Membership of the European Union plus political reform have created opportunities for the griffin eastern european fund
Central European countries' membership of the European Union, which will happen in 2004, makes a strong case for investing in the region, while a strong political consensus for change and reform is giving investors confidence to return to Russia, according to Jürgen Kirsch, fund manager of the Griffin Eastern European Fund.
With this optimism, Kirsch's fund has outperformed Standard & Poor's Europe Emerging Markets Equity Sector by almost 60% over three years, returning 87.69% compared with the sector's 29.73%.
The investment style of London-based Griffin Capital Management is bottom-up, with frequent visits to companies. The firm's team, who have invested in the region since 1994, employ active management practices, incorporating a strict selling discipline when a target price is achieved, and on an absolute return basis.
Griffin's research database - a proprietary system - combines global sector analysis, detailed profit and loss and a balance sheet for each stock, as well as discount cash flow analysis to establish absolute price targets.
The Griffin Eastern European Fund was launched in Dublin in October 1998, and its performance since launch reached 349%, compared with the fund's benchmark - the Nomura Eastern European Index - which achieved less than a third of Griffin's performance (97%) over the same period.
At a geographical level, the largest allocation of the E328m fund is in Russian companies, which comprise 38% of the portfolio's exposure. According to Kirsch, there are several reasons to be optimistic with regard to Russia. First, and most importantly, there is a strong political consensus for change. Secondly, there is a dynamic reform process already underway. The tax reform will see the introduction of a 13% flat income tax rate, and a 24% corporate tax rate. Tariffs will be rebalanced, particularly domestic gas and utility tariffs, which are set to increase.
Thirdly, there is evidence in Russia of solid macro-economic development. This is a combination of strong growth (>6%) and falling inflation (<15%), a Budget surplus of 1%, a current account surplus of 5% and rising hard currency reserves greater than US$60bn.
According to Kirsch, the fourth reason is evidence that capital flight is reversing and foreign strategic investors are putting money to work in the country. Fifth, there is evidence of improved corporate governance procedures.
"Russia is a completely different story from Central Europe, it is very exciting and very positive," says Kirsch. "On a macro-economic level, it is dynamic and strong. It is much stronger than Central Europe. Companies are still a lot cheaper in Russia," he adds. However, he does note that the political environment makes Russia higher risk, though this can, in turn, achieve higher return potential.
On concerns regarding the accounting and auditing practices that have in the past marred the reputation of Russian companies, Kirsch says that for 95% of the fund's holdings in Russia, international accounting standards have been adopted. Auditing is done by the big accounting firms which have offices in the country. "The transparency may not be as great as a Hungarian company," says Kirsch. However, Griffin makes it a point to visit the companies on a regular basis. The smaller the company, the higher the access to top management, he notes.
The remainder of the geographical asset allocation is split between the Czech Republic (23%), Poland (20%), Hungary (15%) and Estonia (3%). These are all countries which are expected to join the EU in 2004. Membership will mean increasing EU subsidies, up 2% of GDP. It will also mean an upgrade from 'emerging markets' to 'EU-member states', and all that this upgrade brings with it: namely, full political integration and real structural improvements of the legal, regulatory and economic environment. These countries will also be joining the euro currency between 2007-2008, creating full interest rate convergence and a further decrease of the risk premium.
Three-quarters of the fund's sector asset allocation is in telecoms (40%), and banks (35%); followed by energy (12%); utilities (4%), and materials and IT, each represent 3% of the allocation. The remaining 3% is not specified.
As prices in oil stocks reached their target value, Kirsch has increased exposure to banks and telecoms, while reducing holdings in oil.
"With the falling interest rates that comes with convergence, the banking sector has become very interesting," says Kirsch. "Demand for loans is picking up." Kirsch explains that as interest rates fall, individuals and companies find it more affordable to borrow, which may not have been the case in the past when interest rates were as high as 20%.
Convergence will have a similar impact on Central European banks that it had on banks in Greece, Italy and Portugal. "The bank sector led the rally in the market," says Kirsch.
Telecom companies are demonstrating very strong balance sheets - reducing capital expenditure and increasing cash flow. According to Kirsch, they paid out shareholder dividends with yields in the region of 6%-8%.
The fund holds between 40-45 stocks, with 75% of the stocks still offering good value and discounts. "The future for these stocks is very good," says Kirsch. They are mainly blue chip companies, only because there is very little other choice left in these markets.
"Several years ago there were some small-caps. But now these could have a hostile shareholder structure, where you do not really know what is going on. Some of these companies have been taken over by Western Europeans. Really, there are no small-caps around," says Kirsch. The blue chip sector starts with companies with around US$1bn in market capitalisation, but could be as high as US$30bn.
Kirsch is optimistic that over the next two to three years, opportunities will continue to grow in the region. He says the year started out well for the region, although it under performed Western Europe's rebound in March. "In the past three to four weeks, it out performed the Western parts, and this may continue," says Kirsch. Western European institutional investors are looking closely at opportunities in the region, and putting some money there. "It is a little bit of money, but it all adds up to quite a lot for the region," says Kirsch. This trend will continue for the next two to three years, he notes, even though foreign investors will remain, for now, relatively cautious.
"People are not completely bullish. If they were, there would not be an upside left. They are still dipping their toes in the water."
The fund deals daily - the dealing deadline is 17:00 Ireland time, two days before the dealing day.
The minimum investment is E5,000, with subsequent payments of E500. The management fee is 1.65% pa, with a performance fee of 15% over three-month Euro-Libor. The initial commission is 5%. The fund NAV is published in FAZ, Handelsblatt, Financial Times, DerSatndard, Reuters (GRIFFUNDS) and Bloomberg (GRIEEUI ID Equity).
About the manager: Jürgen Kirsch
Jürgen Kirsch is manager of Griffin Eastern European Fund and Griffin Eastern European Value Fund. From 1993 until 1997 Kirsch was senior fund manager at Mercury Asset Management in London where he had responsibility for research and investments in Eastern Europe. He was manager of the Mercury Eastern European Fund, which under his management became the largest Eastern European fund with net assets of over DM1 billion. During
Kirsch's tenure the fund achieved a return of over 400%, outperforming peer products by approximately 100%. Kirsch was voted Fund Manager of the Year by the German magazine Finanzen in 1996 and 2001.
Kirsch began his investment career in corporate finance with S.G.Warburg in London. He graduated in Business Administration and Economics at Friedrich-Alexander University in Nuremberg.
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