Ben Aris in Berlin -

The logic was right, but the timing was spectacularly wrong. Sweden-based East Capital launched its inaugural Russia Fund in May 1998, only three months before Russia went into financial meltdown. In the first year, the fund lost 85% of its value and, understandably, was struggling to find more investors. But as the fund celebrates its 10th birthday, those original investors have enjoyed a total return of over 2,000%.

"It was horrible," says Karine Hirn, a Frenchwoman who was one of the investment firm's three founders, speaking of the early days. "We had no seed capital and had to watch this dramatic fall from day to day. No one wanted to buy, as it was too scary."

If only they had waited three months, then the fund would have been up by over 840% by the end of the first year. But Hirn and her partners stuck to their guns, and surprisingly so did many of their retail investors. While almost all of the dedicated Russian funds set up over the last 17 years have targeted institutional investors, East Capital from the off went after small investors. As it turned out, they were hardier and didn't demand their money back immediately, says Hirn. "The Swedes are very interested in Russia and people were already looking for ways to invest. Because of the geography, Swedes know a lot about Russia and are generally better informed than most Europeans about what is going on there. That is why we decided to create a fund that allowed them to buy directly into Russian equities," says Hirn.

Geographical advantage

During the early part of the 1990s, Hirn was working for the French government on a banking development project and commuting between Stockholm and Nizhny Novgorod, where she was supervising an investment into the Nizhny Novgorod Dom Bank as a financial controller trying to teach the bank the basics of risk management and corporate governance. She hooked up with Peter Hakansson, another founder and the fund's manager, after reading an interview he gave to a Swedish newspaper. Hakansson was head of global research at the Swedish bank SEB at the time, but already singing the praises of Russia's potential.

As it's domiciled in Sweden, East Capital held some advantages over other international funds. Most of these were usually domiciled in places like Luxembourg, which until 2006 weren't allowed to buy Russian stocks on the local bourse. However, Swedish agreements with Russia meant that East Capital was investing into locally listed shares from the start.

The first three years was all about surviving, but the Russian fund came into its own in 2001 when it could show the all-important three years of operations, which opened up the field to institutional investors. Following Vladimir Putin's election as president, 2001 was also the year that Russia's recovery from the financial crisis became obvious to everyone.

Today, the fund has a total of €1.5bn under management (East Capital has a total of €4.5bn under management in all its funds, some of which also invest in Russia), making it the biggest dedicated Russian fund of its kind. Private individuals still make up 80% of its client base. Retail clients remain the biggest investors in the Russia Fund, but amongst the institutional investors is Swedish state-run pension fund PPM, which offers the fund as part of its remit to allow contributors to put part of their social taxes into a fund of their choosing.

Unlike many of the other dedicated Russia funds, the East Capital Russia Fund has played down the obvious oil and gas story, and from the start focused on the consumer-spending story. "The lowest the fund has been was 25% weighting to oil and gas - which at the time made up over three-quarters of the index - whereas today it is more like 45%," says Hirn. "The all-time high was 50%, but we have always been underweight compared to the make-up of the index."

The fund's managers have proven themselves good at spotting trends early and Hirn says they have made some big bets in the past. "We were heavily into the telecoms sector in the early part of this decade during the telecoms sector restructuring. Then we bet heavily on the utilities reform, buying into the local generators and distributors, paying the arbitrage during the start of the restructuring of the sector," says Hirn. "Utilities got up to 18% of the portfolio at one point, but today we are betting heavily on the bank sector, which makes up 10% of the portfolio."

"Confidence [in the Russian story] has been shaken and is having an impact, but the country always seems to bounce back," she says. "Considering where we came from at the start of the fund's life, I don't see any reason why it will not bounce back this time too."

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