FUND SURVEY 2014: Unloved and underinvested

By bne IntelliNews September 2, 2014

Nicholas Watson in Vienna -


Erdoganisation, Orbanisation, Italianisation – the last year has thrown up many new terms. However, it was, for the most part, yet another disappointing year for funds invested in Central and Eastern Europe/Commonwealth of Independent States (CEE/CIS).

Though tough, this year was at least a bit better than the previous one, as evidenced by funds' largely positive returns. Last year was blighted by a sea of negative returns, which led to big outflows of investor cash (most this year look distinctly smaller than they were last year). Some funds have even disappeared altogether; in March, Swedbank merged its long-struggling 'Swedbank Central Asia Equity Fund' with its 'Swedbank Russian Equity Fund", explaining that investor interest in such a fund had faded and it did not see any chance of this situation changing.

"The capital markets in Emerging Europe – unlike Asia and Latin America – are facing strong geopolitical headwinds due to conflict in Ukraine with Russia as well as in the Middle East," says Alexandre Dimitrov, head of CEE equity fund management at Erste Asset Management.

It's not hard to see why the region is unloved and underinvested: the bad news has continued to come in waves, beginning for the purposes of bne's survey period – the year from July 1, 2013 to June 30, 2014 – with the riots in Turkey and ending with the conflict in Ukraine and sanctions on Russia for the role it's playing in that.

Fund managers describe it as a politically driven, top-down market – the bottom of which has yet to be reached. And it's characterised by a worrying structural conservatism, where the aforementioned "-isations" are standard features, as well as so-called "reforms" such as the renationalisation of pension assets. "We are returning to a structural conservatism," says Peter Svoboda, senior fund manager of Erste Asset Management's 'Bond Danubia Fund'. "It's amazing to see this come back again. This pessimism of 25 years ago is very unfortunate."

Wider EM problems

In fact, the poor performance of CEE/CIS funds is part of the wider underperformance of emerging market funds over the past few years. "The previous years have not been great for emerging markets in general," says Petr Zajic, senior fund manager at Pioneer Investments. "Since 2010, emerging markets are underperforming developed markets pretty significantly – the underperformance is around 45-50%."

Part of this is due to the slowing economic growth in emerging markets. Some of the slowdown is seen as just a hiccup, but many economists also believe that emerging markets will have difficulty sustaining the kind of high growth rates of the 2000s over the next three to four years. Thus, some of this slowdown reflects lower potential growth and so is probably more permanent in nature. "Estimates of potential growth rates in emerging markets for the next 3-4 years, at 3½ percent, suggest that growth would be on average 1¼ percentage points lower than so far in the 2000s, though the magnitude of the impact varies by country," the International Monetary Fund economists, Evridiki Tsounta and Kalpana Kochhar, wrote in June.

However, Marcus Svedberg, chief economist of East Capital, argues that investors are being too negative on CEE growth. Furthermore, while investors are often tempted to look at GDP growth as an indicator of future stock returns, research has shown that a more effective approach is to do the exact opposite. "The Turkish, Russian, Romanian and Polish markets have gained 30%, 25%, 10% and 5% respectively over the past three months," Svedberg wrote in July. "So if stock market performance is an indicator of economic growth assumptions, then the market is clearly too negative on Eastern European growth."

Inevitably, this has been reflected in money flowing out of CEE/CIS regional funds. In bne's annual survey period (July 1, 2013 to June 30, 2014), figures from fund tracker EPFR show the cumulative outflow from Emerging European equity funds totalled $3.1bn. Russian equity funds lost a total of $2.2bn. In fixed income, EPFR data show that Emerging European bond funds lost a total $158m in the year, while Russian bond funds lost $418m.

This was reflected in the wider emerging market universe. By the end of June, year-to-date outflows from emerging equity funds were around $25bn, well above outflows of $14bn in 2013. Bond funds' losses were about $2bn in the red to the end of June after making something of a comeback since March, following $14bn of outflows in 2013.



Sell Russia, buy Turkey

This year has been a mixed picture for the region's equity markets. According to EPFR, the Emerging Europe regional equity funds that it tracks were down around 5% in the first six months of this year, while Russian equity funds were down about 13%.

"The markets have actually been incredibly relaxed for what is almost a full war scenario. The Russian market is only down about 10%. Could you imagine what might have happened or what could happen?" says Dimitrov. "In risk management, you try to limit the damage. I have difficulty telling you what is going to happen in three months from now."

The standout performer in the region was Turkey (and Greece, now considered again an emerging market), which over the past year is up almost 5% and year-to-date up 29%. "For this year it's been a typical Russia-Turkey switch," says Zajic. "I don't think people are really bullish on Turkey, but part of this solid performance is part of this selling Russia, buying Turkey move."

This is vividly illustrated by the performances of the 'East Capital Turkish Fund' and 'East Capital Russian Fund'; as of August 7, the former was up 25% so far this year, while the latter was down 16%. It also illustrates the volatility of the market, notes Erste's Dimitrov: Turkey moved from being minus 20% in February to 40%-plus in early August.

As Zajic sums up: "This year the overall picture has been negatively driven by the performance of Russia; it was positively affected by Turkey; and for the future everything depends on how the situation in Ukraine will develop."

So it should come as no surprise that the winner of the "bne Best Equity Fund 2014" is one that features Turkey, the 'East Capital Balkan Fund', which invests in companies in Romania, Croatia, Serbia, Turkey, Slovenia and Bulgaria. For the year period to June 30, the fund was up almost 26%.

Says Tim Umberger, senior advisor at East Capital: “Our long-term view that the Balkan markets offer attractive investment opportunities continued to materialise over the past 12 months. Most of the economies started to show significantly better growth numbers, which together with relatively low valuations formed good conditions for stock markets to perform. At the same time, an overall better sentiment spurred a new wave of larger transactions and deals, both on mergers and acquisitions as well as on privatisation fronts. In certain cases, East Capital’s involvement was crucial for deals to go through, while at the same time it allowed us to build new positions at attractive prices, which in turn helped generating solid returns for our investors.  We continue to be very active in some of our key holdings, pushing for better corporate governance and higher dividends."

Other notable equity funds this year were the 'East Capital Baltic Fund' up 14.7%; the 'ELANA High Yield Fund' up 14.99%; and the 'VTB Equity Local Fund' up 12.7%.

Bad start for bonds

In fixed income, the year got off to a bad start when in May 2013 the US Federal Reserve began talking about "tapering" its bond-buying programme, causing emerging market bond prices and local currencies to drop sharply.

"In 2013 we had this big drop as rates increased quickly in the US and so June, July and mid-August were really very disappointing months. For global Emerging Markets generally, and Central and Eastern Europe specifically, we had a lot of outflows until the end of last year, though these outflows started to rebound at the beginning of the second half of this year," says Margarete Strasser, senior portfolio manager at Pioneer Investments.

Erste's Svoboda says the main story this year has been CEE corporate bonds, which have seen the highest issuance in more than 10 years, in both euro and local currency. "They are taking advantage of low rates and lengthening maturities – it’s a very positive sign that corporates have dared to test the market," he says.

Indeed, Erste lead managed a €710m three-tranche bond issue for the Czech gas transmission system operator Net4Gas, whose CZK7bn tranche (€250m) was the largest corporate koruna-denominated bond issue in the last decade. Tomas Cerny, head of CEE debt capital markets at Erste, says demand for the issue was around €1.5bn, implying that investors are hungry for any pickup in yield. Thus, selling debt into this market is a matter of price, rather than the capacity of the market to absorb such debt.

The winner of the "bne Best Fixed-Income Fund 2014" is the 'Pioneer Funds Austria - Bond Opportunities 6/2019' with a return during the year to June 30 of 9.79%. Other fixed-income funds that performed well were VTB Capital Investment Management's 'VTB Treasury Fund' with a return of 6.19% and last year's winner, Erste Asset Management's 'ESPA Bond Danubia', up 5.41%.

The winner of the "bne Best Balanced Fund 2014" is Sturgeon Capital's 'Sturgeon Central Asia Balanced Fund' with a return of 15.9%, edging out the 'ELANA Balanced EUR Fund' at up 15.6%.

Says Clemente Cappello, CIO and CEO of Sturgeon Capital: "The performance of the 'Sturgeon Central Asia Balanced Fund' was generated both by allocation decisions between equities, debt securities and cash, and by its security selection process. As a result our Fund outperformed regional benchmarks and its peers, even where markets were not easy (eg. Kazakh Tenge devaluation, Russia turmoil etc). Although the Fund was established in 2007, we at Sturgeon Capital became its investment manager only in December 2012 and worked hard on better positioning the fund. This included implementing our holistic risk approach and using our in-depth knowledge of the investment universe honed over seven years focusing solely on Central Asia.

"Our current focus on the resurgence of the Kazakh and Georgian banking sector, high dividend yielding stocks and cheap natural resource stocks may result to a further significant re-rating of the debt and equity securities in its portfolio in the next 12-24 months. In addition, the strong economic growth in the region, coupled with low valuations, may of course be a further potential boost to performance."

The winner of the "bne Best Alternative Fund 2014" is Prosperity Capital Management's 'Prosperity Quest Fund' with a return of 20.5%.

To see a full list of the funds entered, download the pdf here.


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