One of the most successful emerging market investors has said that the current EM sell-off does not amount to a crisis for an asset class that has been a favourite for fund managers in recent years.
“[US president Donald] Trump’s incipient trade war and country-specific concerns in Russia, Turkey and Argentina provided the catalyst for the correction,” Guillaume Fonkenell, the founder and chief executive of Pharo Management, told the Financial Times. “EM fundamentals remain overall attractive for fixed-income investors and I expect inflows to resume within weeks.”
A strengthening dollar has put Turkey and Argentina at the sharp end of the pressure on emerging markets over the past month, prompting the first two-week spell of outflows from emerging market bond funds since 2016.
“ Turkish assets will probably remain under pressure, though, as President [Recep Tayyip] Erdogan is hamstringing the central bank by criticising the current level of interest rates,” said Mr Fonkenell. “Argentina is not yet out of the woods as the government is discovering the hard way that they can’t have it both ways, ie maintain sustainable economic growth while running large fiscal and current account deficits.”
Pharo had some of the highest returns in the industry last year, with its two largest funds — the $4.5bn Macro fund and the $4.5bn Gaia fund — returning 16.5 per cent and 27 per cent respectively. They generated gains of close to 7 per cent and nearly 5 per cent at the end of the first quarter.
The wider hedge fund industry returned about 9 per cent last year, and was flat through the first quarter, according to data from eVestment.
The recovery in the dollar over the past month has unnerved EM markets, where national and corporate borrowers have taken on more debt denominated in the US currency.
But Mr Fonkenell, who after founding the fund in New York in 2000 moved it to London in 2005 to make it easier to trade global markets, said he remained bearish on the US currency. “The US dollar usually rises during EM corrections because US-based investors dump assets that are denominated in non-US currencies,” he said.
“For any investor looking beyond the current correction, the dollar does not offer an attractive investment proposition. The headwinds it has faced since Trump’s inauguration are still there, including the unpredictability of a populist president trying to promote an economic model that became obsolete 50 years ago,” he added.
Based on a history of populist leaders having a negative effect on their country’s currency, Pharo bet that the dollar was likely to drop against both emerging and developed markets currencies following Mr Trump’s election. US policies may continue to have the greatest bearing on Pharo’s portfolio and the global economy over the next year, Mr Fonkenell said.
“There are two big uncertainties in the US,” he said. “One is the Fed: how far and how fast is the Fed going to hike rates? And, the other one is Trump: how disruptive is Trump going to be to the US economy and to the global economy? Those are the two sources of volatility we see so far this year.”
If Mr Trump’s power is diminished by more Democrats scoring successes at the midterm elections in November, Mr Fonkenell said that “would probably be good for the US economic cycle and maybe it would prolong the cycle a bit longer, but Trump continuing to be very disruptive will probably shorten the US, and hence the global, economic cycle”.
With the exception of its Africa fund, Pharo, which trades sovereign bonds, currencies and interest rates, has generated double-digit annualised returns in all of its funds over the past five years.
Mr Fonkenell said he was “puzzled” by his competitors’ underperformance, and the claim by some hedge fund managers that a lack of volatility in recent years has hurt their chance of finding top trades was an excuse.
“I don’t buy the volatility argument,” Mr Fonkenell said. “There has been some volatility in developed markets. The euro moved 20 per cent in the past 18 months. Treasuries have been moving by 100 basis points just in a few months in yield. The yen moved a lot last year. Things are moving in the developed world. So I think the reason why my competitors have not performed is elsewhere.”
At $10.5bn, Pharo is one of the largest macro hedge funds in Europe, despite keeping its four main funds closed to new capital. Funds such as Brevan Howard and Rokos Capital each manage about $8.5bn. When Pharo’s funds grow in size because of performance, like last year, the company returns money to investors.
“It’s annoying and I wish that they were doing better,” Mr Fonkenell said. “I think one of the reasons the industry has not performed well is that you can live very well off of the 2 per cent management fee. Once you have $10bn-plus under management, I think your incentive switches from performing well and generating alpha to maintaining these assets and generating a performance which is just good enough to prevent your investors from leaving.”
Mr Fonkenell said turmoil in several emerging markets, including Argentina and Turkey, will remain. But he is accustomed to swings in sentiment towards EM, recalling that investors were “very much slamming the door on me” when he and former Merrill Lynch colleagues founded Pharo with just $11m. At the time, Russia and Ecuador had defaulted on their debt and Brazil had devalued its currency.
More recently, Mr Fonkenell set up the Pharo Foundation, a charity that promotes economic development in Africa by focusing on job creation, education, training and agriculture. At some point, he plans to gift the hedge fund to the foundation.