Europe’s Stock Pickers of the Decade Part Company on Cost of ‘Russia Risk’
Stock Chart for Gazprom OAO (GAZP)
Europe’s two best-performing equity fund managers over the last decade both invest in Russia from offices three blocks apart in Stockholm. They are miles away from each other on just how risky a place it remains.
Peter Elam Hakansson of East Capital Group says the country is no more risky than other emerging economies and its stocks will beat those in rival markets by 25 percent in the next three years to reflect this. Fredrik Colliander of Carnegie Fonder AB says corruption and corporate governance concerns justify a discount to nations such as Brazil. The two have each returned more than 700 percent in the past 10 years.
“Today when you buy the Russian stock market, you buy the same valuation as you did in 1999,” said Hakansson, sipping tea on the 14th floor of his office, overlooking snow-covered central Stockholm. “There will be a re-rating as people realize it’s not as risky as it used to be. The amazing thing is people are not perceiving this.”
Surging prices of oil and gas, Russia’s biggest exports, haven’t eased investors’ skepticism so far over the country’s corporate-governance record and legal protection for minority shareholders. Investor disputes involving state-run OAO Rosneft’s partnership with BP Plc and the government’s control of firms such as OAO Gazprom have kept the price-to-earnings ratio of Russian stocks at least a quarter lower than rival emerging markets Brazil, India and China.
“The present government has its own interests, messing with the economy in so-called strategic sectors,” said Colliander, 47, who has managed Carnegie’s 603 million-euro ($843 million) Russian fund since 2000. “That will continue for as far as we can see. It’s Russia risk.”
Hakansson, 48, manager of East Capital’s 1.9 billion-euro Russia fund has turned 10,000 euros invested 10 years ago into 97,700 euros today, making it the best-performing European stock fund with more than 350 million euros of assets, according to Morningstar Inc. A 10,000-euro investment in Colliander’s fund 10 years ago is valued at $70,300, the second-best performer.
The same 10,000-euro investment in the S&P 500 Index (SPX) in 2001 would now be valued at 12,900 euros. Hakansson’s fund is up 25 percent in the past year; Colliander’s has risen 16 percent.
Although the MICEX Index of Russia’s 30 largest publicly traded firms has more than doubled in two years, Hakansson and Colliander agree that cheap valuations relative to other emerging markets give room for growth. They’re both picking Gazprom and OAO Lukoil to benefit from higher oil and gas prices caused by demand from China and political instability in north Africa and are also buying banks including OAO Sberbank, Russia’s biggest bank.
They are split over how Russian stocks should be valued compared with other emerging markets. Hakansson says they will likely trade at the same valuations as Brazil by 2014, implying the country’s stocks will grow 25 percent faster than other emerging markets. Colliander says a 15 percent discount to rival economies’ price to earnings ratio is fair.
“There’s definitely risk when you invest in emerging markets, including Russia, but I don’t see a reason for having a lower P/E than Brazil,” Hakansson said. “It’s a hangover from the Cold War. Maybe we have higher expectations on Russians than we do on others.”
Colliander, who worked in the commercial division of the Swedish embassy in Moscow during the late 1980s, disagrees. “It should be a discount because of its specific issues,” he said.
Gazprom, which is 16.2 percent of the MICEX Index, has a price-to-earnings ratio of 5.4, almost half European rival Royal Dutch Shell Plc (RDSA)’s ratio of 10.5. Even with oil prices within 4 percent of a 30-month high, investors have little confidence in the firm’s management, Colliander said.
“Everything happens in Gazprom,” he said.
Gazprom was ranked among eight of the world’s least transparent oil and gas companies in an annual survey published this month by Berlin-based Transparency International and Revenue Watch Institute. All major oil and gas deals in Russia are approved by Russian Prime Minister Vladimir Putin.
Gazprom sold a 9.4 percent stake in OAO Novatek, Russia’s second-largest gas producer, for $1 billion less than its market price last year. “Why in hell would you do that?” Colliander said. “There’s a cap on the whole market until they resolve things like that.”
The stake’s price was calculated using its average value over the six months before the deal, which was agreed in September, according to Gazprom spokesman Sergei Kupriyanov. “The deal was closed in December when the share price was much higher,” he said.
Sweden and Russia
Stockholm has become a center for funds investing in Russia because of its proximity to the country and Sweden’s strong regulatory controls, according to Hakansson. Sweden and Russia were enemies during the Cold War and many Swedes learned to speak Russian, studying the country closely during their mandatory one-year military conscription, he said.
“We have either been intensively trading with the Russians or at war with them,” said Hakansson, a former Swedish marine. “We’ve never been indifferent.”
Colliander and Hakansson’s Russia funds were set up in 1997 and 1998 respectively, almost a decade after the fall of the Berlin Wall, which marked the end of the Soviet Union and thawed relations with Western Europe and the U.S.
Hakansson’s fund had $404 million of inflows in 2010, making it the third-biggest accumulator of investors’ capital among European-based Russia funds, according to New York-based research firm Strategic Insight. Colliander had outflows of about $166 million last year after the fund’s former owner, Stockholm-based HQ AB (HQ), was bailed out by the Swedish government and sold its asset-management division to Carnegie Holding AB.
Hakansson was one of East Capital’s three founding members and started in 1998 with 2 million euros under management. His fund now dwarfs his rival’s with 1.9 billion euros under management compared with Colliander’s 603 million euros.
“They used to be a big competitor,” Hakansson said, pointing out Carnegie’s offices from a meeting room overlooking Stockholm. “Not so much now.”
“He has his views, we have ours,” Colliander said. “I can assure you we are doing our best to compete with East Capital.”
Hakansson was attracted to Russia by his conviction that Russians would embrace capitalism and become as economically and politically tied with Europe as it was in the 19th century. “It was a one-off opportunity to invest in a society turning from a communist one to a capitalist one,” he said.
The strategy paid off. After Russia’s debt default of 1998 and its bailout by the International Monetary Fund, the country’s gross domestic product rose almost sevenfold to $1.34 trillion from 1999 to 2010, according to Moscow-based fund manager Prosperity Capital Management Ltd. During that time the average wage climbed to $650 a month from $50 a month and inflation dropped to 8.1 percent from 84 percent.
Russia’s MICEX Index (INDEXCF) beat all major indexes in Europe, Asia and the Americas from 2001 to 2008, rising almost 700 percent as the country bounced back from its bailout, buoyed by rising commodity prices and higher domestic consumption.
In the second half of 2008, the financial crisis wiped three years of gains from the index as it fell 68 percent, before a rally in oil and gas prices helped the index rebound to within 10 percent of its all-time high this January.
Even with the long-term gains, the MICEX’s price-to- earnings ratio is 9.5, less than the 10.24 it was in 2003, the earliest data compiled by Bloomberg and almost a quarter lower than Brazil’s Bovespa Index. The main exchanges in China and India as well as the U.S. and U.K. have ratios of 12.9 to 16.2, according to data compiled by Bloomberg.
Low valuations are a symptom of an economy dependent on natural resource firms whose stocks move with economic cycles and a legal system with little regard for minority shareholders, according to Joanne Irvine, who helps manage about $40 billion at Aberdeen Asset Management Plc in London.
“The state is involved in a lot of the companies and you have a lot of oligarchs dominating them,” Irvine said. Russia is “one of the weakest places to invest from a corporate governance perspective.”
Aberdeen, which runs the second-best global emerging markets fund over the last year, has an “underweight” position in Russia, preferring India, Irvine said.
The conviction and imprisonment of Mikhail Khodorkovsky, former chief executive officer of Yukos Oil Co., is one case that illustrates the unpredictable nature of the Russian legal system, she said. India is “one of the strongest in terms of corporate governance,” she said.
The biggest threat to Russian growth today is from China as opposed to the late 1990s when its economic problems were internal, Hakansson said. The world’s biggest consumer of raw materials reported the largest trade deficit in seven years on March 10 as export growth slowed.
Colliander agreed that a global economic slowdown spurred by China would hit Russia hard. “If we get risk adversity coming in like we did a few years ago, Russia is the first sell,” he said.
Unlike his cross-town rival, Colliander is also wary of Russia’s propensity to surprise.
“We always get reminded of this special Russian issue,” he said. “Something happens every two or three years. It’s difficult to say what’s it going to be next time, but something’s going to happen. It always does.”
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