Surviving the Russian investment winter
Stuck at the gates of Stalingrad? East CapitalÆs Michael Hanson-Lawson describes the shell-shocked Russian markets.
From NapoleonÆs Grande Armee to the Wehrmacht, Russia can be unkind to foreigners. The same applied in 2008 to investors as the Russian markets (the US dollar denominated index), fell by two-thirds during the year and the rouble fell 30% in the last six months against the dollar. AsianInvestor spoke to East CapitalÆs man in Hong Kong, Michael Hanson-Lawson, about the outlook for the Russian market.
Will the currency keep falling?
I think we are not far off some sort of level now. When Russia defaulted and was bust in 1998, the devaluation was 75%. Today Russia isnÆt bust and has the worldÆs third largest forex reserves.
What caused the stock market drop?
It began to crumble at the beginning of the second half as commodity prices fell û and commodities represent about 70% of the index. That also affected the rouble, which is in a sense a petro-currency. Then Putin reprimanded a mining and metals firm Mechel for price gouging, and because of his track record with Yukos, people thought this was becoming another Yukos and it caused the market to fall. Then there was the Georgian incursion. So there was this series of factors, and underlying that was the belief that earnings would fall as a result.
Is the banking system bust?
There are parts that are illiquid and living on central bank support. One of the major state banks, VNE, has been providing a lot of liquidity loans û up to $200 billion to the banking system and this represents RussiaÆs version of USAÆs TARP. Measured by GDP this is a bigger package than the USAÆs. The smaller banks in trouble, and most of RussiaÆs banks are unlisted, are being pushed into the arms of bigger ones. The listed banks are in satisfactory shape.
Also, the oligarchs have gotten into trouble, borrowing predominantly from western banks against the pledge of their own shares in order to finance expansion. Where they have had obligations that they couldnÆt fulfil with those banks, such as margin calls, they didnÆt of course want to surrender their pledged shares for sale. So they ran to the Kremlin who offered some assistance using VNE Bank to lend them some money. No doubt there will be some equity changes in some of these big companies, as the Kremlin will be selective about which ones it chooses to help and which ones it doesnÆt, and the Government will end up with an interest in the company.
This closes the circle for the oligarchs who became enriched by purchasing those companies on the cheap from the Government during Boris YeltsinÆs time in Government. Now they are losing influence due to having over-extended and those firms may return, in part into Kremlin ownership.
Has the Russian Government been buying stocks?
They set aside money to do so, $7-10 billion. The government said that it no intention to be long term holders or to re-nationalise the companies. So these stakes would be sold at a later date.
What is the market trend today?
There hasnÆt really been a trend since October. There has just been volatility and both the stock market and the currency have traded in line with the oil price.
Have the market problems filtered through to the real economy. Are people losing their jobs?
Arrears in unpaid wages is rising and unemployment, which had been at its lowest ever level in March last year is starting to rise. Certain areas of discontent have arisen. There was a protest in Vladivostok quite recently where taxes on Japanese cars were raised to support local industry. Those affected in the motor trade in Vladivostok protested, and the police presence to quell it had to be flown in from Moscow.
Will these problems undermine the Putin/MedvedevÆs grasp on power?
PutinÆs popularity has consistently about 70-80% for some time. MedvedevÆs is not far behind that. So the popularity has only one way it can go, but to suggest they might lose their grip on government is too far fetched. The organs of state are too strong, the press is muzzled, and things would have to get a lot worse than it is at present.
PeopleÆs expectations have been raised and they may feel disappointed, but theyÆve had ten good consecutive years. With its reserves, the State can cushion the blow to the population, so weÆre not looking at a depression.
Russia is arguing with Ukraine now. What do you think its ambitions are towards the old USSR states? Should investors be concerned?
It shouldnÆt be too much of a worry. Georgia was a one off, and the Georgians did shoot first. Russia has a sphere of interest in the same way the USA does. I donÆt think they want military control, but they do want to trade with them. Russia isnÆt happy the Baltic states are part of Nato. They donÆt mind their EU participation so much, but thereÆs sensitivity about border countries like Georgia and Ukraine joining an organization that was designed to point its guns at Russia.
With the Ukraine dispute, the Ukrainians own a lot of GazpromÆs storage facilities, and theyÆve paid very, very little for the Russian gas transiting through. ThatÆs not the official line, but thatÆs what happens. Gazprom now does have a big capital expenditure programme and needs the money.
Is the timing right to invest in Russia. And if so, where?
Russia is extremely cheap. ThereÆs a possibility the market may go lower, but allocations should be dripped in slowly, not putting it all in at one time. The safest sector now is probably utilities. Rus Hydro is the largest utility of its type in Russia is on about three times earnings, and it should be on 10-12 times earnings. Utility prices are being liberalized and the outlook is extremely good.
Secondly, Transneft has a monopoly on the oil pipelines to the west. ThatÆs trading on a P/E of about one. So you can buy into safe sectors with absurdly low valuations.
The commodity sector has bombed out but has since recovered somewhat.
How has your Russian Fund performed?
It was down in line with the market, but is still up 600% since inception. It is a daily traded fund and in that respect the fact that only 25% of the fall in its asset size (approximately $700-750 million) was in respect of redemptions, is not too bad.
Will East Capital be taking advantage of these opportunities by investing or introducing new products?
Our listed Explorer Fund currently trades at a 46% discount to NAV and yet nearly two thirds of the NAV is actually held in cash. That cash, about Ç200 million, will be invested by the middle of this year, as that is what was agreed with shareholders.
We do have a new fund in the pipeline that will take advantage of the distressed valuations, but we canÆt talk about it just yet.
Will the currency keep falling?
I think we are not far off some sort of level now. When Russia defaulted and was bust in 1998, the devaluation was 75%. Today Russia isnÆt bust and has the worldÆs third largest forex reserves.
What caused the stock market drop?
It began to crumble at the beginning of the second half as commodity prices fell û and commodities represent about 70% of the index. That also affected the rouble, which is in a sense a petro-currency. Then Putin reprimanded a mining and metals firm Mechel for price gouging, and because of his track record with Yukos, people thought this was becoming another Yukos and it caused the market to fall. Then there was the Georgian incursion. So there was this series of factors, and underlying that was the belief that earnings would fall as a result.
Is the banking system bust?
There are parts that are illiquid and living on central bank support. One of the major state banks, VNE, has been providing a lot of liquidity loans û up to $200 billion to the banking system and this represents RussiaÆs version of USAÆs TARP. Measured by GDP this is a bigger package than the USAÆs. The smaller banks in trouble, and most of RussiaÆs banks are unlisted, are being pushed into the arms of bigger ones. The listed banks are in satisfactory shape.
Also, the oligarchs have gotten into trouble, borrowing predominantly from western banks against the pledge of their own shares in order to finance expansion. Where they have had obligations that they couldnÆt fulfil with those banks, such as margin calls, they didnÆt of course want to surrender their pledged shares for sale. So they ran to the Kremlin who offered some assistance using VNE Bank to lend them some money. No doubt there will be some equity changes in some of these big companies, as the Kremlin will be selective about which ones it chooses to help and which ones it doesnÆt, and the Government will end up with an interest in the company.
This closes the circle for the oligarchs who became enriched by purchasing those companies on the cheap from the Government during Boris YeltsinÆs time in Government. Now they are losing influence due to having over-extended and those firms may return, in part into Kremlin ownership.
Has the Russian Government been buying stocks?
They set aside money to do so, $7-10 billion. The government said that it no intention to be long term holders or to re-nationalise the companies. So these stakes would be sold at a later date.
What is the market trend today?
There hasnÆt really been a trend since October. There has just been volatility and both the stock market and the currency have traded in line with the oil price.
Have the market problems filtered through to the real economy. Are people losing their jobs?
Arrears in unpaid wages is rising and unemployment, which had been at its lowest ever level in March last year is starting to rise. Certain areas of discontent have arisen. There was a protest in Vladivostok quite recently where taxes on Japanese cars were raised to support local industry. Those affected in the motor trade in Vladivostok protested, and the police presence to quell it had to be flown in from Moscow.
Will these problems undermine the Putin/MedvedevÆs grasp on power?
PutinÆs popularity has consistently about 70-80% for some time. MedvedevÆs is not far behind that. So the popularity has only one way it can go, but to suggest they might lose their grip on government is too far fetched. The organs of state are too strong, the press is muzzled, and things would have to get a lot worse than it is at present.
PeopleÆs expectations have been raised and they may feel disappointed, but theyÆve had ten good consecutive years. With its reserves, the State can cushion the blow to the population, so weÆre not looking at a depression.
Russia is arguing with Ukraine now. What do you think its ambitions are towards the old USSR states? Should investors be concerned?
It shouldnÆt be too much of a worry. Georgia was a one off, and the Georgians did shoot first. Russia has a sphere of interest in the same way the USA does. I donÆt think they want military control, but they do want to trade with them. Russia isnÆt happy the Baltic states are part of Nato. They donÆt mind their EU participation so much, but thereÆs sensitivity about border countries like Georgia and Ukraine joining an organization that was designed to point its guns at Russia.
With the Ukraine dispute, the Ukrainians own a lot of GazpromÆs storage facilities, and theyÆve paid very, very little for the Russian gas transiting through. ThatÆs not the official line, but thatÆs what happens. Gazprom now does have a big capital expenditure programme and needs the money.
Is the timing right to invest in Russia. And if so, where?
Russia is extremely cheap. ThereÆs a possibility the market may go lower, but allocations should be dripped in slowly, not putting it all in at one time. The safest sector now is probably utilities. Rus Hydro is the largest utility of its type in Russia is on about three times earnings, and it should be on 10-12 times earnings. Utility prices are being liberalized and the outlook is extremely good.
Secondly, Transneft has a monopoly on the oil pipelines to the west. ThatÆs trading on a P/E of about one. So you can buy into safe sectors with absurdly low valuations.
The commodity sector has bombed out but has since recovered somewhat.
How has your Russian Fund performed?
It was down in line with the market, but is still up 600% since inception. It is a daily traded fund and in that respect the fact that only 25% of the fall in its asset size (approximately $700-750 million) was in respect of redemptions, is not too bad.
Will East Capital be taking advantage of these opportunities by investing or introducing new products?
Our listed Explorer Fund currently trades at a 46% discount to NAV and yet nearly two thirds of the NAV is actually held in cash. That cash, about Ç200 million, will be invested by the middle of this year, as that is what was agreed with shareholders.
We do have a new fund in the pipeline that will take advantage of the distressed valuations, but we canÆt talk about it just yet.
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