Small is beautiful

By Kathryn Gaw

8 Aug 2011

In a cautious investment environment, it is a rare institution that will focus exclusively on emerging and frontier markets, but this is exactly what fund of funds (FoF) manager Advance Emerging Capital (AEC) is doing. With a dedicated outlook on the global emerging markets (GEMs) space, the company has built its reputation on choosing best-of-breed, local fund managers, according to CIO and CEO Dr Slim Feriani.

A long-term investor, AEC is very much dependant on its own research and accumulated knowledge of fund managers. Feriani describes the company as being “benchmark agnostic”, preferring instead to conduct its own rigorous manager selection process which can take anything from two to three years. During this time the investment team will track and analyse each fund managers’ activities, looking for that elusive ‘X’ factor. “We want to pick best-of-breed fund managers who are really passionate about what they do,” says Feriani. “We want to look the manager in the eye and see a passion.

“But we are in no rush to invest with anyone. Yes it is a long process but we are long-term investors. When we invest with someone it is going to be for an average of five years plus.”

This strategy means that AEC is constantly searching for fund managers across all emerging and frontier markets, although it is a very specific manager that fits the bill. “We like boutiques and we think small is beautiful,” says Feriani. “We are invested in some big names, but we have a preference for the boutiques because our interests are better in line with theirs.”

A dedicated outlook

Established 15 years ago by former Bank of England executive Nigel Wilson, AEC prides itself on having a staff turnover of zero, and a complete dedication to emerging and frontier investment opportunities. It has a current AUM of approximately$900m, backed by a number of key institutional investors including the British Airways pension fund, South Yorkshire city council fund, HSBC private banking and BNP Paribas wealth management.

The company runs eight funds, six of which are AA rated by S&P. Its flagship FoF, the Advance Developing Markets (ADM) Fund, is valued at approximately $600m, of which approximately 1% is allocated to Mena. Its other closed-ended FoFis the Advance Frontier Markets (AFM) Fund, which was set up in 2007 as the first UK listed frontier fund.

Although the majority of AEC’s funds are weighted towards Latam and Asia, Mena was its initial area of interest. It started investing in the frontier markets of Mena seven years ago, but Feriani now describes the region’s investment potential as “disappointing”. In fact, the AFM fund has decreased its Mena exposure by 10% over the past year, in favour of new allocations to Argentina and Latam.

“We are now in a situation where we have to be a lot more patient with the Mena region,” says Feriani. “We used to have about40% of the AFM fund in Mena but things did not pan out as expected. There is so much potential there: it is a big region geographically, resource-rich and rich in people. But we are still active investors in the region, we’re not passive.”

Hidden Gems

Feriani describes investment allocation and manager selection as the core elements of AEC’s business. Its investment team has approximately 400 meetings each year with potential fund managers, both on the ground and at its London headquarters. “We visit 30 countries a year and we are always trying to discover those hidden Gems and building knowledge, interpreting information and analysing it,” says Feriani. “Africa and the Middle East have negative perceptions about them, but the reality is that things have changed and there are fantastic investment opportunities there.”

Over the years, the company has compiled a database of emerging market fund managers, which now includes approximately 30 companies based in Mena. Currently, AEC is invested in EFG-Hermes Mena Fund, the Algebra Alpha Mena Fund, Blakeney Investors and the Qatar Investment Fund, among other smaller regional it is now championing a ‘long only’ strategy across its asset management business.

allocations. However, Feriani admits that both EFG-Hermes and Algebra are currently on the company’s ‘watch list’ due to the former’s steadily increasing size and the latter’s recent acquisition by Templeton.

An initial allocation from AEC will be worth approximately 0.5% of the total value of its fund, in keeping with the company’s conservative investment approach. “The smaller the market, the smaller the position,” says Feriani. “But this will gradually be built.”

As it stands, the company’s core positions average about 5%, but it will never go higher than 10% in any company for risk management purposes. “We are firm believers in diversity,” says Feriani. “We just don’t feel comfortable putting all our eggs in one basket. On the other hand we don’t want to be more than 10% of any one manager. We don’t want to be the last man standing.”

The company invests in about 80 funds at the moment and has a watch list of about100, with another several hundred in its EM database. “We can’t invest with everyone, we don’t have billions and billions, and we still want to be running portfolios that are relatively focused,” says Feriani. “But too focused means more risk. We have roughly 40 funds in the emerging space and about 30 in the frontier. If we took that down to, say, five, that would represent a huge risk for us. We would have maybe one Russian fund, one Mena fund, etc. I wouldn’t be able to sleep at night.”

North African ambitions

Going forward, AEC is interested in making its first Saudi allocation and has been meeting several Saudi fund managers. Feriani continues to be bullish on Mena and wants to allocate more investments to North African funds in particular. He criticises so-called ‘Mena’ funds which ignore the ‘NA’, keeping investments in the relatively stable investment environment of the GCC and Egypt. “Most of these ‘Mena’ funds are actually ‘ME’ funds,” he says. “We always argue, where is the ‘NA’? If you are truly a Mena manager there’s going to be ‘NA’ exposure and the usual argument is that Morocco and Tunisia are expensive and not liquid enough.”

In Feriani’s view, it is for this reason that Morocco and Tunisia represent interesting investment opportunities. “These markets are neglected and that means there must be opportunities that you can exploit,” he says. “But most Mena managers fail us in giving us exposure to North Africa.”

The recent Mena political crises have done nothing to hurt AEC’s outlook on the region. “I think it was quite a cyclical setback and everyone decided to just wait and see,” says Feriani. “These things take time; they don’t just get sorted within months. If you are a long-term type of investor then you can afford to take a five years plus view. Most people don’t have that kind of investment horizon so they are just sitting on the side-lines and watching.”

However, he admits that when the revolutions began, the company took a step back from its investments. Having said this, AEC maintains a position in Tunisia through investments in two small Tunisian outfits that manage less than $10m each. These allocations are typical of the company’s boutique approach. “We are very mindful of too-rapidly growing fund managers, because when you have someone going from $30m to $100m in six months that is quite destabilising to the way we do things. We like steady growth, but we don’t like too much growth.

“If you are a fund manager and you want to be an investment manager, not an asset gatherer or cash manager, then you have to be disciplined. But people think of the commercial aspect and they just want to grow and grow.”

Feriani predicts that AEC could increase its AUM to as much as $2bn in the next three to five years, but insists that it will be careful not to outgrow itself. “We think managing growth in fund management is very important, so we tell managers not grow too rapidly,” he says. “It’s the same thing with us, we want to grow gradually.”