Ben Aris in Bucharest -
Peter Håkansson, the founder and manager of East Capital, came face to face with Russians for the first time on October 29, 1981, but it wasn't a pleasant meeting.
He was part of a Swedish army detail assigned to make sure a Soviet submarine full of sailors that had gone aground off the coast of Sweden didn't escape, and so spent most of the next two weeks at the centre of an international incident staring at the submariners down the barrel of a machine gun.
"I was doing my national service at the time and it got pretty scary. There was a rescue attempt and helicopters flying in," says Håkansson.
Twenty-five years later and relations have improved. Håkansson went on to become the head of global research at Swedish bank SEB and after the fall of the Soviet Union became increasingly intrigued by Russia and the countries of the CIS.
"I was travelling more and more in the region and saw the opportunities. So we decided to set up a fund to take advantage of that opportunity," says Håkansson.
Specialising in Eastern Europe
East Capital was founded in 1997 as a specialist fund management firm that focused entirely on Eastern Europe. At the start, it collected money from mainly Scandinavian retail investors, who still make up 80% of contributions, but has since expanded with a series of offshore funds that have attracted institutional investors looking for someone with a track record in this volatile region.
And volatile is the word. The fund remains one of the best performing in the world, but East Capital hasn't always got its timing right. For instance, Håkansson decided to launch East Capital's first Russia fund in May 1998, about three months before the Russian market went into meltdown after the government defaulted on its international debt and devalued the ruble.
"Between October 1997 and May 1998 the market sold off 60% and we thought, 'what a good time to set up a Russia fund'," says Håkansson. "It wasn't. In all, the market had sold off 95% by August that year."
More recently, East Capital had some further bad luck when it launched its first Turkish fund in March 2006. The value of the Turkish stock market had almost doubled in 2005 and the country looked like it had turned the corner as EU accession talks finally began to move forward. However, two months after the fund was launched, stock markets around the world sold off heavily as investors ran for cover, fearing the US central bank would raise interest rates. As one of the countries with the weakest fundamentals, Turkey was hit very hard and the fund was down by over a third after only a few months of trading and has yet to claw back its losses from last year.
However, Håkansson sees these setbacks as nothing more than that setbacks. East Capital's philosophy has been to go in early and look for value, then buy and hold for the long term.
"All these market are going to grow. You just have to compare the basics. The average GDP per capita in the Baltics is about 6,000 a year, whereas that in Portugal, one of the poorest countries in Europe, is nearly twice as much. There is still plenty of room for growth," says Håkansson.
There's the rub. East Capital's strategy is founded on the belief that the fall of the Soviet Union began an irreversible process of catch-up and the integration of Eastern Europe with Western Europe.
And it has proved to be a spectacularly good strategy so far. Despite the ups and downs, the ups have always been bigger than the downs. By sticking to its guns, the fund got its big break in January 2003 when the East Capital Baltic Fund ranked as the best performing fund in the world. The team began to talk to stockbrokers around the world and invite them to see their operations. Word quickly spread, bringing with it international and institutional investors.
Morningstar, gold stars
The East Capital team at their recent conference in Bucharest, Romania
Over the last few years East Capital has won five out of the six gold stars that the fund research firm Morningstar has awarded in the last six years as best fund in its category. Håkansson has continued to roll out a number of products to cater to the different stories unfolding in Central and Eastern Europe.
The Russia fund was followed by a Baltic fund and an East Europe fund; amongst the most recent were the Turkish fund and a Southeast Europe fund, which hope to benefit from the gathering pace of growth in Romania, Bulgaria and the Balkans. And this year the fund has introduced dollar- and euro-denominated products to expand this customer base; until now all investments had to be made in Swedish krona.
These are all onshore funds aimed at retail investors. In June 2004 the first of the offshore Bering Funds was launched. With a minimum investment of between $50,000 and $75,000, these funds are aimed at wealthy individuals and institutions and make private equity investments into small and medium-sized enterprises catering, for the most part, to the consumer. The most recent addition to the family will be the Caspian Region Bering fund that closes at the end of March, which will invest into similar companies in countries around the Caspian Sea, with Kazakhstan and Azerbaijan being the most important.
The scale of operations went up another gear in November 2005 with the launch of the East Capital Explorer Financial Institutions Fund that specifically targets banks and financial institutions across the CIS. With a minimum investment of $1m, the fund was specifically for institutional investors and has already invested about $200m of the $350m raised.
"We like banks, as this is a growth story and now have 20% of the Russian portfolio invested into banks," says Håkansson. "The bank sector started to take off in 2005 and the valuations have been soaring, but it is still possible to find value in this sector. The story is very simple; if you look at the basic banking figures, then penetration of banking services is still extremely low but growing extremely fast."
With equity markets around the world suffering bouts of turmoil since the May 2006 sell-off, investors have become nervous. Moreover, some ask whether the growth of banking assets at over 200% a year is sustainable or if it will all end in tears. Håkansson says while that's possible, East Capital has been seeking out banks with a strong retail portfolio as this offers the best protection from the excesses that come with this speed of growth.
"One of our board members is the former governor of the central bank of Sweden and he points out that there has never been a bank crisis started by retail depositors; it is always corporate problems that bring the banks down. And we look for banks that have a strong retail component that have a solid business logic," says Håkansson.
The second plank to the strategy is diversification. While most of the emerging market funds investing in CEE are heavily exposed to Russia and Ukraine, East Capital has tried to spread its investments as widely as possible. The result is that East Capital's overall performances are a lot less volatile than those of many of its peers: all East Capital's funds taken together have returned an annualised 45% a year since 2000, but the value has swung by 15% while the volatility of most of East Capital's competition clusters around the 22-23% mark.
By investing more into the smaller markets especially the newer countries of Southeast Europe - Håkansson argues the risks of these emerging markets can be significantly reduced. For instance, during the May 2006 sell-off, Turkey's stock market fell 45% as foreign portfolio investors hold three out of four listed shares, while the bourse in Belgrade actually rose by 2% as almost all the investors are local.
"The advantage of these smaller markets is that they are not correlated to the international markets in the way that the big countries like Russia, China and India are. It is a hedge against the problems that market might face in a global sell off and so it reduces our volatility," says Håkansson.
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