FUNDS: A game of two halves

By bne IntelliNews August 31, 2009

Nicholas Watson in Prague -

The past year for funds investing in Central and Eastern Europe has been, to borrow footballing terminology, a game of two halves.

Looking at the table of funds (see pdf accompanying this special report), the year from June 30 in 2008 to June 30 in 2009, bne's chosen ranking period, has been an almost uniformly miserable one, with the vast majority of funds finding themselves firmly in the minus column. However, while the whole year may have been a difficult one, the second half has been quite different to the first half.

That's hardly surprising - the full year encompasses the period immediately after Lehman Brothers went bust in September 2008 and markets around the world went into freefall, wiping out trillions of dollars of wealth and leading some to predict financial Armageddon. That, of course, didn't happen and the subsequent recovery - while still fragile, patchy and overshadowed by a forbidding sense that the markets are getting ahead of themselves - has lifted stock markets to levels that were hard to imagine just a few months ago when investors stared day after day at screens of red. "I think it has now become clear that those doomsday scenarios were clearly exaggerated and have not come true. It all looks brighter than in October and November when markets priced in complete economic collapse or at least a 1930s-style depression," says Angelika Millendorfer, head of equities emerging markets at Raiffeisen Capital Management.

A glance at the numbers shows just how far and fast the recovery on some markets, particularly Russia, has happened: Pioneer Investment's Russia Stock fund was down 55% for the year, but up 78% year to date, and Swedbank's Central Asia Equity Fund was down 65% on the year, but up 50% year to date. Even funds centred on countries still regarded as particularly vulnerable have improved markedly: Dragon Capital's Ukraine Virgin Fund was down 44% on the year, but up 3% so far this year and East Capital's Baltic Fund is up 1% year to date after being down 50% over the year.

But the pace of that rebound has left some portfolio managers feeling uneasy. "On the equity side, it's been very quick and very fast, so our opinion is we might see a correction in equities. It's been too fast and not justified by fundamentals," reckons Peter Svoboda, former fund manager of Erste Sparinvest's Bond Danubia fund and now responsible for Erste's overall fund business in CEE.

Bond funds have also rebounded, though in a less dramatic way. Svoboda explains that the key diver for the recovery in bond funds - Erste's Bond Danubia fund is down 10.29% on the year but up 5.24% year to date - has been carry trades, as financing in dollar and euro has been very advantageous. "Spread wise, we are still at really high levels so portfolio gains have mainly come from carry trades," he says.

That should change as spreads narrow over the course of the year. It's becoming increasingly clear that the region will avoid a sovereign default and the Eurobond markets are open for emerging European issuers. Both Hungary and Lithuania have successfully got away Eurobonds recently, two the region's most dodgy credits, and more issues are expected over the coming months from Turkey, Romania, Russia and Bulgaria, amongst others. "Overall, I'm positive on the sovereign bond side - Hungarian and Polish, and I'm not even reluctant to buy Baltic ones, it's a great opportunity to be present in the sovereign bonds of the Baltics," says Svoboda, explaining that the comparison between Latvia and Argentina is a spurious one, given that the former is in the EU - "a shield of prosperity" - and the latter has had a history of defaults.


Another thing that jumps out from this year's fund list is how much less assets the funds have under management now, the victims of waves of redemptions, forced or otherwise. Some funds have even closed. Swedbank's Russian Equity Fund, for example, had only €27.5m under management as of the end of June compared with €112.4m a year earlier. "It was not a good time to be in Russia, it was hit particularly hard. A lot of margin calls went out to strategic and other investors who had a bought a lot on margin - this was really forced selling at incredibly low prices," says Millendorfer.

Even so, portfolio managers report that redemptions from March and April have certainly slowed and even reversed in some cases as the huge rally on Asian markets plays itself out and concerns grow that the torrent of money flowing into that region is fuelling asset-price bubbles; most Asian countries have seen gains of around 50% or more in their stock markets since the start of the year. According to the latest data from EPFR Global, which tracks country and sector asset allocation data for a broad range of global and emerging market equity and fixed-income funds, emerging markets have seen inflows of $32bn this year, outpacing developed markets.

Going into July, bigger was better for many emerging markets fund managers as money began to concentrate on the BRIC (Brazil, Russia, India and China) markets: net purchases of Russian, Indian and Chinese equity by EPFR Global-tracked equity funds hit 18-, 15- and 13-month highs, respectively. These four markets currently account for 44.95% of the average Global Emerging Market Equity Funds portfolio. On the bond side, EPFR reports that emerging market bond funds lifted their Indonesian, South African and Polish allocations to new record highs during June, largely at the expense of Latin America.

Even so, for most of the region the money flowing in is still in relatively small amounts and the buying selective. "After solid outflows for a few quarters, by the end of the first quarter that process slowed and even stopped. Then in the second some bargain-hunting investors again started to put money in the market and in the mutual funds. Currently, we are seeing slow process of return of the investors and modest inflows, which might be accelerated by the current [Bulgarian] stock market rally that took place in the end of July and the first weeks of August," says Ivailo Penev, a portfolio manager for ELANA Fund Management in Sofia.

Svoboda declares that the redemption wave we saw in the months through to March and April is over. "I would say that by April, redemptions had slowed quite significantly. We saw some redemptions through March and into April, but money is slowly popping in again, especially crossover money - not necessarily new money from the region, but mainly crossover money from institutions."

Further indications that things have turned is the performance this year of the Vienna Stock Exchange, which Andras Szalkai, a portfolio manager for East Capital, describes as a proxy for many international investors who are interested in the region. Toward the end of August, the leading ATX Index was up almost 40% since the start of the year.


Svoboda probably speaks for most fund managers when he says, "I have been in the job for 10 years and this has been my worst year."

Most are predicting a better year to come, especially now that Germany (and France) have reported that their economies already emerged from year-long recessions in the second quarter. "A lot depends on Germany, it's the most important player here. If export industries rebound because of a recovery in Germany, then we will come out of the crisis sooner," says East Capital's Szalkai. Even so, no one is seriously expecting a return to the pre-crisis heady economic growth of 6%-plus anytime soon as the region copes with swollen budget deficits, squishy corporate profits, rising unemployment and weak consumer spending.

In terms of where funds are putting money, the first half of the year has definitely been all about banks, surprising on the one hand because it was this sector that the genesis of all the problems, but perhaps not so surprising since it also fell first and hardest. In the second quarter, Deutsche Bank said its universe of banks in Czech Republic, Poland and Hungary delivered 11% quarter-on-quarter aggregate net profit growth in the second quarter, beating its forecast by 23%. "The expectation-beating financial performance was mostly driven by low provisioning - so far only FX options and consumer lending witnessed a significant increase in risk costs, with both corporate lending and mortgages not showing any material deterioration," the bank said.

Another place where banks have been particularly strong is Turkey, which not coincidentally was the focus of the winner of the "bne 2009 best equity fund," given that three of the top holdings in East Capital's Turkey fund are banks: Garanti Bankasi, Vakifbank and Halkbank. Turkey, a firm favourite of emerging markets guru Mark Mobius of Franklin Templeton for many years, has finally rewarded its long-suffering supporters with a relatively firm performance during this crisis. "It's been prone to crises in the past and surprisingly weathered the storm much better than others, because the leverage in the system was that much lower. Banks were not leveraged so much because interest rates were so high, and this served it well in the current crisis," says Millendorfer.

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