Russia’s market freeze takes country closer to Bric exit

Financial News

Jason Corcoran in Moscow

16 February 2009

Falling trading volumes and low liquidity are forcing managers to desert

Temperatures as low as minus five degrees Celsius last week gave fund managers a ready-made excuse for turning their backs on Moscow and finding somewhere warmer. But Russia’s rapidly freezing stock markets had rather more to do with the decision of James Fenkner, founder and managing partner of Red Star Asset Management, to move his fund’s operation to Los Angeles this month. Illiquidity has become the order of the day in Moscow-quoted equities.

Jim O’Neill, head of global economic research at Goldman Sachs, raised the possibility last month that Russia could be dropped from the Bric grouping, only to dismiss it.

Fenkner cited family reasons as his main motivation to relocate, and the fact that his seed investor, Austria’s Erste Bank, pulled its mandate, but he also depicted a market suffering from declining corporate disclosure and crumbling market infrastructure.

He said: “On the business side, Russia has become a pure macro play. Over the past year we have moved most of our portfolio into American and global depositary receipts due to a combination of value and liquidity and we really get active around 5:30pm when London and US open. Micex and most of the local share stories are a joke.”

The worsening economy and the slide in the price of oil has spurred investors to pull $290bn (€226bn) from the country since the end of July, according to French bank BNP Paribas.

Hedge funds and long-only vehicles focused on Russia began switching their focus to trading ADRs and GDRs in London and New York after Russia’s five-day war with Georgia in August. Damaging corporate disputes at miner Mechel and the Anglo-Russian joint petroleum venture TNK-BP shook the domestic markets and exacerbated the investor exodus.

Further market instability, fuelled by falling commodity prices and a weakening rouble, has led to 30 trading suspensions on the Micex stock exchange. Micex has shed 50% of its value, while its dollar-denominated rival RTS has fallen by 75% from its highs last year. The Russian RTS index was the worst performer last year after Ukraine and Iceland and came close to equalling the 85% drop experienced during Russia’s sovereign default in 1998.

Daily trading volumes in Moscow dropped off sharply from $7bn early last year to $2bn by the end of the year, which is on a par with trading volumes of 2003.

O’Neill, who popularised the term Bric as a moniker for Brazil, Russia, India and China, raised concerns about Russia’s over-reliance on oil and its poor corporate governance. Its share index has fallen far behind that of Brazil, the other net exporter of natural resources of the four.

Russian public companies are trading at the price/earnings ratio of three, whereas the ratio in January last year was 11. The average p/e ratio of emerging markets was nine and developed markets was 12 at the end of last year.

One of the results of the fall has been to drive trading back to London. Before the meltdown, analysts at Renaissance Capital estimated Moscow had 70% of equity trading volumes against London’s 30%. Renaissance said the ratio last month was 50%-50%.

Alexander Kotchoubey, head of international development for Russia and eastern Europe at Swiss private bank Lombard Odier Darier Hentsch, said the preference for GDRs and ADRs reflected the realisation that the Russian market possesses little depth or companies that offer diversification. He said: “You have to wonder why one needs to take the risks associated with local markets’ liquidity and closures when similar returns can be had through GDRs and ADRs but with a lot less hassle.”

Hedge funds operating throughout Russia and the Commonwealth of Independent States are cutting their staff and slashing costs in response to market falls and increases in client redemptions.

The closure last year of the Florin FSU Credit Opportunities fund, which was invested in real estate and equity collateralised debt, led to 10 lay-offs at the firm in Moscow and London.

Da Vinci Capital Management’s special opportunities fund, which invested in Russian equities, has bee restructured because of too little assets.

Other funds, including Denholm Hall Russian Arbitrage fund have announced they are considering a restructuring following difficulties.

East Capital Asset Management, which maintains a large investment team in Moscow, has been forced to begin trading more in London because of trading problems. The Swedish firm, which has about $1.5bn invested in Russia and eastern Europe, has cut 40 jobs from its base in Stockholm and from other centres such as Moscow. Peter Elam Hakansson, founder of East Capital, listed falling oil prices, a weakening rouble, corporate governance and financial market regulations as four reasons for Russia’s cheapness.

In a letter to investors, Hakansson wrote: “It is difficult for Russia to influence the first two factors, but the remaining two are even more important for the country to focus on. Corporate governance is once again in the spotlight, after the autumn saw some dubious interpretations of what is right or wrong according to Russian legislation.

“And lastly, financial market regulations have been making the news after the markets on occasions were shut down in such a way as to baffle observers and appear over-dramatic.”



Russia falls away from Brazil

Russian hedge funds face threat of closure

Financial News

Jason Corcoran in Moscow
10 November 2008


The closure of a Russian hedge fund run by Florin Investment Management has led to fears many more could go under as investors flee emerging markets.

It is estimated about 70 hedge funds are operating in Russia and the Commonwealth of Independent States and analysts predict over half will be wiped out by next year.

The closure of Florin FSU Credit Opportunities Fund, which was invested in real estate and equity collateralised debt, led to 10 lay-offs at the firm in Moscow and London.

Florin’s principals Neil Smith and Aidan Freyne are hoping to buy the fund’s architecture from its shareholders at Trust Capital and relaunch the fund as a distressed assets vehicle.

Smith was previously head of alternative investments at the UK’s Morley Fund Management while Freyne spent 19 years with Salomon Brothers and subsequently Citigroup.

Smith said: “Credit has been a difficult space to be in but it’s going to be great for distressed and acquiring debt at super-distressed levels.”

Fears are growing that other Russia funds with their mainly long-only bias may be wiped out like they were following the 1998 financial crisis.

Florin was set up earlier this year with $100m (€78m) in seed money from Trust Bank and other external sources.

James Fenkner, founder of Moscow hedge fund Red Star Invest, said most Russia funds were equity focused with only minimal shorting so most had been hit by the slide in stock markets.

He said: “I haven’t seen anything like this since 1998. It’s a case of survival. It’s going to be a blow-up of the good, the bad and the ugly.”

Fenkner said Red Star’s Austrian backer Erste Bank was standing behind the fund, which had bucked the trend and returned over 100% during October.

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Red Star enjoys happy third anniversary

Business New Europe

Jason Corcoran in Moscow

July 9, 2008

A detsky sad, or kindergarten, is an unlikely neighbour for a Russian hedge fund, but James Fenkner is not fazed by a little background noise.

The founder and chief investment officer of Red Star Asset Management runs a friendly and informal investment shop on an unassuming residential street situated between Moscow's boulevard and garden ring roads. Red Star's team of seven have their heads buried in work as two-dozen two-year-olds run about shrieking seven floors below. It's also a family affair - Fenkner's sister Elizabeth plays a key role as the head of marketing.



The firm was set up in 2005 after Fenkner quit Troika Dialog where he had served seven years as head of research and initially as chief strategist. "The market was just coming out of deep crisis and there were just four funds in Moscow," recalls Fenkner. "I had gotten one of the best deals from Troika because that's where I met my wife. I left because brokerages are a young's man game."

The firm launched the Red Star Double Alpha Fund, a long/short relative-value vehicle targeting equities in Russia, Eastern Europe and the former Soviet Union. Its investment objective has an absolute return target of 18% to 22%, with volatility less than that of the region's equity markets.

The fund's main backer - Erste Bank, an Austrian retail bank with a network throughout Central and Eastern Europe - came on board after Red Star's US partners pulled out. Red Star's investors are mainly institutions and the firm has a few high net-worth clients.

Happy anniversary

May marked the third anniversary of the fund, which has registered a total return of 77%. The annualised return is 21% and volatility has been 12.6%. Fenkner is keen to make a marketing push for more clients now that funds under management have reached $100m and the firm has post the all-important three-year performance numbers under its belt. May also proved to be fund's best so far, with it's net asset value up 9% due mainly to the rally in Russia's energy stocks. Most of Russia's oil majors rose by over 20% due to record high oil prices and an expectation of a cut in taxation.

Fenkner feels the upswing to Russia's oil sector could be short-lived unless the modest $5bn tax relief amount being offered by the government is increased dramatically. "For the winning streak in oils to continue, the government must play for big money rather than tokens. Discussions with a number of analysts have convinced us that the ante must be upped to $20-25bn for oil production growth to pick up materially."

Red Star's preferred bets for greater taxation relief are oil field service providers and Surgutneftegaz, which has one of the worst production growth track records. Gazprom, the world's third largest company by market cap, is the fund's biggest holding.

With the restructuring of the electricity grid UES almost complete, Red Star is betting that hydro-electricity company RusHydro will become the new proxy for the sector. "RusHydro has been a drag on performance recently, but should be the biggest beneficiary from the break-up of UES on June 6," says Fenkner. " It should be the most profitable of the utilities and it currently trades at a 40% discount to its EM hydro peers."

Fenkner, who is 42. first arrived in Moscow over 13 years ago along a circuitous route taking in the Baltics and the Czech Republic. Back in the US, he had been a fixed income analyst at US mutual fund giant Fidelity after graduating with a degree in economics from California State University, Sacramento and a masters from Tufts University. His original plan in 1993 was to come to Lithuania for a year to work as a Soros Foundation lecturer in economics at Vilnius University. "I was teaching 18- to 20-year-olds at the time and they used to tell me that the Russians had two heads and ate their own children. The level of disinformation was enormous," recalls Fenkner.

The adventure continued when he took up an offer to help set up a brokerage in Prague call Atlantik Financial Markets. Then in 1995, Fenkner came to Moscow and had stints as head of research at AIOC Capital and Robert Flemings.

Bernie Sucher, a fellow American, lured him to work as chief strategist at Troika Dialog, which Sucher had co-founded. Under his direction, Troika's research focused on corporate governance and the opportunities and risks which any change in corporate governance provides to investors. "For a brokerage to be involved in corporate governance was rare. As the environment has matured, the interests of corporate clients has become a more important component of the brokerage business," says Fenkner.

Troika took up some unpopular causes, including backing former Yukos oil tycoon Mikhail Khodorkovsky, who ended up in prison after falling foul of the Kremlin. Fenkner believes the "heady days of corporate governance" are long over with the expulsion of shareholder activist Bill Browder of Hermitage Capital and because Russian corporates have made efforts to reform and evolved to more classical valuations.

Red Star's fund employs market-based activism in its investments. If the firm doesn't like a stock and it's expensive, they tend to short it instead. The fund uses a disciplined approach to invest long in securities that they believe to be fundamentally undervalued and to short securities which they believe to be fundamentally overvalued. He currently has seven short positions, including four in Russia.

Fenkner intends to continue at helm, because it is what he likes to do. He also has his own money invested in the fund, which, he says, "helps keep the mind focused" on performance.

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