Luiz Carvalho and Mario Epelbaum, co-founders of Tree Capital, a long/short equity fund focused on Latin America, think the region is ripe for investment.
“We think that Latin America is the best place in the world, actually, to launch a long/short [strategy] because there are a lot of inefficiencies in the region...it's very poorly covered from a research perspective, everything is in the same time zone, common language," Carvalho told FINalternatives during a recent interview. "Still, there are not a lot of people doing what we are doing, so we are a little bit of pioneers in a space that I think is attracting more attention now,” said Carvalho.
Carvalho and Epelbaum met at Morgan Stanley, where the two worked together from 1996 to 2006. Epelbaum went on to Artha Capital then Marathon Asset Management; Carvalho remained at Morgan Stanley until 2008. A third founding partner Robert Munro Jr., was COO and CFO at Artha Capital; and a fourth, Luis Gomez, also came from Morgan Stanley.
In 2009, they launched Tree Capital—named for both of them, as 'Epelbaum' is derived from the Yiddish for apple tree and 'Carvalho' is Portuguese for oak. It's based in New York because, said Carvalho, “[Y]ou have huge conferences here, a lot of the research groups are based here, the brokers organize themselves as a Latin American group...the management teams, the road shows they all come here and we are closer to our clients—New York is still the capital for Latin American markets.”
Tree Capital runs two funds, which are leveraged and unleveraged versions—or in Carvalho's preferred terms, aggressive and conservative versions—of the same long/short strategy.
“The difference is that one uses 1.6 times more capital than the other,” said Carvalho.
“We're not a macro fund, we're essentially a fundamental shop,” said Carvalho. “These economies are mostly in a state of flux, like most emerging markets; things are getting better, in certain areas, things are getting worse. Technology changes, regulatory changes, growth create a lot of dislocations among industries, so the themes are essentially being long in certain industries and being short in other industries.”
“When we build our portfolio, we first generate these themes, that translates into industries and we have longs and shorts in these industries and that's how we build the book. We don't take a lot of directionality, we really are focused on alpha—more than 90% of our performance since inception has been from stock picking, not from direction, not from data.”
Once they've identified an industry in which they want to invest, they seek companies that meet their liquidity requirements. “We only invest in liquid names,” said Carvalho. “We don't like to invest in any names [with] liquidity lower than $1 million of average daily trading volume.”
Carvalho estimates their investment universe at 400+ firms. These can be listed in Latin America, or can do business in Latin America and be listed elsewhere, like Nextel International, a company that is listed in the U.S. but generates all of its revenues in Latin America.
“When we like the theme—this is not just on the long [side], sometimes on the short—we don't just have one name, we tend to have more than one,” said Carvalho. “So our book is very diversified from the point of view of stocks but it's fairly reasonably concentrated on these themes or these industries.”
These days, they like Mexican REITs (FIBRAs) and Brazilian infrastructure plays. The FIBRAs, said Carvalho, are unleveraged, have a real dividend yield of nearly 6% and assets that are increasing in value as the Mexican economy strengthens.
As for Brazilian infrastructure, “We think that infrastructure is beginning to outpace consumption for the first time in many, many years,” said Carvalho, “and this is a trend to stay so we like companies that are somehow involved in the infrastructure of Brazil, we think will be the place to be over the next years.”
The flip side of that is an expectation for weaker Brazilian consumption, so Tree Capital is shorting Brazilian consumption plays “because we think that...with the consumer credit cycle, people have reached a leverage ratio that is very high for individuals and also companies have been able to pass aggressive price increases, so volumes are falling and consumers are taking a breather. We think that consumption stocks are very expensive and are not going to perform as well as the infrastructure...”
Carvalho said they have also been short blue-chip Mexican consumer companies that have benefited “from the massive amount of capital that went to Mexico over the last two or three years.” He said the popularity of ETFs has generated flows into “very specific stocks, especially the blue chips, so being short somewhat the blue chips in Mexico and long more the second tiers has really paid off for us.”
Diverse Yet Concentrated
Tree Capital holds around 50-60 positions at any given time—roughly 20 to 25 on the short side, 30 to 40 on the long side. The goal is to be a “pan-regional” fund but Carvalho said they must also accept the realities of the region:
“We don't want to be a Brazil fund, we don't want to be a Mexico fund. Now, that being said, Brazil and Mexico are overwhelmingly the largest markets, the largest economies and the deeper markets, so we're always going to have a significant portion of our book in Brazil or Mexico, together they represent...70-75% of the book; 25% being Chile, Colombia, Peru and others...”
They have about $110 million under management now and Carvalho said capacity for the strategy is $600 million at current liquidity levels. The minimum investment is $250,000 and their investor base is “overwhelmingly” institutional investors.
Tree Capital is currently enjoying its best-ever start to a year, despite rather lackluster Latin American markets. The “aggressive” version of the strategy is up 8.7% YTD, while the “more conservative” version is up 5.2 %
“[W]e have very uncorrelated returns,” said Carvalho, “our beta is 0.1—because most of our returns come from our alpha, not our beta...And we have a very high Sharpe ratio, since inception 1.8, so we have good returns and low volatility.”