One of my favourite American authors, Allen Greenspan (FED chairman for a decade) wrote his memories at the beginning of the new millennium. A great book that shows how different factors could influence one endogenous variable: the Financial Market. It seems we are experiencing a regime change moving into an age of turbulences where more and more exogenous variables influences the financial markets aside from the normal factors like earnings, Central Banks’ behaviour and inflation outlooks.
The last quarter of the NESTOR Eastern Europe Fund is a one to remember. The story begun with a surprise sanction from the US imposed on Russia targeting some of its citizens and businessmen and punishing people who are considered “persona non gratas” for the United States. The main target was the Russian oligarch Oleg Deripaska and his listed companies, Rusal Aluminium and EN+ Aluminium Group. As all business partners of these companies could be easily put on the US sanction list, these two aforementioned companies declared a technical default. Needless to say, those measures had an effect on the global markets; the price of aluminium skyrocketed due to supply concerns sending it to a 5 year high.
Nevertheless, the new “sanctions” hit the whole Russian market and caused one of the biggest outflows from the Emerging Markets in general (especially via dedicated ETFs). The next two examples could illustrate how the capitalization of some of the Russian Large-Caps reacted to those sanctions:
- Sberbank, which is in my opinion the best commercial bank in Europe: Stock is down from 21 USD to 12,8 USD (roughly 40% decrease)
- Lukoil, which is the best managed and well diversified Oil & Gas company in CEE: Stock is down from 71 USD to 59,9 USD (roughly 15% decrease)
Nonetheless, it is not necessary to provide other instances to illuminate the fact that with this massive selling pressure there were no exceptions.
Additionally, the geopolitical risks remained the same in the second quarter of 2018. It looks that we have a new friend on the horizon, North Korea, but probably we all wish that a new neighbour like North Korea lived on a different Planet. On the other side, for the Syrian case, unfortunately nothing new and nothing good occurred during the quarter.
The trade war – started by the American president Donald Trump last year – continues, day-after-day we realize a new tariff, tax or any kind of shield introduced by old players (US, China) as well as new players (Canada, Mexico, EU) against each other. It is really hard to remember when the first economics book refuting protectionism was written (may be in the XVII. century), however, it is quite sure that nowadays policy makers should reread it. Maximizing political votes for short term victory is useless, and has negative effects for many generations.
The long awaited mini-collapse of the Turkish capital markets (nearly 20 percent fall of TRY against USD in the second quarter as well as two rate hikes from the National Bank of Turkey to 17,75%) had a general negative impact on the Emerging Markets. Fortunately, the fund did not have any exposure to the Turkish market.
Despite the challenging international investment environment, and with a rebound of the equity prices in Russia at the end of the quarter – which was supported by high and stable oil prices-, Nestor Eastern Europe Fund had a relatively good quarter. The Fund lost only 3,69% of its value in the second quarter of 2018. The worst performer during the period was Hungary (-8,50% in EUR terms). We also noticed a poor performance in Poland (-8,27% in EUR terms) and the Czech Republic (-7,75% in EUR terms). The best performing market was Russia (-1,99% in EUR terms). The Fund’s relatively good performance was supported by the strengthening USD against nearly all major crosses.
As we communicated before, we started the new quarter with an underweighted position in Poland, neutral positions in Hungary and in the Czech Republic, and a bit overweighted position in Russia. The cash proportion of the Fund was high at the beginning of the quarter (more than 3% of the total value of the fund), so during the first sell-off we were able to buy equities with high discounts. Those trading positions brought double-digit profits for the fund. Beyond a shadow of a doubt, our focus in these hard times was on trading.
Nevertheless, we made several strategic decisions related to our investments. In Russia we started to build a small portfolio of Russian Utility Companies like Federal Grid, Unipro Russia, OGK2 and TGK1. These companies have an extremely high dividend yield, sometimes with a sustainable dividend yield above 10%. We believe a low-beta portfolio could counterbalance the high risks surrounding market conditions presently. This is the main added value of active portfolio management. We still believe that active portfolio management is the future of the investment industry.
During the last quarter, we totally sold investments in Genel and Gulf Keystone Petroleum. Both stocks significantly outperformed the general market.
We still see great upside potential in Russian Oil & Gas names; as the valuations of those companies did not react to the increasing oil price. Most of them trade below their book value, with a dividend yield above 6% and Price-Earnings ratio around 5. Nonetheless, The OPEC production hike should balance the oil market in the coming quarters. All in all, our top pick in the region is Sberbank: probably all Western Competitors (Deutsche Bank, Commerzbank, UniCredit Bank, Banco Santander etc…) would have wished they had a balance sheet and capital structure like the ones Sberbank has.
NESTOR Eastern Europe Fund offers investors a balanced portfolio with a high exposure to the Russian market, but balanced with less risky Central European assets in Poland, Hungary and in the Czech Republic. NESTOR Osteuropa Fund has still no exposure to Turkey.