Singapore Hedge Fund

Alternative asset management in Singapore

Investing in hedge funds in emerging markets.

Here is a very good analysis from the guys at I particularly like the conclusion:”using hedge funds to implement emerging market conviction is much more likely to generate attractive returns over the investment horizon than a passive investment”…

After being beaten up along with most hedge fund strategies in 2008, emerging markets hedge funds are roaring back this year along with the fortunes of their target regions.  Hedge Funds Review reports that,  “While prone to volatility, emerging markets hedge funds have historically posted strong gains following market bottoms. In the 12 months following the trough of each of the five largest performance declines, funds have produced an average gain of 23.3%.”

And Citigroup recently told Bloomberg News, “There is going to be an outsized investment back into Asia. Some of the big pensions are going to be looking at Asia; it’s coming onto the radar screens.”

We wondered if this was just a matter of emerging markets beta, or whether emerging markets hedge funds provide added value? For a perspective on this, we turned to our resident emerging markets expert, Peter Douglas, for more. As many of you are aware, Peter is the founder of Singapore-based hedge fund consultancy GFIA, and is a regular contributor to

Special to by: Peter Douglas, CAIA, Principal, GFIA pte ltd.

For long-term investors, hedge funds are the most prudent approach to access the opportunities inherent in emerging markets.

Emerging market equity investing has typically been characterized by dramatic price movements through market cycles in both directions.  In addition, the inefficient, diverse and often rapidly developing nature of emerging capital markets creates challenges which can create unexpected risks for non-specialist investors.

In a recent report, GFIA analyzed how hedge funds specializing in emerging market investing can both exploit these market inefficiencies, and protect themselves from extremes of price movements, thereby generating stronger risk adjusted returns over time.  The paper further evaluates the performance of emerging markets hedge funds against traditional investment methods, including long only funds, using various metrics. The key conclusions of the study are:

  • On a risk adjusted basis (whether risk is measured as volatility or drawdown), emerging market hedge fund aggregates have performed better than both the broader emerging market equity indices, and developed market indices.
  • Emerging market hedge funds have relatively low correlation with developed market asset classes for most time periods in the last 8 years.
  • Adding emerging market hedge funds to traditional portfolios creates powerful diversification benefits which can expand portfolios’ efficient frontiers.
  • During periods of falling markets, hedge funds exhibit lower drawdowns than their underlying markets. This in turn enables them to recover more swiftly when markets return to an upward trend, providing more powerful compounding than unhedged investing.
  • Finally, a terminal wealth study of hedge fund returns versus mutual fund returns demonstrates that, over holding periods of both 5 years and 3 years, terminal wealth from portfolios of hedge funds is superior to that from mutual funds, regardless of starting year of investment.

Emerging market investing

Investing into emerging markets over the long term has been rewarding, though volatile, as the tables below indicate:

While passive investments in emerging markets have performed well over the long-term, Investors can best take advantage of the growth opportunities of the emerging markets whilst insulating themselves from market volatility and inefficiencies, by investing through skill-based investment strategies such as hedge funds and non-benchmarked absolute return funds.  The following table and chart demonstrates the effect of investing into hedged strategies in emerging markets.

The advantage of skill-based investing comes both from the compounding effect provided by absolute return strategies in providing downside mitigation, and also from the diversification effect of using multiple and disparate investment strategies to access the inefficiencies in emerging markets.  Mitigating the deep drawdowns of emerging market equity indices (which hedge funds do) allows a long-term investor to compound their returns much more effectively, and the diversification of multiple investment strategies creates a lower volatility return profile at the portfolio level.

In the recent research paper (ed: available here with free registration), GFIA used an approach pioneered by Pierre Hillion of INSEAD, to demonstrate the persistent effects of a hedged approach to emerging market investing.  This approach ignores short term volatility and market timing issues, and instead focuses on the real-world outcome desired by almost all investors – achieving acceptable returns over a certain time period.

Our analysis demonstrates clearly that portfolios with hedge funds have better returns in all scenarios except in a strong bull market.  However, and given that no investor has prior knowledge of market conditions over the medium to long term, the conclusion is consistent: using hedge funds to implement emerging market conviction is much more likely to generate attractive returns over the investment horizon than a passive investment.

Jean Viry-Babel
senior partner
VBK partners

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