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The Billion Dollar Interview with Constellation Asset Management

Constellation is an equity asset management company founded in 1999 to invest in Brazilian companies using a fundamental approach with an in-depth investment process. Constellation’s strategies are long short and long only, with a mid- to long-term horizon. Both strategies offer vehicles to both local and foreign investors.

Eurekahedge: The Constellation Asset Management team possesses decades of experience in investing in Latin American stock markets, specialising in Brazilian equities. Please share with our readers a bit of history about your fund and its key founders.

Constellation Asset Management started as a proprietary hedge fund named Utor Investments, which was established by the founders of Banco Garantia (Brazil’s major investment bank) in 1999 and current major shareholders of AB-Inbev and 3G Capital. In 2002, after a successful spin-off from Utor Investments, Constellation was established as an independent business.

The company's founders are Florian Bartunek and Jorge Paulo Lemann. In October 2007, Lone Pine Capital in Greenwich, CT, acquired a stake in Constellation, making it Brazil's first equity fund with a foreign partnership.

Florian Bartunek successfully runs the same strategy since 1991 and has one of the longest track records as an equity portfolio manager in Brazil. Prior to founding Constellation, Florian was a partner of Banco Pactual. At Pactual, Florian was head of research, proprietary trader, and manager of all equity portfolios/funds. During Florian’s time at Pactual (1990-1998), he managed the Andrômeda Fund (highest ranked equity fund in Brazil for three consecutive years), the Infinity Fund (highest ranked Brazilian equity offshore fund for two consecutive years) and a segregated portfolio for George Soros.

All partners and members of the management team have a significant part of their net worth invested in Constellation's funds, paying all fees in full. One of our internal policies is that 50% of bonuses earned must be invested in our funds. Currently, 83% of our client base is long-term oriented: composed by institutional investors from the USA, Brazil and Europe (such as sovereign wealth funds, endowments, foundations and insurance companies), family offices, and money from partners, as well as the management team.

EH: Please tell us about the investment strategy utilised by your firm and how it helps to distinguish you from other long only absolute return vehicles out in the market.

Our goal is to compound our clients’ investments at attractive rates in the long run by investing in Brazilian public equities through a rigorous research-driven, ‘bottom-up’ fundamental approach. We look to own stakes in companies that will compound earnings and dividends at attractive rates. For that we think of ourselves as owners of the businesses, and look for the companies that: have barriers to entry, are run by people with an owner’s mentality, have management with both execution capabilities (discipline) and strategic vision (dream), have in-house talent development, have a strong balance sheet and lean structures (constant cost control). History has proven that the longer we stayed invested in the companies, the higher the annual IRR was. We work hard to monitor the companies we own, and to find new ones.
Our priority is to have good companies above all, instead of looking at cheap valuation; we carefully build our portfolio considering the equilibrium of sector and individual risks, avoiding excess concentration in any risk factor. We believe in value investing as well as identifying growth secular opportunities, always adapting our valuation criteria to the profit growth profile.

We believe that Constellation’s competitive advantages are the following:

Structured investment process with thorough knowledge of invested companies - The depth of our investment process and the capillarity of our team (11 research analysts) are two of Constellation´s main competitive advantages. The analysts perform a strong research process driven by some qualitative concepts: industry, fundamentals of the company, management, governance and valuation. For the companies we cover, we take on a rigorous process of due diligence where it is mandatory to do at least 10 visits to companies surrounding our investment target plus five other visits with the company itself (including the top management).

Discipline and patience - The composition of our investor base (more than 55% of our assets coming from institutional international long-term investors such as sovereign wealth funds, endowments, foundations, insurance companies, pension funds, etc.) allows us to have low volatility in terms of assets under management (AUM).

Lessons learnt through difficult times - The Constellation team has over 20 years of experience and has been together for a long time. In addition, Florian Bartunek, partner and CIO of Constellation, has undertaken the same strategy since 1991 and is one of the most experienced equity managers in Brazil.

Focus on avoiding permanent loss of capital and having a balanced portfolio - The construction of a good portfolio necessarily begins with a thorough understanding of the company, a detailed analysis of risks and a balanced portfolio. 

Thorough knowledge and long-term relationship with the companies and management teams – Constellation has been around for over 12 years. It allows us to develop an extremely close relationship with the management of the companies we analyse.

Shareholder structure – Constellation is structured as a partnership and its main shareholders are the executives who work at the company, there is no single controller.

Partners alignment - Strong alignment of interests between the fund's objectives and the Constellation team. In addition to employees and partners representing a significant part of our AUM, a relevant part of executives’ compensation (members and employees) is linked to the performance of the company as a whole.

EH: Can you share with us a rough breakdown of your exposure across the key Latin American equity markets? How much of the fund’s assets are allocated outside of Brazil and how much have they contributed to the bottom line? Do you see this allocation changing anytime in the near future?

We are focused 100% on Brazil. Currently we don’t invest in other countries in Latin America. We believe in specialisation and deep knowledge on invested companies. Brazil is a big market with many opportunities. Our strength is to know companies in a level that competition doesn’t go to. It would be very hard to replicate with the same quality our research process abroad.

EH: Are there specific sectors that the fund targets? How concentrated is your portfolio and are there limits on the maximum exposure you carry to a particular industry or stock name? Could you share with our readers a breakdown of your asset allocations across the various industry sectors, leverage used and net exposure?

It is important to note that we do not have any dogmas in defining the companies to analyse, except for the quality criteria: we do look at small, mid and large caps as we believe that there are very good assets among all market capitalisations. We believe in value investing and secular growth opportunities. Over the years, we noticed that mid-caps presented highest concentration of quality and upside combined.

Our portfolio has in average 20 positions. Usually, the top five positions will concentrate 40% of our exposure. We do not use leverage and our average net exposure is around 90%. Historically our high conviction investments carried a 10% exposure of the NAV. This is fairly concentrated if you compare to a typical US manager, but for Brazilian standards is pretty much average among value investors. Currently our main investments are in education and financials.

EH: The Constellation Long Only Fund has returned an annualised 19.27% since its inception in 2005, far outperforming the benchmark IBOVESPA’s 6.12%. What would you attribute the success of your strategy to, in particular during 2009 where the fund gained in excess of 200%?

There is no rocket science to make a difference. I attribute our results to our team (people) and the discipline of our investment process. It is very common to hear among fundamental driven managers that they have a thorough research process and deep knowledge in companies. The key difference is really doing what you say you do. The ability to put the best team together, motivated them and create a disciplined process will make the whole difference in the end.

EH: Do you regularly hedge against foreign exchange exposure since your fund is denominated in USD? Last year we witnessed a run on emerging market currencies as the Fed began to scale back on quantitative easing program; how well do you think your fund was positioned to handle this macro risk?

No. The cost of hedging the currency in Brazil is too high. If you take any five years window, it will show you that a hedged portfolio would substantially underperform a non-hedged fund. If our fund was hedged, our average annual return since inception would have been one-third of what we delivered. One that invests in Brazil must understand that this volatility will be part of the story and should not take short term decisions influenced by that.

EH: Since its inception in 2005, the Constellation Long Only strategy has grown rapidly to over US$1 billion. What is the key reason behind the popularity of your long-only offerings as compared to the long/short equity fund? Since your clients are largely offshore, is their interest in Latin America mainly to diversify their equity market exposure?

Since 2008 we decided to pursue a more stable capital base to our funds as a result of the experience faced with the redemptions post-2008 crisis. Being a long term investor in companies requires a long term investor profile base as well. As we grew our asset base among institutional international long-term investors such as sovereign wealth funds, endowments, foundations, insurance companies, pension funds, etc., there was a natural preference towards a long only strategy in Brazil by them. Besides, investors have noticed over time how difficult is to constantly generate alpha on short in Brazil.

I would say that most of our investors want to have a stable exposure to emerging markets in their portfolios for the long run and their research pointed to the conclusion that a country specific manager such as Constellation, have a better capacity to generate alpha over time versus a typical global emerging markets funds. We are seeing, more and more, our investors looking for dedicated managers for specific regions.

EH: Institutional investing has been playing an increasing greater role in the hedge fund industry which was originally dominated by private investors. Has your clientele changed over the years to reflect this trend? What do institutions tend to look for in a fund as compared to individuals and family offices?

Yes. As mentioned above, currently our investor base is predominantly institutional. Over 55% of our capital comes from sovereign wealth funds, endowments, foundations, insurance companies and pension funds as opposed to the past when funds of hedge funds played a bigger role.

Institutional investors think like us when we search for companies. When looking for managers, quality plays a very important role. They want to find talented people that they can trust to manage their money on the long run. Likewise, when we look for good investments, we also look for talented managers we can trust.

EH: What are your main risk management principles in limiting your downside volatility? Shorting Latin American equities may pose a challenge; have you encountered any difficulty finding stocks to borrow or with the local regulations regarding short sales?

We see risk as through a permanent loss of capital angle. Permanent loss of capital in EM can come from:

  • Macro risk: Political unrest in Brazil, inflation, strong depreciation of the currency.
  • Valuation risk: Buying an overly expensive stock.
  • Balance sheet risk: Earnings collapsing due to excessive leverage in balance sheet
  • Business/earnings risk: The risk of the permanent or temporary loss of earnings power (competition, changes in management, products, etc.).

Regarding shorting in Brazil, we do believe that it is a very challenging strategy. Borrowing is not much of a problem; the issues are more the cost, the excessive concentration of the free float among mid-caps leading to squeeze risk and the fact that so far, only the best companies in their respective industries got listed in Brazil. It is like shorting in a market where the average quality is high.

EH: Going forward, what are the key macroeconomic risks for Latin America? Do you think that the returns from investing in the region are worth it, particularly in light of the high volatility of returns? Also, how do you anticipate the regional markets to evolve once the Fed hikes up interest rates?

A lot has been said recently about Brazil being a fragile economy. We disagree with that. We suffer though from an incompetent government that failed to produce growth and with a higher interventionist policy lost confidence from the market.

The country will continue to face a challenging environment as inflation will persist, keeping interest rates high too, not collaborating to increase growth. The fiscal side will not help much on this battle as the government is with tight hands on the cost side.

The scenario we see is one of low growth for a while until reforms and results from infrastructure investments begin to affect the economy positively. During this muddling through period, Brazil has enough reserves and funding capacity to face short- and medium-term obligations, posing no solvency risk for investors. As the base case points to no tail winds from the macro environment, we should more than never look at the companies and the opportunities that are underneath this scenario. How we see this:

  • Valuations are attractive
  • There is a historical negative correlation between GDP growth and equity returns in Brazil (incumbent / low competition effect)
  • Our leaders are more profitable than their peers in the US
  • The margin of safety is higher today from most angles (FX, multiples and earnings)

If you were to look at the last four years, why investors lost money generally in equities in Brazil, it was mainly for two reasons: 1) the currency BRL devalued above inflation (50pct), and 2) there was a multiple compression. Investors were less wrong on earnings growth but that was not sufficient to offset the other aspects.

Looking forward the margin of safety is higher as it is unlikely to see the currency devaluing at the same pace and the multiples are much lower. Rests on this equation what is going to happen with earnings. Here comes the point where equity returns in Brazil have been among the highest in emerging markets during the last 20 years. In Brazil, real equity returns average 14pct per year while GDP averaged 3pct. This difference is basically explained by lack of competition, high volatility, red tape and barriers to entry that over time are creating large incumbent companies that through cycles are getting stronger and stronger.
Some examples:
Totvs: ROE 20 vs Oracle and SAP 17
Ambev: ROE 30 vs Heineken 10
Itau: ROE 20 vs Wells Fargo 13

Looking ahead, earnings growth and dividends should point to IRRs around 20pct with modest multiple appreciation. The reality is that, one looks today at this IRR and compares the difference to the same IRR 3 years ago, the biggest change is that the probability of converting this projections into real returns is higher due the margin of safety.

EH: On a final note, with Brazil’s presidential elections just round the corner, do you see any potential major reforms coming and what does it mean for the equity markets?

Regardless who the next president will be, this election clearly comes with a message from the population: they want to see changes. We should then expect the next president to promote reforms such as labour, tax, political, etc. In the long run this will help the economy to increase productivity and, as a consequence, improve growth. However, the short term challenges are very high and we expect more attention being dedicated to the macroeconomic policies. The main idea is regaining confidence by repairing the three-pillar policy framework introduced in 1999 by the Cardoso administration, that was somewhat watered down under the second Lula term, and considerably weakened thereafter.

We foresee the economy performing poorly in 2015 still but with expectations to improve in 2016 once reforms are put in place. The equity market should respond well to the right policies.


Contact Details
Candido Gomes
Constellation Asset Management
+55 11 4501 0031