Nicholas Watson in Prague -
This has been the year of the bond in CEE/CIS. While debt and equity markets struggled in the second half of 2011 as worries about Greece caused investors to lose their appetite for risky investments, they have piled back into bond funds so far this year, leaving regional equity funds in the dust.
"Everyone is talking about the euro debt crisis, but everyone is buying Eastern Europe debt," Heinz Bednar, CEO of Erste Asset Management, tells bne. "Even Hungary has had a very nice performance this year."
Looking at bne's table of funds (available in pdf of special report), the winner of the "bne Best Fixed-Income Fund 2012" is Erste Asset Management's "ESPA Bond Emerging Markets Corporate" fund with a return of 8.01% for our surveyed year (July 1, 2011 to June 30, 2012) and a 6.98% return for the first half of the year. In the weeks since the end of the surveyed period, the fund has continued to outperform. "The absolute performance is above 10% year to date," Peter Varga, senior portfolio manager at Erste Asset Management, told bne at the end of July. "It's a purely hard currency fund and it's quite remarkable actually to have that type of performance, so that shows we have had a quite nice run in this asset class from the desperation of investors to have higher yielding assets in their portfolios."
Erste's winnning fund topped a group of such bond funds that have performed well over the year. ELANA Fund Management's "ELANA Money Market Fund" and "ELANA Eurofund" returned 5.85% and 4.83% respectively; Erste's "ESPA Bond Danubia" fund returned 4.01%; Aton Capital's "ATON Bond Fund" returned 3.05%; and Raiffeisen Asset Management's "Raiffeisen Eastern European Bonds" fund returned 2.43%.
Pioneer Investments' "PIA Central & Eastern Europe Bond" fund also performed well, but shows another feature of the market this year - its volatility. Over bne's yearly period to June 30, Pioneer's bond fund returned 1.99%, and 9.20% in the first six months of 2012. However, extending those periods to the end of July would see returns boosted to 6.9% and 14.6% respectively. "In a volatile market, one month can make a big difference," says Andreas Nurscher, spokesman for Pioneer Investments. "This is one of the reasons why investors in emerging markets should have a long-term time horizon."
The backdrop for the bond funds' performance is of course the solid fundamentals in much of CEE - or at least better fundamentals than in much of Europe and the US. Sovereign debt as a percentage of GDP, for example, in all the countries except for Hungary is comfortably below the 60% threshold stipulated by the rules governing the euro. And even Hungary's debt burden is only around 75% of GDP, far below the levels of 165% in Greece, 121% of Italy, 110% of Ireland or 107% in Portugal.
Likewise, most budget deficit positions in the region are also looking likely to come in below the 3% of GDP stipulated in the Maastrich criteria. While the Czech Republic, Hungary, Lithuania, Croatia and Ukraine will probably report imbalances marginally above the ceiling this year, their deficits will be nothing like the situations in Ireland, the US and UK, which will be closer to 7% of GDP. "Central European EU countries are better positioned than most of the southern EU countries in terms of sovereign debt to GDP. Except for Hungary, all countries' debt/GDP ratios are below 60%," says Margarete Strasser, portfolio manager at Pioneer. "That means the annual budget deficits are much lower than in other developed markets, not only European. Most of them will be at or under the 3% level in 2013."
In addition, growth has been - and will likely continue to be - greater in the CEE/CIS region than elsewhere in Europe. Latest estimates by the European Bank for Reconstruction and Development (EBRD) released in July show that although average growth in the transition region is expected to drop from 4.6% in 2011 to 2.7% in 2012, before modestly picking up to 3.2% in 2013, that's still much better than the Eurozone. The International Monetary Fund said in April it expects the Eurozone economy to contract 0.3% this year, after growing just 1.4% in 2011. "Growth won't come from developed markets, but from emerging markets, and this is one of the drivers of investing in this area," says Strasser.
These solid economic fundamentals, together with the tame inflation, higher interest rates, rising local currencies and tightening spreads on the hard currency side, have pulled in bond investors this year. According to the fund flow data provider EPFR, in the year to August 1 global bond funds took in $223bn, while equity funds surrendered $31bn. That compares with an inflow of $115bn and an outflow of $4bn respectively during the same period last year. "Money is still coming in, some of it institutional," says Anton Hauser, portfolio manager for Erste's "ESPA Bond Danubia" fund. "We've had some quite huge inflows as people continue to switch from Western Europe into Eastern Europe."
This has been especially true on the corporate side. "The [CEE] corporate bond market has seen tremendous inflows, more than $200m so far this year, as people have discovered this asset class. Five years ago it was basically non-existent, globally it was worth $250bn, and now it is approaching $800bn," says Varga.
It is likely to get much larger too. All bond fund mangers are talking about the Russian government's capital market reforms that will make it much easier for foreign investors to buy ruble-denominated sovereign, quasi-sovereign and corporate debt, the centrepiece being the establishment of a Central Securities Depository. "The Russian local bond market might be fully liberalised for non-residents by late autumn 2012," analysts at VTB Capital say, adding that the potential additional demand from non-residents for just the state's OFZ bonds could be as much RUB500bn-800bn (€12.6bn-20.2bn) within 18 months following liberalisation, as global bond investors look to rebalance their portfolios.
Share the pain
Equity fund managers are hoping that some of this shine will rub off on equities, which had a terrible 2011 - not one of the equity funds surveyed had a positive return during the year - but enjoyed a much better first half of this year. "Look at corporate bonds, they have done very well because corporates are earning and balance sheets clean," says Alexandre Dimitrov of Erste. "So maybe some of this will transfer into equities."
The winner of the "bne Best Equity Fund 2012" shows how tough this past year has been for equity funds, but also where most agree the best opportunities lie: Turkey. The winner was Erste's "ESPA Stock Istanbul" fund, which had a negative return of 0.21% in the year-long period surveyed, though returned a huge 30.48% in the first six months of this year.
East Capital's "Turkish Fund" likewise had a negative return of -6.60% for the survey period, but returned a whopping 26.39% in the first half of 2012. "Turkey stands out as a strong market year to date due to a combination of long-term good fundamentals and short-term low volatility in the country," says Peter Elam HÃ¥kansson, chairman and head of portfolio management at East Capital. "The country is not very dependent on exports, and this is a good thing when the economic climate is as uncertain as it is today. Long term, the country benefits from a young and growing population, improvements in efficiency and sound public finances."
Russia too is benefiting from this trend among investors toward investing in the bigger emerging markets, and away from frontier markets like Kazakhstan and Ukraine, though it hasn't seen anything like the run-up that Turkey has. The best performing Russian equity fund in the first half of 2012 was JPMorgan Asset Management's "Russia Fund", which had a negative return of -28.61% over the surveyed year, but saw a turnaround for a 10.46% return in the first six months of this year.
Swiss & Global Asset Management's "Julius Baer Multistock - Russia Fund" had a negative return of -25.19% over the year period, while the first six months of this year saw a negative return of only -3.60%. "Russia is a high beta market - it has more volatility for being highly correlated with commodities and because of corporate governance issues. If we have a risk-off period, then Russia suffers more than other markets, and it tends to outperform on the way up," says Javier Garcia, portfolio manager at Swiss & Global Asset Management. "We had a very good start to 2011, then it started to correct and underperform in November and December with the disputed elections and the associated demonstrations. We had a strong and sharp recovery at the beginning of the year, as people became more optimistic at the start of the year and Russia outperformed the rest of emerging markets until March-April when we had troubles coming out of Europe and fears of a slowdown in China."
Russia proved once again to be the standout performer in the real estate category, with Renaissance Real Estate Company's "Renaissance - Business - Nedvizhimost" fund winning the "bne Real Estate Fund 2012" with a return of 22.0%
Outside of Russia, East Capital's "Baltic Property Fund" returned 1.57% over the year period, implying that the Baltic real estate market is bottoming out after several tough years. "Our fund has performed well this year as a result of years of good and consistent asset and property management, but also hard work in these very challenging markets," says Biljana Pehrsson, CEO of East Capital Real Estate. "Starting from early 2011, the market has demonstrated a noticeable improvement in the general dynamics of the office and retail real estate segment."
In May, East Capital launched its second property fund, the "East Capital Baltic Property Fund II", whose primary focus will be Tallinn, followed by Vilnius and Riga. "In order to benefit from the Baltic real estate market and its bottoming out, the low property prices as a result of halved rents and higher yields, as well as low financing costs, we launched our second property fund in May and almost at the same time closed our first acquisition, the logistic park VGP, at a total purchase price of €24m reflecting a yield in excess of 9%," says Pehrsson.
The biggest determinant of how CEE/CIS funds will perform over the next 12 months is the unfolding European debt crisis, which could see major developments this autumn - perhaps an exit by Greece followed by other countries, or a major step forward in resolving the crisis. Many fund managers, like Hauser of Erste, are doubtful about the latter. "Economies are clearly slowing and the bond markets are trading down. If there's a big resolution to the euro crisis, there will be a big run-up again. But my feeling is we will continue to muddle through - there's no big solution in sight," he says.
For equity investors, it's the very cheapness of Emerging European stocks that give fund managers hope. "Emerging Europe equities are trading at only six-times [price/earnings], which is a 40% discount to other emerging markets. Even Poland is trading at a discount, while Turkey is trading at the same valuation as global emerging markets even after its huge run-up. The room to grow is enormous," says Erste's Dimitrov.
Swiss & Global Asset Management's Garcia says his "Julius Baer EF Black Sea" fund looks to take advantage of what he sees as the attractive factors behind investing in Emerging Europe: the consumer is underleveraged, the corporate sector is underleveraged, and the governments are underleveraged. "You have a growing, young population that wants to consume, that has more disposable income, that has no debt - this creates an interesting consumption story," he says. "In this region you also find a lot of companies with a global competitive advantage and this competitive advantage won't change in the next 5-10 years."
And the winners are...
bne Best Equity Fund 2012 - ESPA Stock Istanbul
"Throughout its history, Turkey has been the link between Europe and the Middle East due to its excellent geographic location. In contrast to previous years, when the economy was suffering from hyperinflation and an unstable political situation, the founding Nato member has in the meantime gone through a process of political stabilisation with a booming economy. The Istanbul stock exchange has not been a one-way street in the past 10 years, with sharp increases and massive corrections taking turns. On aggregate, investors have benefited from holding out for the long term. The impressive performance since our fund's launch, +288%, translates into an average annual performance of +13.2. In spite of the big rise in Turkish equities this year, the current price/earnings ratio of 10x is still low." Amalia Ripfl, fund manager.
bne Best Fixed-Income Fund 2012 - ESPA Bond Emerging Markets Corporate
"The level of government debt in the emerging countries is very low, whereas in Europe and the US it is on the brink of blowing up. The gearing in the corporate sector is minimal as well. The still relatively young asset class of emerging market corporate bonds has been gaining in importance. The issue volume in this segment has almost tripled over the past five years from about $260bn to $735bn (sources: Bank of America, Merrill Lynch). In recent years, the issue volume has even outgrown that of emerging market government bonds. The drastic increase in issue volume is absorbed by investor demand that has been soaring at an equally dramatic rate. As a result, overall liquidity has improved." Peter Varga, fund manager.
bne Best Balanced Fund 2012 - ATON Small Business Fund
"Our fund is an interval mutual investment fund incorporated in Russia. The principal investor of the Fund is the Moscow Government Foundation for Small Business Financing that tendered the management of its assets in 2006. The fund aims for long-term capital growth and stable performance through investing its assets in a diversified portfolio of highly liquid debt securities and equities of Russian companies. The investment strategy of the fund is considered to be conservative. The markets were very turbulent throughout 2011 due to rising concerns about the sovereign debt crisis in Europe, which was the reason we focused primarily on investing in high-profile fixed-income instruments while keeping the equity share of the portfolio at a minimum." Evgeniy Malykhin, head of investment department and portfolio manager.
bne Best Real Estate Fund 2012 - Renaissance-Business-Nedvizhimost
"We are very proud that we have been able to demonstrate strong results for the fund shareholders, despite the tough market conditions. We strongly believe that real estate will continue to be one of the most attractive asset classes within the next three-five years, and that investments into carefully selected income-generating properties with attractive investment characteristics located in Russia will continue to produce strong returns and serve as an excellent hedge against inflation. We are very pleased that our efforts and ability to select solid investment opportunities were recognised by this bne award." Ekaterina Konstantinova, CEO of Renaissance Real Estate
bne Best Alternative Fund 2012 - Wermuth Quant Eastern Europe Strategy IC
"This systematic trading fund is focused on Russia's most-liquid securities. A fusion of an unemotional statistical approach and fundamental inputs is rather unique for a Russia-focused fund. The team of mathematicians and economists with a seven-year experience in quantitative trading continues to achieve superior results, beating their peers. The clue to success is in providing downside protection for the clients due to a trend-following approach and an automated execution process. The fund aims to achieve a return of 20% p.a. Historically it has beaten the RTS$ index two times in terms of compounded annual returns, with just half the volatility. The team aims to reach $50m AUM until the end of 2012 and $100m by 2013." Wermuth Asset Management.
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