Russian economy entices new investors

Financial News

Jason Corcoran in Moscow

06 April 2009

After the sell-off, hopes of good returns are rising

Like heroes inspired by the firebird of Russian folklore to undertake the most dangerous of quests, investors are returning to a resurgent Russian stock market in the hope of riches.

Norway’s $330bn (€249bn) state pension fund, one of the world’s largest sovereign wealth funds, last month awarded Prosperity Capital, the largest foreign fund manager operating in Russia, its largest mandate.

G2 Group, a Swiss family office, has taken large equity stakes in two Moscow investment firms, Da Vinci Capital and Diamond Age Advisors.

Swedish fund manager East Capital has increased its Russia weighting in its largest fund, the $500m east European fund, from 40% to 57%, the highest level in its seven-year life.

Karine Hirn, co-founder of East Capital, said: “Russia is extremely cheap now. It was by far the most oversold of the stock markets last year. In fact, the region of eastern Europe had 10 out of 20 of the most oversold markets in the world.”

Investor enthusiasm has pushed the RTS Index of leading Russian shares up 46% since its low point in late January. Higher oil prices, a stronger rouble and hopes that the international credit markets could soon be prised open for domestic issuers have helped improve investor sentiment.

But investors should bear in mind that, according to Russian folklore, while good fortune lies in store for whoever catches the firebird, trouble is normally close behind.

The Russian equities market has ruined investors twice in little more than a decade, with the RTS dropping 85% in 1998 and 75% last year, spurring investors to pull $290bn from the country between August and January this year, according to French bank BNP Paribas.

It was the combination of collapsing share prices and client withdrawals that forced Da Vinci Capital and Diamond Age Advisors to restructure themselves in the first place.

Alfa Bank co-founder Petr Aven last week warned that bad debts could reach 20% of total loans by the end of year, while finance minister Alexei Kudrin expects 10% in defaults.

Chris Weafer, chief strategist at banking group Uralsib, said: “The economy is still in decline and will need both a sustained rally in the demand for, and price of, commodities – plus a resumption of bank lending – to create new growth. These are more likely in the fourth quarter than in the second quarter, if they happen at all in 2009.”

East Capital’s asset managers said they are focusing on companies with low levels of debt, a strong market position and opportunities to benefit from sector consolidation.

Hirn said: “We are looking more at the balance sheets these days because there are financing issues that need to be resolved for many companies. We are happy to avoid real estate because the debt burden is heavy.”

Hirn said the firm’s east European funds had suffered a sharp fall in valuations since September but only suffered 10% in client redemptions. “We lost a huge amount in valuation in recent months but it was less brutal than 1998,” she said.

East Capital said Russia was still the strongest economy in eastern Europe with exposure to a large domestic market. It said countries dependent on exports such as Hungary and the Czech Republic are more vulnerable. Turkey and Romania also benefit from a strong domestic economy.

The manager last month launched a special opportunities fund to target assets in Russia and the Commonwealth of Independent States where valuations have declined sharply. The board of East Capital has agreed to put $50m in the fund when it launches during the second quarter of this year.

Moscow investment firm Da Vinci Capital also hopes to exploit cut-price opportunities in Russia through its new partnership with G2 Group, which manages $1bn in alternative assets.

Oleg Jelezko, managing partner and chief executive of Da Vinci Capital, said “Our strategy will be different now we are in recovery mode so we won’t need to pursue derivatives. It’s about using different asset classes such as bonds and special situations.”

Mattias Westman, chief executive of Prosperity Capital Management, said his firm’s Russian funds had received more interest from institutions in recent weeks.

He said: “Nothing very big, but it’s more constructive. We have endowments, pension funds and family offices considering further investment. Hopefully the Norwegians will help make Russia something that other major institutions feel more comfortable with.”

Flows into Russian equity funds hit a 19-month high in March, according to EPFR Global, a data provider that tracks funds. It said capital flows into Russian-dedicated funds rose from $7m in the week ending March 18 to $50m the following week.

However, inflows remain modest, as many investors are sitting on the sidelines waiting to see whether the rebound is just a bear market rally.

Angelika Millendorfer, head of emerging market equities at Austria’s Raiffeisen Capital Management, said: “So far our institutional and private investors are not returning to emerging markets. The relative performance of emerging markets has improved but investors are not yet making any substantial moves.”

Millendorfer said the big emerging markets funds and institutions continued to have low allocations to equities and to markets like Russia. She said: “I would be surprised if investors moved into emerging markets if the case for the developed markets does not return first. We need to have confidence that western banks will not collapse Lehman-style.”

Greater rouble stability and recent higher oil prices have been a major reason for domestic equity recovery but questions remain over the banking system, external corporate debt and the high level of inflation.

The biggest risk, partly because it cannot be quantified, relates to the level of non-performing loans in the banking sector and the future ability of big Russian corporates to pay or refinance the amounts they owe.

Norway sovereign fund picks manager for Russian play

Financial News

Jason Corcoran in Moscow

17 March 2009

Norway's $330bn (€257bn) state pension fund, one of the world's largest sovereign wealth funds, has increased its exposure to Russia by two and a half times and hired Prosperity Capital to run a mandate.

Swedish firm Prosperity, which manages about $1.5bn in Russian and CIS equities, said the Norwegian reserve fund’s mandate was its biggest yet, although declined to give details due to client confidentiality.

Mattias Westman, chief executive of Prosperity, said he hoped the faith shown in Russia by a sovereign fund will make other major institutions feel more comfortable about investing in the country. He said: “We have seen an increase in interest in the last weeks. Nothing very big but it’s much more constructive. We have endowments, pension funds and family offices considering further investment.”

A spokeswoman for Norway’s reserve fund said exposure to Russia had increased but declined to comment on individual managers.

The fund does not disclose the size of its mandates, but typically awards between €30m and €160m to new managers, according to its website, as part of a rolling programme.

Russia’s RTS-index of leading stocks has rallied by 15% over the past month after sliding by 75% since last August. Investors are being lured back gradually by the recent bounce in oil prices and signs that the government has managed to stablise the rouble.

The Norwegian reserve fund has outsourced 13% of the fund’s assets, or about €34bn, to external fund managers in mainly emerging markets worldwide and specialised sectors

The fund’s exposure to Russia stood at 0.83% at the end of 2008, according to the fund’s annual report issued on March 11.

The value of Russian companies in its internally managed portfolio increaed by 2.5 times to $840m by the end of 2008. Exposure to Brazil was 0.84% while the other Bric countries of India and China represented 0.77% and 0.79% of investments.

At the end of 2007, the fund has just 14 investments in Russian equities. A year later, its fund managers had stakes in 46 Russian companies, including a 1.04% stake in Ursa Bank, 1% in carmaker Gaz Group and a 1.6% share of retailer M Video.

The fund has also built up exposure to Russia’s recently deregulated electricity sector through a 0.86% stake RAO Energy System East, a 3% stake in OJSC Interregional Distribution Grid Company Co Center and Privolzhya and 1.25% in OJSC Interregional Distribution Grid Company North West.

Swedes lose patience with Prokhorov

Financial News

23 February 2009

By Jason Corcoran


Letter from Moscow
Moscow’s mild-mannered Swedish investors are mad as hell and are not going to take it any more. Prosperity Capital and East Capital are two of the largest and longest-serving fund managers operating in Russia. The two firms have historically adopted a softly-softly approach to engaging with errant Russian corporates, but those tactics have recently proved as useful as lighting a match in a Siberian snowstorm.

Prosperity, whose founders have been investing in Russia since 1992, is warning of another Yukos blow-up occurring because of a major dispute it has with Russia’s wealthiest oligarch Mikhail Prokhorov over the regional power-generating company TGK-4.

Prosperity, along with other minority shareholders, took a hit when Prokhorov’s investment holding company Onexim reneged in September on a deal worth close to $1bn to buy back minorities. Prosperity has since been appointed as de facto spokesman by East Capital and a bevy of western portfolio investors, to defend their interests.

The comparison with Yukos, whereby the company was stripped of its assets and its founder Mikhail Khodorkovsky was jailed, is overstated although the number of western financial institutions being dragged into litigation is going up.

Prokhorov’s Onexim, which has a 50% stake in TGK-4, has issued a flurry of lawsuits against Deutsche Bank, Citigroup, Morgan Stanley, Clearstream and other minority shareholders. Onexim has disputed its obligation for the mandatory buyout of the minorities and has won recent cases in court against Halcyon Advisors and Deutsche. The larger minorities continue to defend their position while Morgan Stanley and others have settled.

Prosperity has received backing from the main market regulator, the Federal Service on Financial Markets (FSFM) and various ministries and even made its case to Russia’s Prime Minister Vladimir Putin, but to no avail. And just like the news anchor in the seminal US film Network, the Swedes have reached the end of their tether and are beginning to shout their discontent from the rooftops.

A release last week by Prosperity described actions taken by Prokhorov’s Onexim group as “a stark example of legal nihilism”. It said: “Prokhorov’s Onexim Group is now inflicting serious damage on Russia’s reputation as a place to do business. The company’s latest statements on the TGK-4 situation are dishonest, self-serving and plain wrong – and everyone involved in Russia’s financial markets knows it.”

Onexim, a Cyprus-registered investment group, has responded by calling Prosperity’s management “speculators” and “foreigners” because they raise their money from overseas.

Disputes between minorities and controlling shareholders are on the rise in the recently deregulated utility sector and other sectors where controlling shareholders face the squeeze.

Prokhorov, however, is king of the cash pile after selling his stake in metals giant Norilsk Nickel last April at the top of the market for an estimated $10bn.

Moscow financiers say the spat reflects badly on local brokerage Renaissance Capital, which Prokhorov took a 50% stake in last October at a knockdown price of $500m.

Renaissance may want to rein in Prokhorov but its hands could be tied trying to put out fires elsewhere. One banker said: “Renaissance’s great reputation in the market with investors is being tarnished by association, but it could be the case that Prokhorov has them over a barrel.”

Russian power plays highlight risks for minority investors

Financial News

Jason Corcoran in Moscow
17 November 2008

Energy company has been hit by governance failings

The crash in Russian equities has exposed serious risks for minority shareholders, despite an amelioration in the country’s corporate governance over the past few years.

The growth of Russian capital markets and the recent boom in initial public offerings has led to an improvement in corporate governance and accounting practices among the blue chips, but violations continue in the small to medium tier. A number of Russian utility companies that were spun off from the electricity monopoly have been particularly affected.

A group of 15 minority shareholders in power generator TGK-4 last month wrote to President Dmitry Medvedev claiming Onexim Group, an investment firm owned by Russian billionaire Mikhail Prokhorov, had exerted pressure on Russian officials to act in Prokhorov’s interest after Onexim agreed to buy it in May.

By law, as a majority shareholder, Onexim was required to offer to buy out minority investors. Investors said Prokhorov promised to do so.

However, following the slide in the Russian stock market, the required offer price for the buyout of TGK-4 shares stood at a 50% premium to the utility’s market price.

The group of minority shareholders, headed by Swedish investment firm Prosperity Capital and including a number of Russian and international hedge funds, claims Prokhorov reneged on his promise.

In an open letter to the President, the investors accused Prokohorov of “trying to avoid obligations by manipulating facts and using legal loopholes.

The shareholders wrote: “We appeal to you with a request to take immediate measures to protect the foundations of the Russian financial market and legal system, and to help set right these flagrant violations of the principles of corporate management.”

Alexander Branis, a director at Prosperity, which has about $4bn in funds under management, said the Kremlin had not replied. The Kremlin did not return calls inviting comment for this article.

James Fenkner, founder of Moscow hedge fund Red Star Invest and a local authority on corporate governance, added: “TGK-4 has been made into a strategic asset. The situation is borderline criminal, but you can see that corporate governance always gets worse at the bottom of a cycle.”

Onexim said it was no longer obliged to buy out the minority shareholders despite initially promising to do so when they acquired the majority sake in May.

Since its purchase of the stake, it had managed, in a way Prosperity questions, to lower its stake in TGK-4 below 50%, eliminating its obligation to buy the remainder of the shares.

TGK-4 also recently landed on a list of state “natural” monopolies, which prevents those companies from being bought. Investors claimed Onexim had applied pressure on the anti-monopoly regulator to include it on the list.

Prokhorov says he has a big capital investment programme, which will benefit the company and its shareholders who lost out from the buyout.

In a statement, he said: “I am certain that, once TGK-4 carries out its investment programme, the investors will earn a lot more than they would by pulling out their money now.”

Prosperity has sold down its original 18% stake of TGK-4, but remains a substantial shareholder. Other large investors include RusHydro and Federal Grid Company, which were spun off from the electricity monopoly UES. Fund sources suggested the latter two might come to a separate arrangement with Prokhorov in relation to their stakes in TGK-4.

Igor Goncharov, analyst at UBS in Moscow, said the market weakness had highlighted problems at energy companies TGK-2, TGK-4 and OGK-3 and could led to potential risks at OGK-2, 6, TGK-6, 7 and 9.

He said: “The most apparent risk is that the core shareholders may economically dilute minority shareholders by buying newly issued shares at current valuations, which we find to be substantially below intrinsic fair value for most of the companies.”

Branis of Prosperity said Russia’s main financial regulator, Federal Financial Markets Service was beginning to talk robustly about minority shareholders rights and had stepped in at OGK 3 and TGK-4 in a practical way. The free float in these other utilities is rather small and Goncharov is concerned that abuses could occur.

He said: “The regulator has mobilised itself to get involved in upholding the rule of the law and this is very encouraging.”

Governance concerns remain despite cosmetic improvements

Jason Corcoran

Financial News: Focus on Russia

Companies chasing international investment are trying to improve their image

Hostile takeovers, asset stripping, threats of imprisonment and violence have long been unpalatable features of doing business in Russia. Corporate governance was a little known concept even five years ago.

Critics claim it remains a myth and that reforms are cosmetic. However, Russian companies seeking international investment say they are responding to demands for greater accountability, independent directors and transparent corporate structures.

Stanislav Vartanyan, former chief executive of the Investor Protection Association, a Russian shareholder group, said: “The corporate world and the stock exchange here have made a quantum leap from the wild days when it was the law of the jungle. We now have a more civilised investor oriented culture.”

Vartanyan, who heads investor relations at Russia’s largest shipping company Fesco, is realistic about the extent of change required, but points to the declining influence of Russia’s oligarchs as being key to reform. Fesco has seen its share of controversy.

It was accused of extortion by a British investor and board member, and it was alleged that its ships spied on the US Navy and blinded pilots with laser beams.

Fesco’s main shareholder, the investment vehicle of former Energy Minister Sergei Generalov, has made several changes since buying a controlling stake in 2002 after a two-year campaign by the state to end shareholder conflict and stabilise management.

Vartanyan said: “One of the first things the new owners had on their agenda when they accumulated the controlling stake was to improve the company’s corporate governance, which at that time was typical for most Russian companies of that era – meaning there was no corporate governance at all.

“The new owners hired a new chief executive and a new chief financial officer, they introduced internal control procedures reporting to shareholders, the decision-making process was streamlined and the board of directors has become an efficient element of the company’s governance.”

Further changes have been made ahead of the Fesco’s initial public offering planned next year in London. Generalov has diluted his group’s shareholding from 80% to 64% while William Owens, former Colorado Governor and a friend of US President George W Bush, joined the ranks of independent directors.

Investors also point to improvements at aluminium producer Rusal since its merger with Sual, and at steelmaker Severstal since its IPO last year, as evidence that governance is improving.

Elsewhere, mining company Suek has created a internal audit management structure and oil group TNK-BP is introducing an anti-corruption programme.

Progress remains slow. A report this year by Standard & Poor’s found its transparency index of Russia’s 50 largest companies had risen from 50% in 2005 to only 53% in 2006.

“Corporate governance in Russia is generally becoming more transparent and more information is being disclosed, thanks to increasing pressure from international investors. Improvements in these two categories are particularly imperative for Russian companies and banks that seek more foreign listings,” said S&P.

Western investors remain wary of Russian companies coming to market and argue that changes barely scratch the surface of the problem. Vadim Kleiner, head of research at Hermitage Capital, one of Russia’s biggest foreign investors, said: “From my experience with Russian IPOs, an investor always has to ask the question of why management has chosen to sell out and go public.

“In many cases there may be something negative lurking beneath the surface that makes it a good time for these people to cash out to the public markets.”

Indeed, negative western perception of Russian corporate standards prevails. Calpers, the California state pension fund known for its focus on governance, continues to exclude Russia from its permissible equity investments, while UK manager F&C Asset Management refuses to invest in the country.

The Edelman Trust Barometer for 2007 described Russian business as the least trusted in the world because of a lack of corporate governance, lack of transparency and poor business ethics.

Investors point to the incarceration of oil tycoon Mikhail Khodorkovsky, and the final dismantling of his oil company Yukos in May, as a sign that little has changed. They also highlight how Russian tax inspectors and environmental watchdogs are squeezing western energy companies from production-sharing agreements.

A recent reminder of the bad old days is the case being undertaken by Russian investigators against Mikhail Gutseriyev, the head of Russneft, the country’s largest privately held oil company.

In echoes of the Khodorkovsky case, the interior ministry has charged Gutseriyev and his colleagues with tax evasion and illegal business activities. Reports suggest the political pressure on Gutseriyev stems from his alleged refusal to negotiate on the sale of Russneft to a state-controlled entity.

Stephen Jennings, chief executive of Renaissance Capital, claimed such incidents were rare and had not dissuaded foreign investors.

Jennings said: “Most people believe the risks are quite low. Otherwise, you wouldn’t have seen the kind of investment and development that we have seen.

"There is a definite sense that these incidents can be quarantined. If those incidents had been broader or more random, they would have had a bigger economic consequence.” Article tags: