Emerging markets have received significant capital from institutional investors looking to diversify their portfolios, as they seek new investment opportunities outside traditional and developed regions. Although emerging markets can be considered highly volatile investments, a significant proportion of investors pursuing potential high returns have invested in these markets. Despite these high growth economies having the potential to become fully developed markets, higher fees and increased political instability in these regions discourage cautious investors.
Preqin’s Hedge Fund Investor Profiles online service currently tracks 1,189 investors which have an appetite for investing in emerging markets, representing a quarter of all investors, 770 of which are US-based. Home to more sophisticated and experienced investors, a significant proportion of US-based investors are willing to take on this riskier strategy and allocate a healthy amount of capital into emerging markets. It is not surprising that 37% of all US-based fund of hedge funds managers demonstrate a preference for investing in these regions. Funds of hedge funds managers, with their greater expertise in these regions, have the resources, knowledge and connections which allow them to offer US-based investors exposure to emerging markets through their fund of funds vehicles. Fund of hedge funds allow institutional investors to gain exposure to emerging markets for the first time, especially for investors which do not have an in-house investment team to do the necessary due diligence in these markets. Appetite for emerging market hedge funds has increased across all investor types, with a sizeable proportion of many other US-based investor groups targeting emerging markets, including private pension funds (34% indicate an interest in the region), public pension funds (29%), foundations (26%) and endowments (25%).
Despite the risks involved with emerging markets, investors are more likely to benefit by investing through a hedge fund structure than other types of investment structures, as hedge funds allow investors to generate risk-adjusted returns. Long/short and event driven are currently the most common strategies among the US-based institutional investors that have a preference for emerging market hedge funds, with 90% and 70% of these investors interested in the respective strategy. Other strategies that are of interest to US-based investors include long/short credit (62%) and macro funds (61%).
Emerging market hedge funds account for approximately 12% of all hedge funds currently open to investment. After a loss of 1.98% in January, emerging market-focused hedge funds recovered by posting five consecutive months of positive performance, the leading regional benchmark in Q2 2014, with average returns of 4.27%.
As investors seek to diversify their investment portfolios and look for additional methods of generating returns, emerging markets should continue to receive inflows of investor capital.