The Best Kept Secret In Moscow?

Savvy scouting has brought the Hermitage Fund stellar returns

On a hot summer day in Moscow in 1996, William F. Browder invited one of the largest investors in his fledgling Hermitage Fund to meet the chief executive of a Russian oil holding company. To their surprise, the CEO urged them to sell his company's stock, saying he expected its price to fall. Instead, Browder bought more. "The books looked good," he explains. "I figured he was talking down the price so he could buy more himself." Good figuring. Since June, the stock is up more than 2,000%, and Hermitage has made $100 million from the investment.

Browder's instincts have made Hermitage one of the best-performing offshore funds this year, returning more than 313% through Aug. 15. Moscow-based Browder's close relationships with local brokers, frequent visits to Russian companies, and a more stable ruble have helped the fund gain almost 910% since its inception in April, 1996. Assets have grown from $25 million to $816.7 million as of July 31.

"BOOBY PRIZE." Browder wasn't always bullish on Russia. He spent three years in Poland as a privatization consultant, then managed a private equity fund for British media mogul Robert Maxwell. In 1992, Salomon Brothers Inc. hired him to help run its investment-banking activity in the former Soviet bloc. At the time, Browder thought colleagues in charge of Budapest and Prague had more promising portfolios. "Moscow was the booby prize," Browder recalls.

He quickly changed his mind. With Russian privatization in full swing, the government was unloading companies at fire-sale prices. Convinced that "there were absolute fortunes to be made," Browder went solo in the summer of 1995, launching Hermitage with backing from private investor Benjamin Steinmetz and Republic National Bank of New York.

By focusing on little-known companies with big potential, the fund has outperformed Russia's high-flying stock indexes. It also has trounced established rivals, such as the Templeton Russia Fund and the Regent Pacific funds. Browder "always seems to be ahead of the curve," says Peter Kizenko, who heads equity trading for ING Bank Moscow.

Take preferred shares. In early 1996, some brokers at Moscow's United Financial Group told Browder they were collecting a $22-per-share dividend on preferred stock they had bought in a small oil company for $5. Intrigued, he accompanied UFG's chief executive officer, Charlie Ryan, to the Moscow office where Lukoil, Russia's first integrated oil company, stores its share registry. Browder wanted to find out if the preferred shares of blue-chip companies such as Lukoil offered the same spectacular payoff as the small fry. They did. Says Ryan: "We couldn't get out of that office fast enough, we were in such a rush to buy Lukoil preferred shares." Soon, Hermitage had loaded up on preferred stock in blue chips such as long-distance telephone monopoly Rostelekom and Unified Energy System. In the past year, preferred shares are up 1,000% on average.

LOCAL REPS. More recently, Browder has focused on the hard-to-buy shares of oil holding companies. During privatization in the early 1990s, Russia sold stakes in many small oil companies that were to be merged into 11 big holding companies. Except for Lukoil, shares in the new holding companies were held mostly by big Russian banks. That didn't deter Browder. Last May, he paid local brokers to go out to the regions and buy shares of Yukos, an oil company 95% owned by Menatep Bank, from workers. Fifteen months later, the stock is up 2,170%.

Browder's tenacity in going after illiquid but promising stocks has paid off. He was one of the first foreigners to buy shares in Sberbank, a former state savings bank with 34,000 branches and 75% of Russian bank deposits. The stock has soared 1,705% since Hermitage began buying it in July, 1996.

The Hermitage Fund is now closed to new investors, but Hermitage II, which came on the market on Aug. 1, will pursue the same strategy. Like most Russia funds, it is geared toward deep-pocketed investors who put in more than $1 million each.

Catering to millionaires is hardly in Browder's blood. His grandfather, Earl, headed the American Communist Party from 1932 to 1945. If Earl could see how his grandson has profited from Russia's turn to capitalism, he'd probably turn over in his grave.

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