FYI...
Portfolio
D' Russians 'R Coming! D' Russians 'R Coming!
by John Tompkins
Russia has been a fountain of bad news for years: an endless litany of crime, corruption, tax evasion, Yeltsin's poor health, discontent in the army, whispers of revolution. In recent months the troubled former Soviet Union has quietly changed for the better. It's reflected in the stellar performance of the Russian stock market, which roared up by 150% in the year-and-a-half to date.
How could this be in the face of problems so massive and universal? Well, it reflects the ``good news'' side of the ``good news/bad news'' equation. The trouble is that the news media report the bad news and ignore the good. No one suggests that Russia is out of the woods yet, but a few American funds have done awfully well. For example,Lexington Troika Russia Fund has chalked up an incredible total 87% return -to-date. Troika's sub-advisor is a Moscow company with a number of
multinational and Russian clients.
Troika's net assets have shot up from $13.8 million the first of the year to a present $92 million, a small fund but one that's enjoying a tremendous growth rate. Part of this represents the increase in the value of the stocks it owns, but most of it is new money that's flowed in from investors who want to make a bet on Russia. The biggest risk, says Keith Bush, advisor to the fund, continues to be President Yeltsin's health. Few Russians expect him to serve out his four-year term. If he dies, prime minister Viktor Chernomyrdin would become acting president until an election, which the constitution says must be held within 90 days.
Four men are the current favorites to succeed Yeltsin. Boris Nemtsov, first deputy prime minister, leads in the polls as most trustworthy. Former general Alexander Lebed is popular but lacks political resources. Yuri Luzkhov, the mayor of Moscow,has done a superb job but is not a national figure. Chernomyrdin has the advantage of incumbency. But, says Bush, if Yeltsin becomes a part time figurehead -- which many Russians expect -- Chernomyrdin, Anatoli Chubais, first deputy prime minister, and Nemtsov, also a first deputy prime minister, may be the real rulers of Russia.
Lexington Troika is the only mutual fund dedicated entirely to investing in Russia. The other Russia-oriented funds are closed
ends on the New York Stock Exchange. Prices reflect supply and demand rather than asset value. Among these Templeton Russia Fund (NYSE:TRF) has doubled from $30 a share late in April to $60 this week. And Morgan Stanley Russia & New Europe Fund (NYSE:RNE - news) went from 24 late in April to 38 this week. Trading volume in both is unusually high.
There are a number of other mutuals, such as Robertson Stephens Developing Countries Fund, that have begun to add a few Russian stocks to their portfolios. Michael Hoffman, portfolio manager of Robertson Stephens, sees his Czech and Polish investments diminishing in the future as he believes their currencies are overvalued and disappointing earnings may be on the way. He currently owns LUKOIL Holding, an oil and gas company with twice the reserves of Exxon (NYSE:XON), Monsenergo, an electric utility, and Chernogorneft, another oil and gas stock. Hoffman is very bullish on Russia, but is a careful bottom up analyst who triple checks Russian numbers. LUKOIL and Monsenergo are among the most liquid Russian blue chips and the Russian Exchange has begun trading futures contracts on them.
Lexington Troika's portfolio is heavy on electric utilities, oil and gas companies, and telecoms because they offer liquidity and
predictabl e earnings. But Troika has begun to spread its portfolio beyond these blue chips. It owns, for example, Krasny Oktyabr (Red October) which is a candy company, not a secret Soviet submarine. It also has positions in Trade House GUM,a retailer, Primorsk Sea Shipping, and 80,000 shares in a service company with the hard to pronounce name Tsum Jsc Torgovy. The fund's annual report notes that 10 of its holdings, such as Primorsk Sea Shipping, are not liquid under guidelines set by its board. No more than 1 5% of assets can be invested in illiquid securities.
How can the Russian stock market be surging? Yeltsin is hardly a picture of health. Organized criminal gangs are selling
weapons abroad. Blatant insider deals go on in newly privatized companies. But some of the biggest problems are well on their
way to being solved. Most notable, and least reported, is the impressive success of Moscow's tax collectors. In mid-March,
Yeltsin brought some market-oriented people into his cabinet and collecting taxes became a priority. Corporate managers were
given three choices: 1) pay overdue taxes in full, 2) go to prison, 3) declare bankruptcy and see assets auctioned.
According to Lawrence Kantor, executive vice president of Lexington Troika, the choices got the tax evaders' attention. Even more helpful was a special squeeze on Gazprom, an immense oil and gas producer that owns a quarter of the world's gas reserves. Gazprom is so huge that the World Bank estimated paying its back taxes would add 2% to 3% to Russia's GDP and go a long way to closing the deficit. Last month, the company paid 14 trillion rubles, or about 0.6% of the GDP. Kantor says
the decision of Gazprom managers not to go to prison convinced hundreds of other companies to pony up as well.
Still, there are some foot draggers and Alexander Pochinok, head of the State Tax Service, is naming names. He believes the government should look into the tax payments of the Zil and Moskvich auto companies, and keep the feet of car maker AvtoVAZ to the fire to ensure that it keeps paying. Pochinok wants to investigate the Moscow and Ryazan oil refineries as well as the Severstal steel complex in Chelyabinsk, and the West Siberian Metallurgical Plant. While 14 of the 15 biggest tax debtors have been pressured into making payments, another 50 firms are on the Tax Service' blacklist. Nizhnevartovskneftegaz, the main production unit of the Tyumen oil company, is being put into bankruptcy.
Tax collections are mundane perhaps, but without worldwide publicity they've made it possible for Moscow to begin paying the
army and sending pension checks to retirees. At the same time inflation, which was 2,650% in 1992, and 22% last year, is now
around 5%. Interest rates have tumbled from astronomical to reasonable, which is luring rubles from short-term paper into
stocks. The change in Russia's fiscal situation just in the last month, says Kantor, is so positive that Moscow says it may not
need to sell a Eurobond issue planned for the fall.
Remarkably, there's been no rush of mutual fund money into Russian stocks in spite of the fact that the average price/earnings ratio of the Russian favorite 50 blue chips is 3.5, though a few well known names are much higher. Lenenergo, an electric utility has commanded 75 times earnings,LUKOIL has sold at 21 times earnings, and St. Petersburg Telecom has a P/E of 20. But Norilsk Nickel has sold at only 1.2 times earnings, Northern Shipping at 1.8, and Kotlass Timber, a pulp and paper producer at a P/E of 0.4.
Last year when many P/E ratios were in the 1 to 3 range, several U.S. fund families said they were considering a Russian fund but except for those sold only abroad none have been launched. We suggested to Larry Kantor that perhaps the industry lacked the nerve, but he disagrees giving two reasons: custody of stock and low trading volume.
While the advent of the Russian Trading System (RTS), which is similar to NASDAQ, has created a nationwide stock market it's still struggling to set up a reliable infrastructure for clearing and settling trades. The risk that scares many portfolio managers is that stock transfers are still entered by hand on company share register books and ownership could be lost through fraud, negligence, or oversight. Second, the market for most Russian stocks is thin which means that a big fund or even a medium-sized one would have trouble buying and selling without upsetting the market. Troika has been willing to invest in some illiquid stocks because it plans to be a long term investor.
It's extraordinary that a country recently shrouded in paranoid secrecy is now trying so hard to be open that it sometimes
makes the U.S. seem backward. The IRS would never openly hammer corporations in the Russian style, but some American historians complain that when you want to research the history of the Cold War it's easier to get access to formerly secret data
in Moscow than in Washington.
A few days ago, First Deputy Prime Minister Nemtsov went to bat for a Russian Public Television reporter whose press credentials had been revoked by the Foreign Minister of Belarus because he said the man was insulting and biased. ``The government will defend Russian journalists wherever they work,'' Nemtsov thundered, ``be it Belarus, North Korea, or Cuba.'' We can't recall the last time Washington stood up for an American reporter. |
