In the last quarter of 2018 we witnessed a significant correction in almost all equity markets. Most of the bourses have tumbled close to the 20% bear-market-threshold from their peaks. The correction itself, which is considered a normal phenomenon in the financial markets, should not be disturbing. Nevertheless, the observed patterns of the correction as well as the extreme intraday price movements were completely disconnected from the existing data and news. In other words, it was hard to find a “fundamental” rationale underlying the buying and selling transactions executed in the market. It was absolutely a hard mission for active portfolio managers to find a good timing for taking investing positions. However, before starting to dig in the developments of the central European markets, it’s worthy to shed a light on some of the reasons that could explain those unusual price movements in the financial markets.
We are all living in the internet shaped world. In the previous decade, we witnessed an Information Technology (IT) revolution, and over the years more people were growing attached to this evolution using more and more digitalized services. We believe that this technology advancement increased significantly our economic productivity as well as our standard of living. Consequently, it should not be surprising that the trading of listed and non-listed securities has grown dependent on globalization.
Digitalization entered the financial world with some algorithm based trading platforms called High Frequency Trading (HFT). Those machines react to any news or market movements in nanoseconds, before any human brain could process or react to this data. Though we believe that digitalization is affecting positively our standard of living, we tend to be more worried about the penetration and the growing role of HFT. According to the latest statistics, about 60 percent of the daily volume of the trading in the S&P 500 is dominated by the HFT algorithms. On the FX market, about 80 percent of the daily volume is dominated by those digitalized algorithms. It would be scary to realize that the machines are becoming the dominant market-makers in the world financial markets.
During the last quarter of 2018, the central European markets followed the world financial markets and finished considerably lower. The worst performers were the Romanian and Czech markets, which decreased 12.2% and 10.2% in EUR terms subsequently. The Russian market suffered also a loss of 9% of its value. On the other side, the polish market ended the quarter on the same level while in Hungary the stock market has risen 6%. The NESTOR Osteuropa Fund lost 7.08% in the last quarter of 2018.
Looking at the whole year 2018, the NESTOR Osteuropa Fund had a negative performance of 3.45%. The main central European markets had meanwhile the following performances: in Russia, the stock market decreased 2.96% and the Hungarian market declined 3.87%. However, the Polish and the Czech markets tumbled more severely losing 10.27% and 9.19% of their values respectively. The NESTOR Osteuropa Fund overperformed the benchmark, the global equity markets and most of its peers.
The best performing equities last year were the Russian Oil and Gas companies (Novatek, Tatneft, Lukoil, Rosneft and Gazprom). In Poland, only Lotos performed well leaving most other companies struggling considerably. On the other side, the worst performing stocks were the consumer related companies (Magnit, Lenta Eurocash, LPP and Richter).
One of the most interesting stories of 2018 was the rise and fall of Sberbank. The Russian giant – and the fundamentally best operating bank in the CEE region – rose above 21 USD in the beginning of the year before falling considerably below 10 USD later in summer. The profitability of Sberbank remains rock-solid, its financial numbers are unique; Sberbank produces in the difficult Russian economic environment a Return on Equity (ROE) above 20% and more than one billion USD of monthly net profit. Nonetheless, the scare of new financial sanctions against Russia destroyed investors’ confidence and penalized ruthlessly the value of the stock. While OTP and Polish banks stocks are traded with prices equivalent to the double of their book values, Sberbank is priced below its book value at the moment.
In the previous quarter, NESTOR Osteuropa Fund closed its long positions in Russian O&G companies - parallelly with the decline of the oil price - and went long considerably in the Sberbank. We kept our underweighted positions in Poland and in the Czech Republic and were neutral on Hungary. Although some signs of stabilization appeared in Turkey, we have not decided yet to enter the Turkish market.
As usual, there were many trades in the quarter, and we are willing to keep our active portfolio management style in the future as well. We do believe that this could create significant added value to the performance of NESTOR Osteuropa Fund.
With an extremely high dividend yield (above 6% is USD terms in Russia), low valuation and a high political risk, this region offers a high risk – high return investment potential.