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IT’S NOT SO very long ago that the average Russia hedge fund manager had little to worry about. Just still being in a job was a good start. Now, after years of stellar returns on the Russian stock market, managers are awash with concerns. Where to find a properly qualified nanny, the price of a decent bottle of wine in Moscow’s top restaurants, and how to convince erstwhile classmates at public school reunions that being a Russia hedge fund manager doesn’t mean you’re a spiv. Ah, the slings and arrows of making an outrageous fortune.
Last, but by no means least, there’s the added pressure from clients to continue to produce the triple-digit returns that many hedge fund have been able to deliver in recent years. Although there is a wide variety of investment approaches among the hedge funds that invest in Russian equities, the one common strand is that producing the sort of returns that have been seen recently will become increasingly challenging. This common stance apart there are widespread differences between the attitudes of different firms about the correct approach to investing in Russia.
Take the thorny issue of investor activism. William Browder and his team at Hermitage Capital Management, which has more than $3 billion of assets under management, has become famous for his principled opposition to robber-baron aspects of some Russian corporates and has been vociferous in challenging murky practices. As a result he has been banned from entering the country.
However, Eric Kraus, managing director of the Nikitsky Fund, believes that an activist stance is not conducive to producing returns for investors. "It may be good for a fund manager’s ego, but it’s not necessarily good for his clients," he says. "We consider it to be, even at best, an expensive waste of time, at worst it can be deeply counterproductive. We feel that our investors’ best interests are served by having the fund align itself with the interests of management – not trying to force change on an unwilling reference owner with interests radically different from our own."
Kraus adds that activist investment in Russia is suitable primarily for venture capital funds or others willing to take equity stakes of more than 25% in return for board representation. "Nikitsky does not take management stakes in any company, though we will, of course, support activist investors with our votes," he says.
Michail Kart, managing partner at Marcuard Spectrum, takes a simple view on corporate governance abuses. "If we don’t like something a company does, we simply sell out of it," he says. But he adds that in recent years there’s been a massive overall improvement in corporate governance – "owners now understand that’s it’s easier to comply with investors’ requirements than it is to try to rob them". Although in principle applauding Hermitage’s stance, Kart says that in practice small fund management groups such as Marcuard Spectrum simply cannot afford the management time and effort involved in adopting an activist stance.
Florian Fenner, managing partner at UFG Asset Management, is another activist investment agnostic. "Activist investment presupposes a system where you can rely on the courts to back you up, which is still a questionable proposition in Russia," he says.
Improvement
Nikitsky’s Kraus, who was once one of the most vociferous critics of corporate ethics in Russia, believes that while the notion of corporate governance might have been an oxymoron in the 1990s, the more egregious practices are now a thing of the past. "The cumulative success of Russian IPOs in the west means that more and more managers see this route as a realistic exit, which gives them an incentive to be more investor-friendly," he says. He adds that while good corporate governance is an undoubted positive, it’s by no means a be all and end all in terms of determining whether Nikitsky decides to invest in a company or not. "The best opportunities are often to be found not in those companies with the best current governance, but rather where an improvement in practices is under way," he says.
There is also a wide diversity of opinions about the relative merits of taking long or short positions. Although Hermitage’s Browder famously believes that if you want to be short, you don’t want to be in Russia, James Fenkner, managing partner at Red Star Asset Management – founded in 2005 and so one of the most recent additions to the Russia hedge fund universe – believes that while a long-only bias has worked well over the past couple of years, funds with a long/short component will increasingly come to the fore in terms of investment return performance. Since its inception in 2005, Red Star’s assets under management have more than doubled to exceed $100 million.
"Long-only has been the right strategy in the last 18 months or so, but the Russia story is changing – it’s not just a cheap play any more, so we believe that increasingly you need to have a long/short approach," Fenkner says. He adds that the ideal conditions for a long/short approach are when you have a deep, inefficient and choppy market. "The market here in Russia is deep and inefficient, and is beginning to become increasingly choppy." He says that on so-called Terrible Tuesday in February, Red Star’s long/short mix worked well and that the firm’s portfolio of shares ended five basis points up on a day when the market lost 3.5% overall.
One of the hotly debated topics among Russia-dedicated funds is the growing influence of the Bric (Brazil, Russia, India, China) investment theme on market behaviour. In line with this, a growing number of mainstream emerging market fund managers have stopped trading smaller, thinner markets to concentrate on the bigger, deeper markets. When the Chinese stock market tanked and dropped by nearly 10% on February 27, the shock waves were soon felt in Russia, where the markets lost 3.5% on the same day and slipped by another 10% in the following week. UFG’s Fenner says that based on economic fundamentals there should be no correlation between the Chinese and Russian markets. "Given the strength of the Russian economy and of the Russian equity market there should be no fundamental correlation between Moscow and Shanghai," he says. But in practice, he adds: "The big Russian blue chips are all part of Bric-focused portfolios and so investors liquidating positions in one market can have an effect on the performance of other markets in the same portfolio."