October 15, 2012 / 6:45 PM / in 5 years

Emerging market hedge funds stand out in mediocre year

* Emerging market funds up 7.8 pct in YTD through September

* Last year emerging market funds lost 16.4 pct

* India-focused funds beat S&P 500 index in Q3

By Katya Wachtel

NEW YORK, Oct 15 (Reuters) - Fund managers that specialize in investing in emerging markets have achieved standout gains of nearly 8 percent in a year when the typical hedge fund has eked out returns of about 5 percent, recent data showed.

Emerging market-focused hedge funds gained 4.5 percent in the third quarter, adding about 2.6 percent in September, according to industry tracker eVestment|HFN.

Hedge funds, on average, gained only 1 percent in September and 2.79 percent for the quarter. Year-to-date average returns in the more than $2 trillion industry were about 5 percent through September, compared to emerging market funds, which were up 7.8 percent over the same period.

Those gains still trailed the benchmark S&P 500 stock index , which added 2.25 percent last month and climbed 16.43 percent for the year through Sept. 30.

Still, the quarterly gains achieved by emerging market hedge funds were better than any other major category of fund, data from eVestment|HFN showed, including credit funds, which have posted solid performance this year with successful investments in high-yield junk bonds as well as mortgage-backed securities.

This year’s gains represent a turnaround for emerging market funds, which lost 16.4 percent in 2011, far more than the 5 percent losses recorded by hedge funds on average.

Despite strong returns among emerging market funds, investors withdrew $4.9 billion in July and August. Through Aug. 31, emerging market funds experienced outflows of almost $18 billion, according to the latest eVestment flow data.

“Investor flows for emerging market hedge funds have been among the worst in the hedge fund industry over the last year with net outflows occurring in 11 of the last 12 months,” Peter Laurelli, head of industry research for eVestment|HFN emailed.

“However, there isn’t necessarily a lack of interest in emerging market exposure from institutional investors,” he added, noting that large investors are opting to get emerging market exposure “outside the hedge fund space,” where fees are smaller.

Emerging market mutual bond funds, for example, have attracted inflows for their attractive yields while emerging market hedge funds have seen money pulled out.

The Barclays Capital Global Emerging Markets Index has jumped 15.1 percent this year compared with a 3.77 percent gain for the broader Barclays Aggregate Bond Index, as investors have flocked to emerging market bond funds in the period.

For example, the TCW Emerging Markets Income Fund, which is up 16.17 percent for the year, attracted nearly $784 million in new money in the third quarter, according to mutual fund tracker Morningstar.

Some hedge funds the bet in emerging markets have posted similarly impressive gains. BTG Pactual’s Global Emerging Markets and Macro Fund rose about 20 percent through Sept. 28, according to data from HSBC’s private bank.

And Contrarian Capital Management’s roughly $220 million Emerging Markets OFF Fund rose about 13.3 percent through September, according to HSBC data.

Some emerging market funds, however, have struggled to keep pace with their competitors. Louis Bacon’s Moore Emerging Equity Long/Short Fund was down 16.4 percent through Sept. 30, for example.

While most hedge funds trailed the broader stock market, India-focused funds beat the S&P 500’s 6.35 percent rise in the three months to September, with gains of 9.4 percent, according to eVestment|HFN.

Hedge funds that focus on investing in India added about 10 percent in September alone, and have gained 23.3 percent for the year. Those funds sank almost 34 percent last year.

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