As Brevan Howard, the world’s third largest hedge fund, moved operations from London to Switzerland, Asia, the US and Channel Islands in 2013 to escape EU regulation and grow internationally, according to reports, its emerging market fixed income fund couldn’t escape a difficult market environment.
Brevan Howard: Emerging market debt
Brevan Howard’s Emerging Markets Local (BHEML) fixed income fund products ended broadly in the red in 2013 amidst a difficult market in emerging market debt, according to an investor letter reviewed by ValueWalk.
The long only J.P.Morgan Government Bond Index Emerging Markets Global Diversified fell 8.98%, the letter noted, and experienced significant volatility during the same period. The index fell more than 15% between May and September, a period during which the Brevan Howard’s Emerging Markets Local Class A shares were -1.92% in May, -0.65% in June, -0.21% in July and -0.19% in August. The roller-coaster ride continued in the J.P.Morgan index, as it rallied over 10% in September and October and then fell 6% from October to December. “Much of this volatility was influenced by news flow in Developed Markets (for example US Federal Reserve and Bank of Japan announcements), making overall position-taking in Emerging Markets assets difficult to time,” the report to investors said.
Brevan Howard: Roller coaster markets
Reviewing the roller coaster of a year in emerging market debt, the investor letter noted the year started on a subdued tone. “During the first quarter, Emerging Markets showed relatively little direction as participants’ attention was focused on Developing Markets, in particular US and Japanese monetary policy and, in Europe, on the aftermath of the Italian election and then Cyprus’ bailout,” the report said. “As a result the Fund’s net exposure to Emerging Markets remained subdued, although there were material idiosyncratic positions, both long and short. This led to subdued returns for the Fund, with Class A USD rising a modest +0.22% over the quarter, while the J.P.Morgan Government Bond Index Emerging Markets Global Diversified fell by -0.12%.”
Brevan Howard: Increasing volatility
As volatility increased in the second quarter, the fund’s strategy adjusted. “During the second quarter Emerging Market currencies and bonds rose initially as the Bank of Japan signaled an aggressive increase in quantitative easing,” the report said. “This overall strength in markets dominated single country risk, causing losses in the Fund’s short positions, especially in rates markets, which were not sufficiently offset by corresponding gains from long positions. As a result the interest rate shorts were reduced, and overall net duration taken slightly positive. Short positions in currency markets were maintained, but long positions were increased. Towards the end of May and through June, markets weakened sharply, reflecting concerns about to the potential tapering of US quantitative easing and the tightening of liquidity by the People’s Bank of China. As a result the long positions lost value and the Fund’s net exposure to Emerging Markets was scaled back, with short positions being concentrated in currencies vulnerable to deteriorating fundamentals or overweight foreign investor positioning.”
Overall, the J.P.Morgan Government Bond Index Emerging Markets Global Diversified fell by -7.04% during the second quarter, while the Fund (Class A, USD) fell by -3.80%.
Brevan Howard: QE tapering fears
Over the summer, emerging markets continued to be dominated by fears of tapering which impacted results. “Such fears continued to generate the reversal of the portfolio flows that had entered emerging market funds over the past few years. During this time, portfolio risk was generally maintained with relative little net emerging markets exposure and a focus on long-short positions reflecting different countries’ relative vulnerability. During July markets were calmer and portfolio outflows slowed. As a result the Fund’s FX positions moved moderately net long. However, in August tensions resumed and vulnerable emerging markets fell sharply again. Therefore long exposures lost money and were cut back. In September markets rebounded ahead of the FOMC. Ahead of the meeting, the Fund’s net exposure was maintained at a low level so as to avoid any sudden falls due any unexpected decisions at the meeting. In the event the FOMC decided to delay tapering and so net FX long exposures were increased again.”
Overall the J.P.Morgan Government Bond Index Emerging Markets Global Diversified fell by -0.43% over the quarter, while the Fund (Class A, USD) gained +0.18%.
In the fourth quarter, the market continued to lack a clear direction. “Emerging markets continued to oscillate based on expectations of tapering of QE, providing short-term volatility, although little net direction – rising in October, falling in November and December. The Fund’s net FX exposure remained relatively subdued, while continuing to hold short positions in vulnerable currencies and long positions in currencies with more stable fundamentals. A short position was built in rates markets.”
The J.P.Morgan Government Bond Index Emerging Markets Global Diversified fell by -1.54% over the quarter, the Fund (Class A, USD) fell by -0.44%.
2014 trepidation, nervousness predicted by Brevan Howard
In 2014 Brevan Howard notes with trepidation the unpredictable path and impact of US quantitative easing. “Emerging markets remain somewhat nervous with a focus on the impact of tapering of US QE,” the report said. “Where countries have received significant portfolio inflows in previous years, they remain exposed to further outflows which is likely to cause falls in the currencies, especially where the external balance is also negative. At the same time other countries have positive external balances and are less exposed to portfolio outflows. This combination should enable profits to be made from paired long and short positions as well as yielding more directional trading opportunities from time to time. Yields in several emerging market countries are low relative to both historical levels and inflation rates, leaving them exposed to rising yields globally with the result that a short position continues to be held in rates markets.”