When East Capital co-founder Karine Hirn first arrived in Moscow in 1991 as a young French student, the city was reeling from a coup attempt two weeks earlier. Tanks were still in the streets and there were shortages of everything, including food.
For Hirn, this turned out to be a blessing in disguise.
“I was starving and there was nothing in the shops, the only way to eat was to go to restaurants or be invited to people’s homes,” she says. “That meant you had to make friends quickly. I learned Russian in four months, because I was obsessed with food.”
She also acquired an enduring fascination with Russia and went back to her studies in France determined to return.
Three years later she succeeded, this time as a French government-funded consultant to a local bank in Nizhny Novgorod. “I had just graduated from Sciences Po Paris and I was helping bankers understand credit risk without knowing much about it myself,” she says.
After moving to Stockholm in 1995, she heard of a Swedish entrepreneur looking for Russian speakers to manage a growing portfolio of businesses in the former Soviet Union. These included a small bank in Moscow and, at the age of 23, Hirn found herself running it.
As with many of Russia’s more than 1,500 lenders at the time, the bank’s main function was to provide funding for the group’s companies. “It was basically just a treasury department under supervision,” says Hirn.
After two years of commuting between Moscow and Stockholm, she read a newspaper article about Peter Elam Håkansson, global head of research at SEB’s investment banking arm. “They had just helped Hansa Bank in the Baltics to raise money,” says Hirn. “He was saying the Baltics were exciting, but Russia was even more exciting. I said I have to meet this man.”
She got in touch and they talked Russia. Two weeks later he called to say he had left his job and was starting an investment firm dedicated to Russia and the Baltic states. The 25-year-old Hirn immediately signed on, along with several equally young people from the Baltics.
By May 1998, they were ready to launch East Capital Russia, one of the first-ever equity funds to offer retail investors exposure to the former Soviet Union. A Baltic fund was added the following month.
“At the time, we were all very excited,” says Hirn. “The market had fallen 50% in the wake of the emerging market crisis that had started the year before in Asia; we thought it was a fantastic opportunity. So many stocks were really attractive. Of course that was our first lesson – the market can always fall further.”
It fell a lot further. By October, after the devaluation of the rouble and Russia’s default on its domestic debt, East Capital’s new Russia fund had lost 83% of its value.
“We actually outperformed the index, which was down by 92% – but when you’ve only just got the money that’s no consolation,” says Hirn. “You can’t say to clients: ‘Hey, we’ve outperformed by 10%’ when they’ve just lost most of their investment.”
Our first lesson was that the market can always fall further- Karine Hirn
The firm also lost several of its original team, who went back to more secure employment. By 1999, East Capital consisted of just three partners – Håkansson, Hirn and Lithuanian Kestutis Sasnauskas – in a tiny basement office.
Nevertheless, they managed to keep the fund going and continued travelling to Russia, where they soon became convinced they had spotted a big investment opportunity.
“We realized that domestic consumer names were thriving, because competition from abroad had vanished,” says Hirn. “We went to see a dairy producer in St Petersburg. They had been struggling to compete with firms from Scandinavia, but now they were doing great business because no one could afford to buy imported yoghurt.”
Today, the importance of domestic consumption as a growth driver is a staple of emerging market investing. At the time it was a ground-breaking insight. “Twenty-two years ago, for most people Russia was just about oil and gas,” says Hirn.
East Capital began looking for ways to get exposure to the consumer sector. “Very few firms were listed, so we had to do it indirectly,” says Hirn. “We invested in listed Finnish breweries that had local operations in Russia and the Baltics, and in Turkish construction companies that were building the shopping centres that were springing up all round the big cities in Russia.”
Their post-crisis experience also reinforced for East Capital’s team the value of getting to know the people behind the companies and doing on-the-ground research.
“When we have a presentation we start by asking people to guess what would have been the best season of the year to visit Russian companies back in the late 1990s,” says Hirn. “We found it was winter – because if companies were telling you how great their balance sheet was, but they couldn’t afford to pay for heating, you knew something was wrong.”