Both of the regional funds use the MSCI Emerging Markets Europe 10/40 Index as their benchmark. Russia dominates, accounting for almost 50% of the index, and in GDP terms it is by far the largest country in the region. Poland and Turkey each account for almost 20% of the index, Greece is about 7% and the Czech Republic and Hungary make up the balance. None of the other countries in the region are represented.
Even with the weighting restrictions imposed by the 10/40 methodology, a few large stocks dominate the index including Gazprom, Lukoil and Sberbank (the top 10 are about 42% of the index’s market cap). The Barings fund operates with a portfolio of 50-60 stocks, while the BlackRock fund is much punchier – running with less than 30 holdings.
The Baring fund is a little larger than the BlackRock one (£132 million market cap versus £92 million), they trade on roughly the same rating – currently around an 11% discount – and, although the Baring fund has a better long-term track record, generally, since 2009, when Sam Vecht and David Reid took over the management of the fund from Pictet, the BlackRock fund has outperformed.
Matthias Siller, manager of the Barings fund, has probably been let down recently by his higher weighting in Russia; he had been anticipating a resurgent Russian economy in 2014 but was sideswiped by the events in Ukraine.
Russia has seen enormous capital outflows since the start of the crisis and its external debt is now close to losing investment grade status. All sorts of accusations are flying backwards and forwards about the current situation. Russia must recognise that the longer it drags on, the greater the risk it faces of causing long-term damage to its economy, especially if Western Europe steels itself to finding permanent alternatives to Russian gas imports.
Realistically, I think both funds need to see an improvement in the Russian situation before they come back into favour with investors.
JPMorgan Russian is really the only fund that is a pure play on the Russian stock market; Prosperity Voskhod, which specialised in small and mid cap stocks, is in the process of winding up. I wrote about the JP Morgan fund in September 2012. I cautioned then that an investment in The trust was always going to be a rocky ride. The fund did quite well from the end of 2012 until March 2013 but gave up most of its gains over the next few months and has lurched downwards again this year.
Russia looking cheap
Superficially, Russian stocks now look inexpensive and Oleg Biryulyov, manager of JPMorgan Russian, says his base case is that the tensions between Russia and Ukraine persist for some time but do not escalate and that there is no step up in sanctions. On this basis, he believes the depressed valuations in Russia may represent ‘an important buying opportunity’.
The three funds I have mentioned so far are probably the best known and safest ways to play Emerging Europe, but there is a raft of other funds specialising in the region – most of which are property funds. I will have a look at some of these another time but I thought I might finish up this week by mentioning the private equity funds investing in Eastern Europe.
All four were launched in the heady days of 2005-2007 and it would be fair to say that they have turned out to be dreadful investments. Aurora Russia is in the process of liquidating its portfolio and is handing back £8.5 million to shareholders by tendering for 40% of its share capital. It has another £9 million in reserve and two investments – a bank, Unistream, and a DIY retail business, Superstroy. It trades on a discount of about 18% currently but I would not be surprised if this widened out a little following the tender.
Tau Capital was launched to invest in Kazakhstan and neighbouring countries. It went into wind-up mode in July 2012 with the aim of selling off everything within 24 months. We should be coming to the end of the process now.
Tau has just handed back $5.5 million to shareholders and has only two investments left – Stopharm and Lucent Petroleum – and the directors have written down the value of the investment in Lucent to zero so everything now hinges on what happens to Stopharm which, when Tau last talked about it, was having problems with its working capital. After the asset write downs, Tau isn’t on a massive discount so, again, I’m not too sure the rating will hold up.
Ukraine Opportunity was caught, like many other funds, by the credit crunch but, from about September last year, its fortunes started to improve. It sold its stake in one of its holdings, Platinum Bank and delivered a 17% increase in its NAV over 2013 but was then hit by the events in Crimea.
The board seem relatively sanguine about the situation and, if things do not worsen from here, it might be cheap – trading as it does on close to a 50% discount. One for the very brave perhaps.
Reconstruction Capital II – which I mentioned last week and was the trigger for this article - is also trading on a sizeable discount. It is focused on investments based in Romania. Its manager is aiming to make disposals from its private equity portfolio but is finding it tough.
The fund is indebted to its fund manager and needs to address this situation. I am not sure it is worth a closer look until it has sorted out its finances.
James Carthew is a director at Marten & Co