corporate pension in Latvia, and a fund of hedge funds in Switzerland.

When speaking with the Swiss-based fund of funds, the CIO had a perspective on African markets that was unique because it was a combination of both positive and negative sentiments. On the positive side, he believes that investment capital will trickle down from the BRIC countries to the frontier markets, specifically Africa. He noted that there have been inflows of capital to the region and he expects it will continue. There are the obvious growth signals as well. First-tier African nations such as South Africa have a growing hedge fund industry and a well-advancing economy. Again, there are nations such as Nigeria with banks that are “dirt cheap.”.And Nigeria along with countries such as Angloa and Zimbabwe have extremely young populations that are consuming massive amounts of domestic products, a trend that is expected to continue to grow.

What was also intriguing to this CIO is that in a large portion of Africa, it is extremely difficult for businesses to obtain financing from banks and other lenders, which means they must be self-sufficient, using their own cash flow to grow their businesses. He also anticipates that those investors that missed out on the emerging market boom of the last 15 to 20 years will want to get involved in the “next Brazil”.

On the negative side, the CIO does not believe the region has long-term growth potential, and he recognizes that the great weaknesses and flaws in the continent cannot be ignored. These include a lack of infrastructure, a lack of national identities in the majority of nations leading to civil unrest, a lack of leadership, poor or inconsistent governance, and “huge” structural and operational issues in the countries’ governments and economies.

Although the CIO believes in the negative long-term effects of these weaknesses, he is striving to be a front runner in the wave of investor interest and capital toward the region. The firm has a two- to four-year bullish outlook on Africa, and feels that because the market capitalization within these markets is extremely small that an investor could double or triple an investment in a very short time period. However, he believes it is extremely important that investors navigate this region and time period very tactically with liquid investments. Private equity, which is illiquid, is very susceptible to the instability and economic risks, such as hyper-inflation, that have plagued certain African nations at times. He will be trying to ride this wave by seeking strong directional long-biased managers in the short term.

The next five to ten years are somewhat unclear for Africa. Investors will learn whether or not Africa truly is the next emerging market. It is clear is that investor interest and capital is entering the region, but it is not clear for how long it will last and if it will be sustainable in the long term.

1 HFM Week, “BRIC and beyond,” April 21, 2010, http://www.hfmweek.com/features/527447/bric-and-beyond.thtml.

2 Hedge Funds Review, “Investors wary of high-performing emerging market hedge funds,” May 20, 2010.

3 HFM Week, “BRIC and beyond,” April 21, 2010, http://www.hfmweek.com/features/527447/bric-and-beyond.thtml.

4 Wealth Daily, “Investing in Africa with ETFs,” March 8, 2010, http://www.wealthdaily.com/articles/africa-economic-growth-beats-forecasts/2363.

5 Hedge Funds Review, “Insparo Africa and Middle East Fund: Insparo Asset Management,” May 27, 2010, http://www.hedgefundsreview.com/hedge-funds-review/profile/1648929/insparo-africa-middle-east-fund-insparo-asset-management

A benefit of being a BHA research analyst is hearing the countless views and opinions of hedge fund, private equity, and real estate investors. From call to call and day to day, BHA analysts hear a wide variety of interpretations of alternative strategies. An area that generates a lot of debate is commodities and managed futures investing. Many investors have a preference for how these managers approach their trading day

The BHA Quarterly Research Report | Q1 2010 noted a recent rise in investor interest in the high-frequency, algorithmic trading strategies that are often associated with commodities and managed futures funds. Trading-oriented investors are conducting more research of these sophisticated—and at times controversial—short-term trading operations.

Although these high-frequency trading programs have attracted many investors, there are still many that prefer near to longer-term, discretionary strategies. And for every manager that seeks market momentum and quick gains, there are many others that remain focused on steady, long-term growth.

This past week, a BHA analyst spoke with a portfolio manager overseeing research and fund selection at a wealth advisory firm. He was searching for commodities and managed futures funds, preferably funds of funds. The firm is focused on true discretionary managers that have longer-term holding periods. It knows that very short-term, systematic and algorithmic funds are an attractive and new niche. However, it also finds that it is difficult to understand the many facets of high-frequency trading and interpret them for clients.

Many investors also want the ability to speak with a portfolio manager who is able to clearly articulate why he or she decided to buy or sell a certain commodity or futures contract at a certain time. This is preferable to being told that such decisions are incorporated into an efficient and automated trading model. They want old-school traders that use their own market knowledge and experience to make trading decisions rather than a systematic or black-box trading model.

The portfolio manager who spoke with a BHA analyst last week recognized that many of these algorithmic trading platforms are able to prove their worth at times with high, attractive returns. However, he also stated that there are times when such models can hurt a portfolio because they don’t have the ability or foresight to change their view or position on the market as a whole.

Many who fall in line with this opinion point to the drop in performance among many systematic commodities and managed futures funds from 2008 and 2009. During 2008, short-term trading commodities and managed futures funds were able to outperform the vast majority of other hedge funds and caught the attention of many investors. However, this was followed by very mediocre performance at best during 2009, when many shorter-term commodities and managed futures managers struggled to profit.

Although there are many investors that pursue commodities and managed futures traders to add volatility and great short-term returns to a portfolio, these funds can serve a different purpose. Many investors incorporate this asset class into a portfolio that is designed for long-term growth and preservation of capital over a span of quarters and years as opposed to days and weeks.

The financial crisis of 2008 has altered the way investors view the world’s economy and especially the mortgage-backed securities sector. At the heart of the steep stock market decline and decrease in investors’ appetite for new investments was the mortgage and credit crises. In the months and years leading up to the credit markets near collapse in the fall of 2008, many large and well-known lenders throughout the developed world became far too liberal and aggressive in issuing sub-prime mortgages. These mortgages were then packaged and repackaged in hard-to-understand investments that became dangerously illiquid and unattractive to almost any investor. In the end, this hurt not only the lenders but also the market at large.

Lately, there has been some sentiment among economists that the residential real estate market has bottomed out. This may lead some to assume that there could be a trend toward investment in mortgage-backed securities by investors that want to get ahead of the industry’s recovery. However, throughout 2009 it was clear to BHA’s analyst team that investor sentiment toward mortgage-backed securities was bleak. In fact, they remained one of the least popular hedge fund strategies among investors.

In early September, an analyst spoke with the president of a wealth advisory firm based in Illinois. He articulated an interest in niche opportunities such as PIPES/Regulation D, capital structure arbitrage, and asset-based lending funds. However, he specified that the firm wanted no exposure to real estate through asset-based lending or mortgage-backed securities funds. Also, he and many of his colleagues in the industry had no plans to have any exposure to real estate-related strategies for the foreseeable future despite the fact that there was sentiment that the industry may have bottomed out.

After reviewing investment data compiled by BHA analysts and receiving similar feedback from many investors, it remains clear that the mortgage-backed securities market continues to face increased scrutiny and decreased popularity. Even those who remain optimistic about such investments admit that it will take years before mortgage-backed securities products regain investors’ trust.

A vice president of a family office in Dana Point, California, spoke with a BHA analyst in late October and again in early January regarding her interest in U.S.-focused mortgage-backed securities managers. She explained that the majority of her clients are retired individuals who have a need for steady and reliable income. As a result, she has focused her search on finding managers that offer full transparency and have portfolios comprised of “seasoned mortgages”—securities that date prior to the newer and toxic mortgage products created after 2005. Although her firm remains interested in mortgage-backed securities and considers itself an opportunistic investor, she agreed that credit markets still have to loosen up a great deal before interest in the mortgage-backed securities market returns in full force.

For the past two years, the hedge fund industry has been expecting sophisticated investors to begin looking toward the Middle East specifically and Africa as well to get an inside edge on the hidden investment opportunities in these regions. These two large areas are made up of underdeveloped economies that some believed had long-term potential. Although both regions have fallen victim to a great deal of misgovernment and economic stagnation over much of the last century, many industry players saw attractive investment opportunities.

One of the main reasons why various fund managers anticipated such investor interest was that the major world equity and fixed-income markets were so puzzling. Unable to foresee where the markets were headed, many managers expected a new trend: investors researching regions they had previously overlooked or disregarded, specifically in the Middle East and North Africa. Sentiment overseas was similar. An article published by Hedgeweek stated: “…industry players and governmental agencies in the region are rubbing their hands with glee, as seasoned foreign investors, failing to find any kind of rhythm in developed markets, are seeing the Middle East as their new investment Mecca.”1

Although some investors recently interviewed by BHA have expressed an interest in both the Middle East and North Africa, research analysts have not noticed a significant increase in interest in these two regions. In fact, many investors are skeptical of such investments. In mid-July, a BHA analyst spoke with the managing director of an investment consulting firm located in Portsmouth, New Hampshire. In previous conversations, the firm had mentioned that it may have an interest in emerging and frontier market opportunities in lesser developed economies late in 2009 or early in 2010. However, the firm has now labeled such investments as “gambling” and stated that during such uncertain times, investing in volatile and under-researched regions was no longer an attractive opportunity for the firm.
The recent events at Dubai World, a government investment company that has been at the forefront of the region’s largest and most ambitious projects, will not help attract investor interest in the Middle East near term. When word spread through international media channels that Dubai World had requested a stand-still to repay some of its debt, traders and investors around the world began to fear that the impact of the global financial crisis had not been fully felt by the world’s economy, and particularly by the developing regions of the Middle East.2

Of the roughly 2000 hedge fund mandates compiled by BHA research analysts thus far this year, only 114 have specified an interest in the Middle East, 120 in Africa, and 40 in frontier markets. Although there is no arguing with the fact that there are strong growth drivers and investment opportunities in these regions, the vast majority of investors still prefer exposure to the traditional and more developed markets such as Europe and the U.S. It seems that it will take more time before the majority of investors to warm up to the idea of investing in the Middle East, Africa, and similar frontier markets.

1 Hedgeweek, “The New Investment Mecca,” October 11, 2008.
2 Telegraph, “Dubai default fears rock markets,” November 26, 2009.

Since the beginning of 2009, the research analysts at BHA have found that the three most popular hedge fund strategies have been long/short equity, global macro, and CTA/managed futures. The strong interest in long/short equity and global macro strategies is not surprising. These are original, core hedge fund strategies. Many investors have reverted back to these with the hope that markets have stabilized and that these traditional strategies, which focus on the stock markets and inefficiencies in the global economy, will be wise investments in the long term. An example of this sentiment was articulated by the managing director of a wealth advisory firm located in Boca Raton, Florida. He explained that after experiencing the market volatility and chaos of the last 18 months, both he and his clients felt more comfortable investing in old-school and talented stock-pickers that run long/short equity portfolios. He further explained that traditional long/short equity strategies are easier to understand, and they make more sense now that the stock market has seemed to calm and bottom out.

CTA/managed futures strategies usually involve a higher degree of leverage than most other strategies and are susceptible to greater volatility. In many instances, these funds entail black box or quantitative strategies that deter many investors because of their complexity and untraditional approaches. After the worldwide economic turmoil of the past two years, it would seem unlikely that a significant portion of hedge fund investors would still have an appetite for this strategy. However, data compiled by BHA research analysts tell a different story. Year to date, there have been 708 investors that have articulated an interest in CTA/managed futures funds, 331 of which have voiced an interest during the past four months. This is the third most popular strategy among hedge fund investors. The greatest interest has been in long/short equity managers (1,137 mandates) followed by global macro managers (875 mandates).

When providing mandate information to BHA analysts, many investors specify their manager requirements. A common criterion has been that prospective managers use a quantitative approach. Year to date, 250 investor mandates have stated this requirement.

The driver behind the rise in CTA/managed futures interest is the performance of the HFN CTA/Managed Futures Index. In 2008, it outpaced the rest of the hedge fund industry. Many talented commodity and futures traders profited from the pricing extremes in these markets. For example, oil reached an all time high of $147 a barrel in July of 2008 before falling to $32 a barrel the following December. During such times, numerous CTA/managed futures managers employed systematic and strong trend-following strategies, and took full advantage of the markets. These managers also provided better liquidity terms compared with the rest of the industry because of the high-frequency, short-term trading involved. CTA/managed futures were one of a select few hedge fund classifications that produced positive average performance in 2008. The HFN CTA/Managed Futures Index outperformed the broad industry index by 25 percent. (See: Strategy Focus Report: CTA/managed futures by Peter Laurelli http://www.hedgefund.net/publicnews/default.aspx?story=10480).

The past two years have brought a great deal of volatility to world markets. Equity markets around the world sharply declined, and in many regions, credit markets collapsed. In addition to dealing with the reality that the world economy was in the midst of a historic recession, many hedge fund investors had to face the fact that they had few options since their capital was not readily available.

BHA analysts have recently heard a number of investors express their desire and need for better liquidity terms from hedge funds. A manager of a fund of hedge funds in England stated that he and many of his colleagues now believe that lock-up periods have given the industry a “black eye”, and that such fund structures that restrict an investor’s ability to access their invested capital is unethical. An investor mentioned an interest in investing in emerging markets, but the firm was hesitant to invest through an emerging markets hedge fund as it had done in the past. The firm preferred to use instruments that provide exponentially better liquidity, while still providing excellent diversified exposure to specific emerging-market nations. The investor believed that an emerging markets exchange-traded fund (ETF) would be the ideal instrument to use rather than an emerging markets-focused hedge fund.

ETFs are relatively new and innovative products that offer investors the diversification of traditional mutual funds or even hedge funds, but with the liquidity of stocks that trade intraday. ETFs enable investors to get excellent diversification, and similar to hedge funds, ETFs allow investors to profit in both up and down markets; investors have the ability to go long or to short certain indexes, regions, and sectors. can also employ leverage that will enhance potential profits and losses, as do many hedge funds. Recently, ETFs have gained a great deal of sophistication through tracking and replicating certain hedge fund strategies. The first such ETF was IQ Hedge Multi-Strategy Tracker (QAI), which was launched in March of this year.

During the past year, BHA analysts have been gauging investor demand for better liquidity terms. One might assume that the effects of this economic recession along with many investors’ inability to gain access to their invested capital, would have led to a strong demand for better redemption terms and a decline in the number of investors that would invest in funds with a lock-up period. However, only part of that assumption is true.

So far in 2009, there has been a strong demand for both monthly and quarterly redemption periods. Of the hedge fund investors interviewed, 585 required monthly liquidity or better, and 815 required quarterly liquidity or better.
Only 32 hedge fund investors stated that they would be comfortable with yearly liquidity, and 307 said they had no preference. Clearly, investors prefer hedge fund managers that can provide defined liquidity terms that are better than semi-annual.

However, it is important to note that lock-up periods have not been neglected by hedge fund investors in their search for a suitable manager. This was articulated by a research analyst at a fund of hedge funds in New York City. She stated that her firm has always and will always be encouraged by funds that have lock-ups as a part of the fund structure. They, like many investors, still see lock-ups as a sign of funds’ stability and operational abilities. Year to date, the ratio of investors that are looking to invest in funds with lock-ups as opposed to those who are not is more than 2 to 1. Of the hedge fund investors profiled by BHA analysts in 2009, 1,151 stated that they would consider a fund that imposes a lock-up, while only 533 stated they would not.

This data clearly shows that investors remain open to lock-up periods. While the majority of investors desire better redemption terms that are more investor friendly, the majority of investors also still see lock-up periods as a sign of stability within a fund. Lock-ups allow managers to avoid redemption outflows that can seriously hamper their operations and even put them out of business.