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In a year when hedge funds are getting crushed, emerging and frontier market-focused firm Caravel Management is up over 30%.Business Insider heard Caglar Somek, a partner and portfolio manager at Caravel, talk about the firm’s strategy at Bloomberg’s Hedge Fund Summit last week.
He piqued our interest when he said that the the $225 million AUM fund was “heavily invested in banks in Nigeria.” It’s what he considers one of the firm’s best investments of 2012.
We caught up with the Goldman Sachs alum this week so he could tell us more about the firm’s investment thesis. He said that Caravel liked Nigerian banks because they were rounding the corner from of a crisis that it experienced from 2008-2009.
The source of the crisis was over leverage and high levels of non-performing loans on banks’ books. The country’s central bank stepped in and forced banks to clean up their assets and created a separate vehicle to take on NPLs.
“The banking system came out well capitalised and with quite liquid balance sheets because they were deleveraging. Yet they were tracking 0.6-0.7 price to book multiples,” said Somek.
Caravel started building a position in the sector in 2009.
However, the fund had been looking for investment opportunities in Nigeria since its inception 8 years ago. The hedge fund’s 8 investment professionals each travel to 2-3 frontier and beyond BRIC countries every quarter trying to find the best ideas. There are about 40 countries in Caravel’s investment universe, and the fund is invested in 20-25 of them.
Somek cut his frontier investing teeth during his time as a Senior Investment Research Analyst for Goldman Sachs Asset Management International. There, he covered Asia and became interested in what Goldman calls the ‘Next 11’ booming economies (Bangladesh, Egypt, Indonesia, Iran, Korea, Mexico, Nigeria,Pakistan, Philippines, Turkey and Vietnam).
If Goldman’s thesis is correct and growth continues, these countries will eventually take the place of the BRICs. For Somek, going to Caravel was a chance to look at even more economies and build his own team to do it.
With 40 countries in its universe, though, clearly Caravel is looking beyond the norm.
What makes a country attractive to Caravel are domestic growth drivers — young, growing populations with rising levels of consumption. The fund is index agnostic, meaning that just because a country is on the frontier index, doesn’t mean it’s attractive to Caravel. Think: rich, low population countries that are dependent on commodities for growth, like Kuwait and Qatar.
And of course, Caravel is looking for something that’s undervalued. The firm left Pakistan not only because it did not have confidence in the country’s governance, but also because of concerns about balance of payments.
Somek also said that Caravel conducts private equity-type research into each company it invests in so that the firm doesn’t fall into, what he considers, the most salient trap for frontier/beyond BRIC market investors — investing in companies without adequate cash flow.
Unless a company has enough cash in these rapidly growing domestic economies, it won’t be able to keep its supply caught up with demand. When that happens, companies go back to the market to seek financing, and if they go back to the well too much, companies can over-lever themselves.
“We’re not traders. We’re not buying stuff for the quarter. We usually perform 3-5 year modelling on a company,” Somek explained.
Apparently it’s working.