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Lazard
Alternative Emerging Markets
The emerging-market alternative
investment universe offers institutional
investors the opportunity to enter
an uncongested marketplace with
unlimited growth potential.
Since the term “emerging markets” originated over 30 years ago,
the asset class has developed to become a common allocation for
institutional investors. The number of eligible countries has increased
from 10 to more than 40, while investment instruments have expanded
beyond equities to include debt, frontier markets, derivatives, and more.
Meanwhile, the construction of emerging markets indices has not kept
pace with the asset class’s rapid development, resulting in a multitude
of underexploited investment options.
Compared to developed markets, emerging markets have much less
participation from alternative investment strategies. While hedge funds
in the developed world operate and compete in a mature marketplace,
the index dominant structure of most emerging-market mandates
leaves a rich alpha opportunity for emerging markets hedge funds.
Lazard’s Alternative Strategies team has 25 years of investment
experience in the emerging markets and has spent nearly fifteen years
together identifying high-quality alternative investment managers.
Investors seeking a strategy that has historically offered lower volatility
than the MSCI Emerging Markets Index and strong risk-adjusted returns
should consider the Lazard Alternative Emerging Markets strategy.
Strategy Benefits
• Expansive Investment
Universe: The emergingmarket universe is one of the
largest and fastest growing,
with underrepresented analyst
coverage, giving rise to significant mispricings.
• Attractive Diversification
Opportunity: Blending alternative strategies may provide a
diversification advantage and
virtuous asymmetry that helps
manage risk in down markets
while capturing a significant
portion of the upside.
• Significant Industry
Experience: Lazard’s
Alternative Strategies team
has worked together for nearly
fifteen years identifying quality alternative investment
managers with a significant
background in emerging markets. Inside Lazard they are
also able to leverage the firm’s
experienced emerging markets
analyst teams.
• Strong Track Record: Our
strategy has significantly outperformed its benchmark since
inception with roughly onethird of the index volatility and
has shown reduced correlation
to traditional asset classes.
Snapshot
SP23395
Benchmark
Number of hedge funds
Volatility
Other portfolio guidelines
Minimum Investment
MSCI Emerging
Markets Index
Typically 15–25
Seeks to target less than 50%
of the volatility of the MSCI
Emerging Markets Index
Max single fund investment: 10%
Max single firm investment: 15%
$100M (customization
available).
Development of Emerging Markets
When emerging markets were identified as a distinct asset class in
the 1980s, institutional investors first sought access to developing
economies in order to capture the superior risk/reward dynamics
of unstructured sovereign debt that benefited from comprehensive
economic, and, in many cases, political reform. Once a path to
macro stability was achieved, countries focused on developing their
domestic capital markets. Investors were attracted to the promise
of strong corporate earnings growth at compelling valuations. This
meant capturing beta by investing in the best managed, most liquid
companies that constituted the once nascent emerging-market indices.
Institutional investors believed volatile emerging-market equity return
streams were worth enduring as the expected earnings growth, and
consequent capital appreciation, compensated for the risk. Thirty
years later, many of the original emerging economies have developed
into middle-income countries and their capital markets have matured
to encompass a broad range of instruments, including equities across
a broad array of sectors and market caps, sovereign and corporate
external debt, domestic interest rate securities, convertible bonds, warrants, options, and distressed assets. Emerging markets now include
frontier markets whose structure, maturity, and investment rationale
resemble emerging economies in the 1980s. While the emerging
markets have evolved, invested assets remain heavily weighted toward
large-cap companies, typically accessed either passively through MSCI
Emerging Markets Index funds, or actively through an emerging
markets equity manager. The fairly recent segmentation into style
benchmarks is a step forward, but it still leaves investors with a volatile, beta-rich emerging markets product range and significant point
of entry risk. This risk was highlighted during the emerging markets
sell-off in the first half of 2013, where even as market performance
diverged across country, region, and asset class, standard emergingmarket bond and equity benchmarks were universally weak. This
exposed the inherent risks associated with a traditional approach to
investing in emerging markets.
“While the emerging markets
have evolved, investment
vehicles remain heavily
weighted towards the largecap approach...”
The Case for Emerging Markets
Hedge Funds
As emerging markets have developed, so has the ability to short securities, trade credit default swaps and options, and construct index-based
hedges. Many techniques pioneered by developed-market hedge
funds are now being successfully implemented in emerging markets.
However, while developed-market hedge funds now form a well
understood and meaningful proportion of developed capital markets,
the relatively recent ascent of emerging-market hedge funds means
that they represent a smaller and less crowded constituency of their
opportunity set. While hedge fund participation in developed markets
exceeds $2.5 trillion in assets under management (AUM), emerging
markets dedicated hedge funds only possess $0.2 trillion in AUM
and are underrepresented, encompassing only 1.3% of the growing
emerging-market equity and bond universe of over 2,800 issuers.1
Traditional hedge fund of funds have always prided themselves on
their ability to allocate capital among a large universe of hedge funds.
We believe dedicated emerging-market investing, however, not only
requires regional and country expertise (often underutilized by traditional allocators), but also bottom-up security-level experience to
help understand idiosyncratic risks and challenge a manager’s investment thesis. This is where we believe Lazard has a unique competitive
advantage at the firm and team level.
Exhibit 1 demonstrates the potential benefits that emerging markets
hedge funds can provide, relative to long-only offerings. Beyond
merely delivering a passive blend of emerging-market equity and
debt, emerging markets alternative managers grant investors access to
market segments generally not accessible through passive blend strategies (e.g., frontier markets, distressed assets, and uncorrelated styles
such as emerging markets macro).
Exhibit 1
Potential Benefits of Emerging Markets Hedge Funds
Return (%)
12
JPM EMBI
10
HFRI EM
8
MSCI EM
6
4
2
0
5
S&P500
10
15
MSCI Global
20
25
Standard Deviation (%)
The chart represents information from 1 January 2000 to 30 August 2013. Information
provided for illustrative purposes only. Past performance is not a reliable indicator of
future results. Source: HFR, MSCI, Barclays, Bloomberg. Not representative of any
product managed by Lazard. One cannot invest in an index
3
Lazard Alternative Emerging Markets
Strategy
Lazard’s Alternative Emerging Markets strategy offers unique access to
an uncrowded opportunity set, building on Lazard’s broader emerging
markets platform and incorporating the insights of dozens of sector
and regional specialists. Our experienced hedge fund investment team
combines top-down and bottom-up views, and leverages Lazard’s
emerging markets expertise to deepen the discussion during the manager sourcing and due diligence process.
Investment Philosophy
We believe the key to building a successful portfolio of hedge funds
is to select managers who have the investment skill to deliver the
desired return on capital and the business skill to operate a robust and
fiduciarily-sound investment enterprise that ensures the return of capital. We are proud to have an analyst team composed of experienced
money managers and traders enabling us to form a more refined view
of a manager’s investment strategy. We utilize Lazard’s Integrated
Knowledge platform to better understand markets and asset classes
and to provide us with unique insights into underlying managers’
investment rationale. Lazard’s emerging markets research platform
enables us to go deeper than our competition at monoline fund of
fund firms. The Lazard Alternative Emerging Markets strategy may
be a versatile solution for investors searching for yield, seeking absolute returns, looking to reduce volatility, or reallocating away from
traditional emerging-market strategies, or passive index investments.
Additionally, because of the strategy’s broad characteristics, it can
be utilized for a variety of asset allocation frameworks (equity, fixed
income, or absolute return).
Investment Process
Lazard’s investment process, depicted in the chart below, encompasses
three distinct elements.
Manager Selection
• Screening—Based on operational and investment criteria, Lazard
narrows the 1,300 EM hedge fund universe to fewer than 250 eligible funds.
• Due Diligence—This process combines quantitative analysis with a
systematic and detailed assessment of critical qualitative attributes
where both investment and business skill are scored.
Portfolio Construction
• Incorporate Return Expectations—Expected sources of return are
given forward-looking estimates and assigned levels of confidence.
Return and volatility projections are calculated, stressed, and tested
against history.
• Portfolio Construction and Rebalancing—Typically the strategy’s
assets will be allocated among 15 to 25 underlying funds that utilize
a variety of investment strategies and manage their own portfolios
with sound risk management practices. Understanding that our
clients have unique investment goals, customization is available.
Risk Management
• Monitoring—Monthly manager dialogue helps us to identify areas
of risk, assess opportunity sets, reconcile portfolio action with past
strategy, and track changes in business infrastructure.
• Exposure Reporting—Each manager’s underlying capital market
exposures are aggregated across the portfolio regularly. Additionally,
factor risk analysis is performed at the investment and portfolio level.
Exhibit 2
Our Investment Process
Manager Selection
Portfolio Construction
Risk Management
Screening
Incorporate Return
Expectations
Exposure Reporting
Due Diligence
Portfolio Construction
and Rebalancing
Monitoring
For illustrative purposes only.
Lazard Alternative Emerging Markets Strategy
Portfolio Management Team
Christopher (“Kit”) Boyatt
Christian Frei, CFA
Director
Portfolio Manager/Analyst
Director
Portfolio Manager/Analyst
Strategy Description
Lazard Alternative Emerging Markets targets the returns of the MSCI Emerging Markets Index, while targeting less than half of the
volatility of the index over a market cycle. The strategy typically invests in 15 to 25 underlying hedge funds while seeking portfolio level
geographic and asset class diversification. The strategy seeks best-in-class managers invested in Asia, Latin America, Eastern Europe,
Middle East and Africa, and Frontier Markets across various asset classes including equities, local markets, sovereign debt, and currencies.
Typical Strategy Diversification
Geographic
Style
Asset Class
Global
40%–70%
e.g., Global EM equity Long/Short, Relative Value Credit
Long/Short
30%–100%
Equities
Regional
10%–40%
e.g., LatAm Long/Short, EMEA Long/Short
EM Macro
0%–30%
Local Markets
Country
10%–40%
e.g., China Long/Short, Thailand long biased
Relative Value
0%–30%
Sovereign Debt
Specialty
5%–15%
e.g., EM distressed Assets, EM macro, EM pair trading
Event Driven
0%–30%
Currencies
Notes
1 HFR, MSCI Red Book, August 2013
Important Information
Published on 6 April 2016.
An investment in any alternative investment is speculative, involves a high degree of risk, and may lose value. Privately offered investment vehicles are unregistered private investment funds or
pools that invest and trade in many different markets, strategies, and instruments. Such funds generally are not subject to regulatory restrictions or oversight. Opportunities for redemptions and
transferability of interests in these funds are restricted. The fees imposed, including management and incentive fees/allocations and expenses, may offset trading profits. Investors should not
invest in any fund or strategy unless they are prepared to lose all or a substantial portion of their investment. The performance of the strategy is largely dependent on the talents and efforts of
certain individuals. There can be no assurance that LAM’s investment professionals will continue to be associated with LAM and the failure to retain such investment professionals could have an
adverse effect on the strategy.
The strategy is subject to a number of actual and potential conflicts of interest involving LAM and its affiliates. LAM and its affiliates provide investment management services to other investors whose investment objectives may be similar to, or different from, the investment objective of the strategy. The directors, members, officers, and employees of the strategy, LAM and its
affiliates may buy and sell securities for their own account or for the account of others. The investment manager may receive an incentive allocation and such a compensation arrangement may
create an incentive to make investments that are riskier or more speculative than would be the case if such an arrangement were not in effect. The underlying hedge funds selected by the portfolio management team may invest in securities of non-US companies and which trade on non-US exchanges. These investments are denominated or traded in currencies other than US dollars
involve certain considerations not typically associated with investments in US issuers or securities denominated or traded in US dollars. There may be less publicly available information about
issuers in non-US countries that may not be subject to uniform accounting, auditing, and financial reporting standards and other disclosure requirements comparable to those applicable to US
issuers. The underlying hedge funds selected by the portfolio management team will invest in and actively trade securities and other financial instruments using a variety of strategies and investment techniques (including but not limited to, arbitrage investing, investing in distressed and convertible securities, short selling, and utilizing leverage) with significant risk characteristics. The
underlying funds invest wholly independently of one another and may at times hold economically offsetting positions or cause the strategy to be concentrated. Investment management fees
and performance fees are charged by both LAM and the managers of the underlying funds.
This document reflects the views of Lazard Asset Management LLC or its affiliates (“Lazard”) and sources believed to be reliable as of the publication date. There is no guarantee that any
projection, forecast, or opinion in this material will be realized. Past performance does not guarantee future results. This document is for informational purposes only and does not constitute an
investment agreement or investment advice. References to specific strategies or securities are provided solely in the context of this document and are not to be considered recommendations
by Lazard. Investments in securities and derivatives involve risk, will fluctuate in price, and may result in losses. Certain securities and derivatives in Lazard’s investment strategies, and alternative strategies in particular, can include high degrees of risk and volatility, when compared to other securities or strategies. Similarly, certain securities in Lazard’s investment portfolios may
trade in less liquid or efficient markets, which can affect investment performance.
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