1. Claritas
Overview
Latin America accounts for 6% of the world’s GDP and 9% of the world’s populationi
. But its
capital markets are bigger than those numbers would suggest. Some Latin assets, notably
fixed income and derivatives, are very liquid – according to an EMTA surveyii
, more than US$ 3
trillion of Argentinian, Brazilian and Mexican debt instruments (including local instruments and
eurobonds) were traded in 2006, which is equivalent to a daily turnover of approximately US$
12 billion.
Similarly, it’s not an exaggeration to say that Latin America is still an under-represented region
in the global hedge fund industry. With an estimated US$ 20 billioniii
of assets and 126 hedge
fund managers, it represents less than 2% of the total universeiv
.
The majority of Latin hedge funds are focused on Brazilian markets and Brazil is where most of
the assets and managers are. That is the reason why the main focus of this article lies on the
development of the Brazilian hedge fund industry.
As opposed to what happened in Argentina and Mexico, for instance, there was no exodus of
talent from Brazil and most of the Brazilian hedge fund professionals spent most of their careers
working for indigenous investment banks or local branches of big foreign investment banks. The
long tradition and the size of the mutual fund industry in the region, particularly in Brazil also
contributed to the genesis of the hedge fund industry.
The breakdown of assets and managers per geographical coverage is shown next:
Table 1 - Assets under management and number of managers
(a)
Assets Number of
US$ million managers(b)
Brazil - onshore funds 16,014 84
Brazil - offshore funds 2,213 25
Argentina 133 2
Latin America 1,772 15
Total 20,132 126
Global Emerging Markets 41,529 80
(a) sources: Claritas (proprietary database), ANBID, Eurekahedge
(b) do not include emerging markets hedge funds with a exclusive mandate of Asia and/or Eastern Europe.
We adjusted the figures for double-counting, in the case of managers which run more than one fund.
At a glance, the first thing that calls our attention from Table 1 is the predominance of the
Brazilian hedge funds, both onshore and offshore, totalling US$ 18.2 billion of assets. Funds
Latin American Hedge Funds
March 2007
Enio Shinohara
Thais Batista

2. Claritas
that have an explicit Pan-Latin America mandate, typically with a heavy weight in Brazil and
Argentina; these funds have in aggregate around US$ 1.9 billion of assets. Finally, funds that
overlook the entire emerging markets universe where Latin America corresponds to an average
risk exposure of roughly 20-40% of the invested capital - that group have in total an estimated
US$ 41.5 billion of assets. Whereas hedge funds focused on Brazil and Argentina are usually
managed by locally-based managers, global emerging markets hedge funds are more often ran
by investment professionals based in NY or London.
In comparison with the same figures we estimated in April 2006 (see table 2), it is clear that the
industry continued to grow in the last few months.
Assets - US$ million Jan 07 Apr 06
Brazil - onshore funds 16,014 14,014
Brazil - offshore funds 2,213 2,021
Argentina 133 187
Latin America 1,772 655
Total 20,132 16,877
Global Emerging Markets 41,529 33,759
(a) sources: Claritas (proprietary database), ANBID, Eurekahedge
Table 2 - Asset growth(a)
We estimate that half of the growth came from assets appreciation (from April 2006 to January
2007, MSCI Emerging Markets appreciated by 14%) and the other half from net inflows. In terms
of investors flows, it seems that investors preferred to allocate into Latin American-focused
funds as opposed to Brazil onshore vehicles. This phenomenon outline what we think might be
a long-standing trend given the complexity involved whenever a foreign allocator invests in a
Brazilian onshore hedge fund.
Market environment
Latin capital markets offer good liquidity, depth and volatility. Notably, the most liquid markets
are fixed income (cash, bonds and derivatives) with relatively long yield curves (up to 40 years
in Brazil and Mexico) with a variety of derivatives. Currencies are still not fully convertible but
there is good liquidity in spot and derivatives markets.
Latin equities are liquid, especially companies that have listed ADRs in the US – according to
a recent report from UBS, there are at least 75 Latin companies with ADRs that are relatively
liquid. In terms of locally-traded stocks, the Brazilian stock exchange is by far the most liquid
market in the region, averaging US$ 1 billion of daily turnoverv
. The wave of IPOs in Brazil in the
last few years is been very helpful to improve market liquidity- 26 companies listed shares in the
Brazilian exchange in 2006 and in 2007 it is expected that 50 new companies will list.

3. Claritas
One question often raised by investors is the availability of instruments to hedge equity risk
in Latin America. Stock borrowing in Latin America is certainly not as easy as in the US or
Europe, but there is a reasonable array of instruments for hedge fund managers to go short
equities. According to the estimates of Claritas equity teamvi
, the short interest of both shares
traded in Brazil and Brazilian ADRs averages US$ 5 billion and it is possible to borrow shares
of approximately 100 companies. In addition to single stocks shorts, in the Brazilian stock
exchange (BOVESPA) and in the derivatives exchange (BM&F), hedge funds might use index
futures, ETFs, stock options and index options which in aggregate trade over US$ 1.4 billion/day
(notional value).
History
The inception of the hedge fund industry in Latin America was a by-product of the economic
stabilisation plans that contained hyperinflation in Latin America from the 1990s. This is not a
coincidence - without a minimum set of functioning institutions, economic/political “normality”
and stability of rules, there were no solid grounds for the development of hedge funds or any
other alternative investment. The first local Latin hedge funds appeared in Brazil in mid-1990s,
after the successful implementation of the Real Plan.
We can identify four major milestones for the hedge fund industry:
The end of hyperinflation in the early 1990s and growth of influential local investment
houses, notably well developed investment banks with big risk appetite. At that time, there
weren’t many independent hedge funds as we know today, but the proprietary trading desks
operated as true hedge funds, having a relevant impact on prices and volumes. There was
also a relevant technology transfer from the US/foreign banks to the local shops;
The aftermath of Asian and Russian crises (1997/98): consolidation of hedge fund and mutual
fund industry and strengthening of the banking system leading to an overall reduction of
leverage and systemic risk in the financial system .
The retrenchment of foreign investment banks’ operations in the Brazilian pre-election
(2002) which triggered a new harvest of managers, most of them ex-proprietary traders.
The emerging markets bull cycle (2003-2007) which prompted higher growth in terms of new
hedge funds and capital raised from the more established managers. The equity markets
rally provoked the appearance of several long-short equity managers.
1.
2.
3.
4.

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Pre-History
hyper inflation
extinguished
any incentive
to create
hedge funds.
Investors
just wanted
to protect
themselves
against
inflationary
corrosion
Birth of the
first local
hedge funds
First hedge
funds and fund
of funds started
in Brazil
1990 1994 1997 2001 2004 2007
Asia+Russian
Crisis 97-98...
... triggered the
first round of
consolidation in
the industry
Brazilian
devaluation
Industry got
back on track.
Number of Start
ups picked up
Achieving
critical mass
after a “Post-
Lula” effect,
many ex-prop
traders started
their own hedge
funds
Emerging Markets
bull cycle
equity bull mar-
ket triggered the
growth of long-
short equity funds
Real Plan 95: Tequila Crisis
99: Brazil Devaluates;
Ecuador defaults
Argentina
defaults
02: Lula is elected
in Brazil
Beggining
Consolidation
(First Wave)
Consolidation
(Second Wave)
Growth
Nonetheless, it is a new industry – we estimate that at least two-thirds of current Latin managers
set up their businesses after 2002.
Strategies
Most hedge fund strategies are represented in the region. Convertible arbitrage, CTA/managed
futures and options arbitrage, however, are not ran as dedicated stand-alone hedge funds and
that is pretty much a function of the scarcity of instruments available to trade.
Out of the universe of 126 hedge fund managers, we estimate that a bit less than half of them are
macro funds, with a strong bias towards directional trading. These and the stated multi-strategy
managers, are hedge funds that mirror the
shape and dynamics of an investment bank
proprietary trading operation – some of them
are, as, or more, aggressive than prop traders
although this is the exception and not the
rule.
One relevant observation, however, is that
the so-called multi-strategy do not resemble
homonymous funds in the US. The number
of sub-strategies is much less than in the US
so that managers that use the denomination
“multi-strategy” should be viewed as
06: Lula is reelected
MaturityoftheHedgeFundIndustry
Strategy Breakdown (AUM)

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managers that enjoy great flexibility to trade
different markets and instruments rather
than managers who allocate capital among
different sub-strategy teams which operate
independently.
Long-short equities managers form a
heterogeneous group, ranging from the more
directional (Jones-model) managers with fairly
concentrated portfolios and sometimes very
active trading to the more “neutral” managers
(however difficult might be to define neutrality
in less developed markets) who emphasise
pairs trading, either intra or cross sectors with
low net exposure (typically, around +/- 20%
NAV).
Interestingly enough, the split between directional equity managers and more “market-neutral”
managers is relatively balanced.
As a result of the rampant liquidity in Latin equity markets and a renaissance of the IPOs in
the region, long-short equities have been multiplying, both in number and assets managed.
The growth of that strategy is visible by the fact that today, more than 1/3 of the hedge fund
managers run long-short equity portfolios. A couple of years ago, that same figure was less than
10%.
Fixed income managers tend to focus on the more liquid fixed income markets, notably focusing
on yield curve trading, interest rate and credit trading. It is undeniable, however, that some of
them are not pure arbitrageurs but clearly have a long bias. As their G-7 peers, they do employ
leverage to maximise their returns, but the typical gearing is probably around 3-5x NAV which
is low compared to similar strategies in the more developed markets.
More recently, we saw interesting developments in the fixed income markets. As the major Latin
economies continue to grow and to pursue responsible fiscal policies, the indebtness of Latin
countries (measure by the debt/GDP ratio) has consistently fallen contributing to a substantial
decrease of the external debt and likewise, a decrease of the outstanding sovereign debt.
At the same time, we are seeing the emergence of other fixed income instruments such as
asset-backed securities (mortgage-backed and trade receivables, among others) and structured
credit.
There is a reasonable number of event-driven managers, primarily focused on distressed
securities. We saw an upsurge of such managers after the multiple credit events in the region
(default in Argentina and Ecuador, devaluation in Venezuela, Brazil). Distressed debt managers
mostly trade debt instruments; as opposed to Asia where managers are basically positioned in
Strategy Breakdown (number of managers)

6. Claritas
floating rate and loan-based assets, Latin distressed managers predominantly trade fixed rate
bond-type instruments.
As in other emerging markets, some managers are increasingly focusing on less liquid assets or
“special situations” as they commonly name those opportunities. Managers who are trading in
that space are also getting involved with private-equity–like situations.
Location
The majority of managers are locally based - Brazil (São Paulo and Rio de Janeiro) and Argentina
(Buenos Aires) are the major centres. Outside Latam, New York and London attract important
names of the industry mainly because many emerging markets traders spent part of their careers
there, including former long-only portfolio managers who were used to work in conventional
asset management firms.
Among the less conventional locations, we could mention Miami (midway between NY and
Latam) and the US West Coast. We do think that it is quite important to be in loco to enjoy
a more efficient information flow and have a better assessment of the markets. Offshore
managers however enjoy the advantage of being closer to global investors, which speeds up
their capital raising effort.
Size
Size varies across the spectrum of strategies, but macro and event-driven (distressed) managers
are visibly larger than the other strategies.
Global emerging markets hedge funds tend to be larger than their Latin peers. This makes
sense because the opportunity set in the global emerging markets is much wider than that of
Latin America, although we also recognise that in terms of volumes and market cap, Latam
perhaps represents more than 25% of the global emerging markets.
We estimate that less than 25% of the Latin funds are closed for new investors. There is still
capacity and potential allocators should find good managers capable of accepting new money.
For the managers that offer onshore and offshore vehicles, one interesting phenomenon that is
been occurring is that some of them closed the onshore funds and keep the offshore vehicles
open, for the sake of diversifying their investor base and better managing their liabilities.
Organisation/People
Organisationally, the average Latin hedge fund is not dissimilar to its US, European or Asian
peers. Hedge funds are normally ran by small advisory firms, organised as partnerships
where the investment side is segregated from the operational side. Almost without exception,
administration, pricing and custody services are outsourced to major local institutions or well-
known foreign names.

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Since most of the managers had previous experience at Wall Street investment houses or well-
established proprietary desks, professional training and skill sets are on average compatible
with the global standards.
However, as it is the case elsewhere, the transition from a prop desk to a hedge fund business
is not painless and carries some obstacles.
According to various pieces of research, more than 50% of failures of hedge funds are due to
operational problemsvii
. Latin America is no exception, and there have been cases of intentional
and unintentional mispricing, mishandling of assets, non-compliance with investment mandate,
and absence of proper compliance which led to the termination of some hedge funds. Mortality
rates are roughly the same of those in developed markets.
Therefore, operational risk is a critical issue in Latam as anywhere, aggravated by the relative
youth of the industry. Any allocator should pay close attention to how the hedge fund is structured,
how staff are incentivised, how efficient and effectively utilised are the risk management systems,
and how sound is the compliance framework. Needless to say, hiring 1st tier service providers
is not sufficient to prevent a hedge fund of having operational problems.
Regulatory environment
In terms of regulation, onshore and offshore funds belong to very distinct universes.
Brazilian onshore hedge funds are backed by an advanced regulatory framework.
The Brazilian Securities Commission (CVM) supervises the whole industry including investment
management companies that are based in Brazil. The regulation on the managing companies and
the individuals is quite strict. Any investment professional involved with the asset management
activity has to show a minimum set of technical skills and passes through a background
checking.
ANBID (National Association of Investment Banks) gathers most of the asset management
companies in Brazil, including the bigger hedge fund groups and also acts as a self-regulatory
entity. Often times, principles contained in the self-regulation code are even stricter than the
government regulation.
The large majority of the Brazilian onshore hedge funds reports daily NAVs, which means
that NAVs are reconciled on a daily basis. CVM receives the NAV data and the fully-disclosed
portfolios of all onshore managers on a daily basis in order to monitor the amount of leverage
and thus mitigate systemic risk. The daily NAV reporting does not mean, however, that hedge
fund managers provide daily liquidity – most of them require 30 to 90 days prior notice for
redemptions. Onshore hedge funds are subject to the same legislation applicable to mutual
funds with some amendments accounting for specific issues related to hedge funds such as the
use of leverage, negative NAV and so forth.
The standard legal structure of Latin offshore funds follows the best practices in Europe and in

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the US. Hedge funds are normally set up as mutual fund companies or investment companies
in Cayman Islands, Bermuda or BVI and the investment manager/advisor is based in Latam or
in the US/Europe.
Even though offshore vehicles are set up in a different jurisdiction from the location of the
investment manager, in the case of Brazil-based hedge fund managers, the investment managers
are subject to same scrutiny of CVM as any other money management firm.
Still regarding the offshore vehicles, an additional risk to be taken in account is the convertibility
risk for the portion of assets that is kept onshore in order to trade local assets. In terms of
governance, unlike in Asia, it is still unusual for a Latin hedge fund to nominate independent
directors.
In summary, an allocator should have the same concerns when investing in a Latin offshore fund
compared to an US/European offshore hedge fund.
Opportunities, risks and future developments
We see the combination of a supply of good investment professionals and inherently inefficient
capital markets in Latin America as an interesting opportunity for allocators in hedged
products.
So far, the demand for Latin American hedge funds has been predominantly local which can
be seen by the large number of onshore hedge funds in Brazil. We could thus expect a further
internationalisation of the demand going forward.
For allocators in general, the region offers an interesting opportunity of investing in highly skilled
but relatively unknown managers. Hedge funds are probably the best investment alternative
to benefit from the opportunities in the region, using relatively low leverage and being less
sensitive to the cyclicality that is characteristic of emerging markets.
On the supply side, we believe that the pipeline of new managers will continue to be mostly
filled by local talent. High entry barriers exist for managers that do not have local knowledge/
presence. The successful non-Latin managers are the ones who have been trading in the region
for a long time and as such have already climbed the learning curve. Language is not a critical
barrier, but knowledge of local markets is.
For hedge fund managers, one of the key challenges going forward is how to handle the asset
growth without diluting performance. Arguably, there is less opportunities in the macro space
now than 5 years ago so that we might see a further degree of specialization in certain market
niches as well as a structural shift from fixed income and FX-related trades to equities. To some
extent, that shift is already going on as we see some macro managers that are deploying more
resources (time + people) in identifying opportunities in the equity markets.
We also think that hedge fund managers will have to adapt themselves to a more dynamic
market environment driven by a rampant integration of the Latin markets with global markets.

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That implicates in a higher correlation between Latin America and the rest of the world which
will ultimately require from managers a better comprehension of what is going on in other
markets, particularly in the US.
March 2007.
We would like to thank Carlos Ambrosio (Claritas Investments) and Jose Brazuna (ANBID) for their invaluable
insights.
Enio Shinohara is a partner of Claritas Investments and the portfolio manager for all Claritas (G4) Fund of Funds. Enio
started his career at Hedging-Griffo where he built the Fund of Hedge Funds business, becoming a partner of
the firm in 1998. In May 2000, he moved to GP Investimentos where he put together a proprietary Fund of
Funds. Subsequently, he joined GFIA pte ltd, an advisory firm based in Singapore advising portfolios of Asian
hedge funds.
Thais Batista is a hedge fund analyst at Claritas Investments. Thais started her career at Unibanco (one of the largest
banks in Brazil) where she worked in different business units and more recently in the Asset Management unit.
At Unibanco, she participated in the structuring of the Fund of Funds team which sooner became the second
largest FoF group in Brazil. She was also the portfolio manager for a Fund of Funds of Brazilian Hedge Funds
since its inception.
i Source: World Bank
ii Emerging Markets Traders Association, EMTA Survey, Jan 2007.
iii Claritas estimate, on the basis of data collected from Eurekahedge, ANBID and Claritas proprietary database.
iv Different sources provide different figures for the total hedge fund universe. Those figures average US$1,400 billion of assets
and 6,000-8,000 of hedge funds (sources: HFR, Eurekahedge).
v Source: Economática
vi Claritas equity team runs the largest and one of the oldest equity long-short portfolios in Brazil, with over US$ 450 million of
assets.
vii “Valuation issues and operational risks in hedge funds”, Capco, 2004; “Quantification of Hedge Fund Default Risk”, EDHEC
January 2007.