Cool wind blows through the Baltics

Financial News

Jason Corcoran in Moscow
09 June 2008

Swedish manager sees opportunities in downturn
A marked slowdown in the Baltic economies has cooled the interest of many investors, but others continue to sense opportunities.

Swedish fund manager East Capital Asset Management hopes to raise €150m ($232m) for a fund with a 20% exposure to the three former Soviet republics of Latvia, Lithuania and Estonia, to add to its €4.4bn of assets under management. Its Bering New Europe fund will invest in small to mid-sized companies in the central European and Baltic markets.

Managers at East Capital believe the sharp adjustment has spawned companies with attractive valuations. East Capital director Andras Szalkai said: “We see good growth and limited risk for central Europe and the Baltics that we want to mirror in our fund. The global market situation has created many investment opportunities.”

He acknowledged there had been a slowdown in the Baltics, which he said was caused by several Scandinavian banks reining in their credit lines. This led to a decline in real estate and construction, and a drop in retail sales across the region.

The three republics joined the European Union in 2004 and experienced a consumer boom that drove a surge in economic growth. But the double-digit growth of the past three years has fuelled inflation and driven current account deficits to record levels. Credit conditions have tightened and interest rates have risen sharply.

Edgars Makarovs, head of portfolio management at Parex Asset Management, based in Riga, Latvia, said international investors had long since left the market, which he said was illiquid and difficult to operate in.

He said: “There are cheap and attractive valuations but the financial results of these companies have not been promising enough to make you want to invest. I think things are getting worse and not everyone understands the severity.”

Parex, which has $1.2bn (€780m) in funds under management, has shorn its exposure to Baltic equities to a minimum. However, its Baltic opportunities fund is fully invested in the three states and has fallen in value by 30% over the past year.

Makarovs said: “This fund has just about matched the benchmark. The stock market index in Riga is down 24% over the year, Estonia is down 35% and Lithuania is off by 12%.

With equities depressed, Parex has bought into local fixed-income bonds, where yields are between 10% and 12%. Makarovs anticipates being underweight in local equities for another six months at least and overweight in the more under-developed economies of central Asia and Ukraine.

Parex has also established a distressed property fund to capitalise on the 20% to 30% slide in residential real estate prices over the past year. The fund plans to raise €25m to buy real estate from owners in financial trouble.

Estonian banks and pension schemes have invested in 400m kroon (€21m) of local junk bonds issued mainly by real estate developers and loan providers. The move by the pension schemes caused a stir.

The Tallinn Stock Exchange had refused to list the bond issue of one real estate developer because of the high risk of defaulting, while another property development that issued a bond was found to have sold its main assets and is now practically worthless.

Sven Kunsing, head of East European investments of North European financial group SEB, said fund managers were aware of the risk and were keeping their share of junk bonds to a minimum in their portfolios. In a note, he said the media was focusing too much on such problem investments. He said: “Do you want us to stop investing altogether?”

Carmelina Carluzzo, an economist at UniCredit, said gross domestic product figures for the first quarter of this year indicated that central European countries, such as Slovakia, Czech Republic and Hungary, had proved more resilient to the global credit squeeze than their EU cousins in the Baltics.

She said: “Estonia, with an expansion in gross domestic product of only 0.4% in the first quarter, emerged as the slowest-growing economy in the EU, while Latvia’s growth decelerated to 3.6% from 8% in the fourth quarter. A slightly better outcome was recorded by Lithuania, whose GDP growth decelerated to 6.4% from 8% in the previous quarter.

“However, given the marked slowdown of the two other Baltic countries, a further cooling of Lithuanian growth can be expected in the next quarters.”

Inflation will continue to be the main concern for investors. Latvia has been one of the fastest-growing economies in Europe, but the boom appears to have been checked by inflation, which reached a 12-year high of 17.5% in April. Inflation in Estonia and Lithuania stands at 11.4% and 11.7%, respectively.

All three countries had hoped to adopt the euro soon after joining the EU in 2004 with the incentive of €124bn in convergence funds to drive them on. But a resurgence of inflation has pushed these plans back to 2010 at the earliest.

East Capital is continuing with its fund launch despite these doubts. Marcus Svedberg, chief economist at East Capital, said the high economic growth of recent years in the Baltics was not sustainable, so it was inevitable that a period of adjustment would come.

He said: “There is a marked slowdown occurring due to the build-up of imbalances, with widening current account deficits and inflation. We are now seeing an adjustment exacerbated by the global slowdown.”

Svedberg said the Baltics had begun correcting last year before other emerging markets and were further into the cycle. He said wages were rising rapidly to keep pace with inflation.

“If the Baltic economies grow by 3% to 4% over the next couple of years, it will still be a good performance compared with forecasts of 1% to 2% for the eurozone and 0.5% for the US,” he said.
“Adoption of the euro being delayed by a few years does not concern me as long as accession is on the agenda.

“The convergence criteria were not set up with fast-growing emerging markets in mind but rather for larger, more slowly growing, mature economies."

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