Ben Aris in Moscow -
"Buy to the sound of cannons, sell to the sound of trumpets," Lord Nathan Rothschild said in 1810. If so, now may not be such a silly time to set up new Russian funds.
Private equity firm Da Vinci Capital (DVC) and financial powerhouse VTB Capital Investment Management (VTBC) both launched funds in February to attract new investors into Russia's super cheap stocks and high yielding bonds as the world slowly moves out of the 2008 crisis.
The timing may look off. Following Russian President Vladimir Putin's welcoming of Crimea as the latest addition to the Russian Federation on March 18, tensions with the West are very likely to rise further. But then investing into Russian securities has always been a rollercoaster ride.
Russian assets are certainly cheap as chips at the moment. "Russia remains very cheap vs the other emerging markets. China is slowing and banking sector asset quality is at risk. Turkey has got internal political questions. Russia looks strong and very cheap on a price to earnings basis, below 4 times by MSCI Russia index" says Vladimir Potapov, CEO at VTB Capital Investment Management.
Tech and debt
DVC closed the first round of fund raising for its Da Vinci PE Fund II in February, with the European Bank for Reconstruction and Development - in its only sponsoring of a private equity fund in the Commonwealth of Independent States (CIS) in 2013 - plus five global funds acting as cornerstone investors that contributed $100m. A second round is planned for April, for which Oleg Jelezko, DVC's managing partner, hopes to double that amount.
DVC's first fund has a strong track record having been a key investor in the Moscow Exchange, which made a packet for its shareholders. It also invested in the software engineering firm EPAM, which has most of its operations in Belarus. It floated on the New York Stock Exchange in February 2012 and the shares have since doubled in value.
The new fund has already made three investments: it acquired a controlling 63% stake of IT-Invest, one of the leading online brokerages in Russia, aimed at high frequency traders, and took minority stakes in electronic procurement system B2B Center and debt collection company First Collection Bureau.
B2B Center is particularly interesting, because as Russia's largest e-procurement player it typifies the country's rapidly developing "new economy". "If Gazprom needs to buy 100,000 pairs of gloves for its workers or 1,000 computers of its offices, then it can put a tender on B2B Center and producers can bid," says Jelezko. "The company can easily set up its own tender, get bids, choose the cheapest one. It eliminates the need for face-to-face meetings, which automatically eliminates the usual kickbacks and bribes."
B2B Center remains a pioneer in the market and it is the very difficulty of working in the CIS that is a big factor in the company's success. It already has over 100,000 registered participants that are offering more than $20bn worth of tenders a year, in which companies typically save 20-30% in costs.
First Collection Bureau (FCB) is also in a particularly attractive sector. Worried by the ballooning levels of consumer lending, at the start of this year Russia's central bank (CBR) introduced strict new prudential rules that have in effect made it very costly for banks to hold bad debt on their balance sheets: the CBR now demands that banks double their provisions from 11% to 22% once a debt is more than 180 days overdue. The debt collection business was already growing rapidly as consumer debt starts to rise, but the new rules have lead to a boom in the business. Many banks have just sold their debt to collection agencies.
Banks sell debt at a maximum of 5-8% of face value, or less depending on how overdue the debt is. Despite their "repo man" image, much of debt agencies' work is done over the phone, trying to figure out what the debtor can afford to pay and collecting payments that can be a fraction of the original sum. "If someone owes RUB100,000 plus RUB70,000 in interest payment, the question is what they can actually pay," says Jelezko. "A typical deal will be to agree a repayment of RUB2,000 per month over two years, which won't even cover the principle, but it still earns the collection company a profit given the discount they bought the debt for."
Jelezko says he hopes that DVC will be able to take at least one of these companies public in the next couple of years, but the global political crisis over the fate of Ukraine has made any talk of Russian IPOs difficult for the foreseeable future.
High rates and rotations
The VTB Capital IM Russia & CIS Debt Fund takes an altogether different tack, concentrating on fixed income.
One of the reasons that Russian equities are so cheap, argues Potapov, is because Russian bonds are still so profitable. The IM Russia & CIS Debt Fund is the first of a series of funds that the asset management arm of VTB Bank hopes to launch in the coming years. "There is an interest in the fixed income fund and lots of interest by both foreign and domestic investors as it has high rates and good credit quality. The Russian sovereign Eurobond curve is trading at 150-250bp spread over its pre-Crimean-crisis levels," says Potapov.
The fund was also launched in February and seeded with $40m, half of which was provided by a Russian anchor investor. But it is now in the process of raising more money. "We can potentially raise a couple of billion dollars. Just the fixed income market total amount outstanding is about $500bn so we are aiming for $5bn total," says Potapov.
VTBC already has some RUB248bn ($7.5bn) of assets under management, the vast majority of it Russian money, but the new fund is aimed at slowly bringing in more international investors. The fund has been set up with best international practices in mind and is targeting bonds in Russia and the CIS.
Local investors are still happy with the high rates that Russian bonds are yielding. Unlike most of the rest of the world, Russia's central bank has held rates high in an effort to keep a lid on inflation. Indeed, the CBR hiked rates by 150bp in early March to stave off a drop in the ruble against the dollar following the military incursion by Russian troops into Crimea. While yields remain high, there is little incentive to invest into the more volatile equities.
Potapov argues that Russian equities are at the end of a process that sees investors go from developed market (DM) bonds to DM equity and then to emerging market (EM) bonds and finally to EM equity. With interest rates slashed to the bone in the developed world, at the moment the world is still in the DM equity phase of this chain, but with significant investment also starting to flow into the EM bonds last year. That will change eventually. "The big question is when is the global rotation finally going to come to emerging markets," says Potapov, who says VTBC IM will eventually set up a Russian equity UCITS fund and other products. "There is interest in Russia but the rotation has not arrived yet."
"Inflation is still moderate and fixed income real rates are still positive, so there is no trigger for domestic investors to move into equities yet," he adds.
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