US bond rally eases pressure on emerging market hedge funds


Falling US bond yields and a weakening dollar are helping drive a recovery in emerging market-focused hedge funds, after some managers including $12bn-in-assets Pharo Management struggled following a tough start to the year.

Emerging market funds gained 1.9 per cent last month, according to data group Eurekahedge, ahead of a 1.1 per cent gain among hedge funds more broadly. That leaves them up 5.4 per cent this year, still behind average hedge fund gains of nearly 8 per cent.

Emerging market managers have been benefiting from a recent decline in US Treasury yields, which soared earlier this year as the easing of coronavirus lockdown restrictions raised investor expectations of a strong US economic recovery and rising inflation.

The 10-year Treasury yield soared from 0.9 per cent at the start of the year to more than 1.7 per cent at the end of March as prices fell. However, it has since fallen back below 1.5 per cent, driven in part by rising US-China tensions.

Investors often pull out of emerging markets when US growth picks up and Treasury yields become more attractive, but they tend to pour money back in when US bond yields fall. The weakening of the dollar over the past two months has also helped to push down the costs of servicing debt in emerging markets, as a lot their debt is denominated in the greenback.

Line chart of US 10 year bond, yield % showing US treasuries have rallied

London-based Pharo, which is headed by former Merrill Lynch banker Guillaume Fonkenell and which is one of the world’s biggest emerging markets hedge funds, was hit hard in the first quarter.

Its $5.6bn Gaia and $5.3bn Macro funds, which had both made money in each of the past five years, were down nearly 9 per cent and 7 per cent respectively at the end of March, according to numbers sent to investors, while its Trading fund was down around 11.5 per cent. The firm had been bullish on emerging markets and on some longer-dated emerging market bonds, said a person familiar with its positioning.

However, it has pared some of its losses over the past two months, benefiting from the more favourable conditions for emerging markets. Its Gaia fund is now down 6.3 per cent this year to the end of May, according to people who had seen the numbers. Its Macro fund is down 4.7 per cent, while its smaller Trading fund has lost 7 per cent, the people said.

“The last year has been tough for fund managers” in emerging markets, said Peter Sleep, senior portfolio manager at Seven Investment Management.

Pharo declined to comment on what had driven performance.

Other funds that have gained recently include London-based Carrhae Capital, which was up 2.7 per cent in its hedge fund and 4.5 per cent in its long fund last month, according to numbers sent to investors. The hedge fund has gained 2.1 per cent for the year, while the Long fund has gained 9.6 per cent.

Ali Akay, Carrhae’s chief investment officer and a former partner at hedge fund SAC, said that rising US bond yields had driven emerging market investors from growth stocks into value stocks, which had benefited some of its positions.

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