Manager Monday: Gávea Investimentos

It’s not every day that a former Central Bank President runs his own Hedge Fund. And it’s not every day that he’s in charge of the main stock exchange in Brazil (Bovespa). Not surprisingly, he also worked alongside one of the best-known Hedge Fund managers of our time, George Soros. He’s even been described as the Alan Greenspan of Latin America. If you’re not impressed by Armínio Fraga Neto yet, keep reading.

Fraga Neto’s Gávea Investimentos is a Brazilian Asset Management company founded in 2003 and located in Rio de Janeiro. It manages around $7B, which makes it one of the largest alternative asset managers in Brazil. The holding company operates Hedge Funds, Private Equity Funds, and Mutual Funds. It uses in-house quantitative and macroeconomic research to support investment decisions. Since 2010, Gávea has been mainly owned by J.P. Morgan’s Highbridge Capital Management LLC. However, it recently disclosed the repurchase of its equity interests.

If you follow our blog, you’ll notice that this is the first time we’ve written about an Emerging Market manager. Unlike our previous Manager Mondays, we decided to utilize our Alpha Platform to derive insights based on public fillings submitted to the CVM (Comissão de Valores Mobiliários) in Brazil.

About our Data

Everything mentioned in this post is sourced exclusively from public data, including the manager’s profile, simulated performance, and all other analyses and commentary. The data used here omits the short side, many non-equity securities, and all non-public information such as actual fund performance and assets under management. The coverage of Gávea is limited and not necessarily representative of the full Private Equity and Hedge Fund portfolios. 

Emerging Market Currencies

Throughout 2015, the Federal Reserve (Fed) has indirectly deterred the performance of most Emerging Market (EM) currencies. Meeting after meeting, it has decided to hold domestic interest rates constant, delaying a painful decision for economies like Indonesia or Turkey. Nonetheless, market expectations have been smoothly priced in EM stock exchanges. For instance, the Jakarta Stock Exchange Composite Index has yielded a negative 16.89% return year-to-date (YTD). Similarly, the Borsa Istanbul 100 Index has lost 12.51% since the start of the year. This same trend is found across EM.

Even if interest rates are not the only factor leading to the depreciation of EM currencies (China’s fiscal and monetary policies are also being closely monitored), a rise in U.S. rates will lure capital away from EM, consequently depreciating EM currencies further. Another example is the Mexican peso, which started the year slightly below 15 USD/MXN and now stands at almost 18 USD/MXN.

Out of all Emerging Market currencies, however, Brazil’s Real has been the worst performing YTD. ‘Worst performing’ is putting it mildly, as this year’s cumulative loss brings the Real to its 13-year low, surpassing the 4 USD/BRL boundary.

With this in mind, it’s understandable that the performance of Brazilian Hedge Funds has suffered.

In the last twelve months alone, the HFRX Brazil Index, which aims to track the Brazilian Hedge Fund Universe, was down by 23.35%. The MSCI Brazil Index dipped even further and lost around 47%. What this means is that in the last year the large and mid-cap segments of the Brazilian market lost around half of their value. Furthermore, Bovespa, the most important stock market in Brazil, detracted 16%.

So how are Asset Managers supposed to make any money in Brazil?

How Does a Hedge Fund Invest in Brazil?

Tumultuous and downward markets are least favorable for equity products. Even if we can’t capture short exposure from Brazilian public filings, it’s safe to assume a significant underperformance of Brazilian managers in the last year.

Although the Hedge Fund industry was born to generate non-correlated absolute returns, in the face of crisis we’ve seen how even the best funds aren’t perfectly risk-managed.

Despite all the above, Gávea Investimentos has been able to create Alpha in the current Brazilian economy. While most of its peers such as Verde Asset Management or M Square Investimentos have lost money not just in USD, but also in BRL, Gávea has outperformed both Brazilian Hedge Funds and Brazilian benchmarks in the last year.

BRL returns (Gávea vs. Ibovespa: +77.69% delta)

USD returns (Gávea vs. HFRX Brazil: +25.13% delta)

How did Gávea achieve such results? What are the magic ingredients that drive its portfolio?

Gávea Investimentos’ Concentration

Gávea Investimentos public information for its equity and equity-like book shows a small number of securities. In the context of Brazil, the ability to choose the few securities that don’t lead to market down-capture is a huge challenge. In the case of Gávea, although the batting average has been rather poor, the capital deployed to winning securities has propelled a 20.4x win/loss ratio (excluding FX effects), mostly coming from its Private Equity investments.

The top 8 positions driving these results are:

These top 8 positions account for 96% of Gávea’s public portfolio and for all of its positive contribution in August 2014-August 2015. These investments are distributed among the several Gávea funds (Private Equity + Hedge Funds).

Gávea Investimentos’ Position Sizing

Gávea Investimentos’ position sizing decisions contributed positively to the portfolio (excluding FX effects). Had it equally invested all of its market value among the securities it held from August 2014 to August 2015, Gávea would have had a negative return of 7.71%. However, the inter-month position sizing decisions helped Gávea achieve a profit of 61.20%.

Gávea Investimentos’ Security Selection

Although the price of paper around the world has gone down around 20% in the last year, there are a few companies that have positively contributed to the Materials sub-sector. One of them is Brazilian Fibria Celulose, which comprises a substantial portion of Gávea’s public portfolio.

(Price in BRL)

Indeed, paper companies in Brazil have been the only securities in the Materials sector that have appreciated in price in the last year (other companies include Kablin and Suzano Papel e Celulose). Half of Gávea’s security selection alpha is attributable to Fibria Celulose during August 2014-August 2015. It is important to note here that Gávea disclosed a >5% stake in Fibria Celulose for its Gávea IV fund (Private Equity).

As the above graph shows, selecting the right securities in difficult markets could save an EM manager like Gávea from catastrophe.

Key Takeaways

As limited as the information may be for non-U.S. managers, there are skills and management decisions that many top tier Asset Managers share, regardless of their geography or exposure.

1. First, concentration: the most conviction in selected stocks and the more concentration, the more your book will maximize the gains of winning bets.
2. Second, position sizing: the better you allocate your assets among those securities that you value the highest, the better the cumulative and compounded performance of your portfolio.
3. And third, security selection: in any country there are always going to be winning and losing companies, even in market crises. The ability to correctly identify the right securities at the right time, the higher chance your portfolio will survive in a continued downward environment like Brazil’s.

Gávea Investimentos public simulation seems to have been following the above during the last year. It‘s by optimizing the portfolios that the Asset Manager is capable of avoiding the misfortunes of most of its Brazilian equity peers. Although it’s not possible to know what specific Gávea fund profited the most from this public simulation, Gávea Investimentos is definitely surviving the current Brazilian market and currency crises.

Nonetheless, Gávea is far from being free of risk. The big bets and substantial risk exposure of the last year could turn around substantially. Finally, currency risk will continue to pose a major challenge to all Brazilian managers alike.