22 May 2019
Colin Croft Fund Manager, Emerging Markets
Hair-raising headlines are par for the course in emerging Europe – but that doesn’t mean that it’s not possible to generate strong returns investing in the region. Colin Croft, fund manager of the Jupiter Emerging European Opportunities Fund, looks back over some of the highlights from the past five years since he took over the fund’s management, and discusses why even crises can present attractive investment opportunities for investors in emerging Europe.
The difficult relationship between the US and Russia has been making headlines again recently, as the two countries take opposing sides in the Venezuelan crisis, and Mueller’s investigation of Russian interference in US elections arrived at its conclusion. This has reminded investors of a concern that has periodically spooked markets over the last few years – the fear of US sanctions. Meanwhile, the Turkish currency and stock markets saw another bout of jarring volatility in March during the run-up to the local elections.
For veteran investors in emerging Europe, this is nothing new. Hair-raising headlines are par for the course: over the last five years, we have seen Russia invade Ukraine and annex Crimea, the West impose sanctions in response, the oil price halving (2014), Greek banks shut down and capital controls imposed (2015), an attempted coup d’etat in Turkey (2016) and a Lira crisis (2018). Even in the comparatively tranquil eastern EU states, populist governments have occasionally surprised investors unpleasantly with new taxes and regulations. If you go back a little further, to 2013, we even saw a listed company have one of its assets quite literally hit by a meteorite.
Considering all of this, you might imagine that it is impossible to make money in Emerging Europe. But in fact, the opposite is true – the Jupiter Emerging European Opportunities Fund has returned 37% in sterling terms for the five years to the end of March 2019.
One reason for this disconnect is that a crisis makes for an eyeball-grabbing headline, whereas things that are far more important for investors – such as a steady improvement in shareholder remuneration practices – don’t really sell newspapers. A decade ago Russia’s largest bank, Sberbank, paid about 0.5 roubles per share in annual dividends, but last year it paid 12 roubles, and this year it will be more than 20 roubles. Yet the stock is so cheap that it yields around 10%. Not many large cap stocks globally have shown that kind of dividend growth – and practically none trade on that kind of bargain-basement valuation.
Similar improvements have been seen at other big Russian companies; state-owned oil company Rosneft, for example, has hiked its dividend payout ratio to 50%. This is an almost tenfold improvement since 2008. Meanwhile, private-sector Lukoil has conducted a trailblazing $3bn programme of buying back and cancelling shares that has powered its share price up more than 20% year-to-date (to the end of March 2019). In the Russian market’s pre-crisis heyday, such a shareholder-friendly buyback would have been nothing more than a blue-sky fantasy scenario for investors, yet valuations now are far cheaper than they were then – despite the fact that investors’ dreams have actually come true in this case!
Thanks to the horrid headlines, none of these improvements have been fully priced in by the market, and this is part of the reason why investors can enjoy such high dividend yields in places like Russia. Not only are the dividends high and growing, you can get your hands on them very cheaply indeed. I previously mentioned Lukoil is up 20% year-to-date, for example, but the stock is still on less than seven times earnings – hardly pricey in the context of double-digit price-to-earnings multiples for oil companies elsewhere in the world. In this case, markets have been slow to price in a structural change for the better because so many investors are distracted by the day-to-day noise about sanctions and geopolitics. Our investment process aims to identify these situations, where positive fundamental change has yet to be reflected in market prices, so that our clients can look to profit from buying a stake in a business for less than its worth.
These kinds of opportunities can be found even in relatively “safe and boring” parts of the Emerging European investment universe, such as Poland. Since the last election, the country has been run by the Law and Justice party, whose disagreements with mainstream European politicians on issues such as judicial reform and migration have attracted an avalanche of negative press.
But the really interesting story for investors is the Polish economy, which grew at over 5% in 2018 – outpacing just about every other country in Europe. This year, the government is injecting extra spending worth around 1.5% of GDP into extended child benefits and other social spending, which is likely to provide a tailwind for listed retailers. Even banks, which were hit by new taxes immediately after the last election, have since seen their earnings recover, buoyed by the strength of the broader economy.
It’s a similar situation with Hungary. Media coverage focuses on the most controversial aspects of prime minister Viktor Orban’s rule, while less attention is given to the positive turnaround – both in the economy and in the public finances – that has underpinned a hat-trick of election victories. That’s not to say that everything that the Hungarian government has done is beyond reproach, but it’s important to note that they have got some things right, and that those successes are often overlooked. One doesn’t have to agree with every single policy of a government in order to invest in businesses that are listed in that country. Indeed, if that were the case, it would be almost impossible to find anywhere to invest your savings, including the UK. At the end of the day, corporate earnings and valuations are what build wealth for investors – and while political noise can cause plenty of day-to-day fluctuations, it only influences long term returns to the extent that earnings are affected.
A good example is Hungary’s OTP bank – a stock that would have tripled your money over the last five years. Back in 2014, its earnings were depressed by bank taxes and the cost of clearing up the toxic legacy of Swiss-franc mortgages. Once the government had accomplished its goals of getting the budget deficit under control and eliminating Swiss-franc mortgages, it changed focus towards encouraging growth. Bank taxes were cut, and this helped lending to rebound, boosting both the economy and bank earnings.
Yet, markets were slow to respond to the positive change, as is often the case. Investors tend to take a long time to digest changes that directly contradict their existing perception of reality, for fear that it might be a false dawn. But this situation can also represent an opportunity for funds like ours, that that follow companies closely and are able to respond more quickly to positive changes, before they have become fully reflected in share prices.
Markets often overreact to scary headlines, and those who are brave enough to step up and buy when everyone else is running for the door can make good returns very quickly, by buying for “scrap value” something that is merely “dented”.
Take last year’s currency meltdown in Turkey. The move to a presidential system of government had raised questions about whether the central bank would remain independent, or whether political pressures would force it to keep interest rates unduly low. This fear snowballed into a self-fulfilling downward spiral of selling as the central bank hesitated. At the beginning of 2017, the Turkish lira was worth around 19 UK pence, but by August it was worth just 11p. The vicious circle was broken in mid-September, when the central bank finally raised interest rates, by a decisive 6 percentage points, which won back the confidence of investors. By this stage, Turkish share prices reflected an unrealistic level of pessimism; even companies with defensive business models and strong balance sheets were trading as if the end of the world were nigh. We felt that this was the right time to buy – and the fund was able to fix substantial profits in a matter of weeks.
Consequently, I am not unduly concerned by the most recent outbreak of market panic in Turkey that has surrounded the local elections. The turbulence may be uncomfortable in the short term, but I am confident that some good bargains will emerge, in the same way that they did back in the autumn. In my view, the lesson learnt from 2018 was that Turkey’s dependence on external funding acts as a natural constraint that ultimately deters its rulers from straying too far for too long from policies that the market considers sensible. With four years until the next elections, politicians have a window of opportunity to undertake the kind of “pain today, gain tomorrow” reforms that can only be done at this stage of the electoral cycle – and which markets tend to like.
Moving on to the next possible crisis – could the US impose more sanctions on Russia? The risk undoubtedly remains. However, the events of last year – in which initially severe sanctions on Rusal were subsequently watered down with waivers before eventually being lifted – have demonstrated how difficult it is for the US to put any more sanctions on Russia without damaging its own interests and those of its allies. Russia is a difficult country to sanction effectively, due to its size and relatively high level of economic self-sufficiency in many areas: it has a current account and budget surplus, foreign reserves of almost half a trillion dollars, and low levels of sovereign debt. Consequently, it simply cannot be arm-twisted to the same extent as countries that cannot do without external borrowing.
The stock-market effect of sanctions has tended to take the form of an initial knee-jerk reaction, which has gradually worn off. In fact, the Russian market is actually among the better performers globally over the last five years, returning more than +58% in sterling terms (to the end of March 2019), largely thanks to the healthy dividends being paid out by Russian companies, which account for around 30 percentage points of the total return.
In the immediate aftermath of the Mueller report’s completion, the Russian stock market responded positively, in large part because there was “no new news”; some investors had been worried that the report might throw up something unexpected. This gives a tiny foretaste of what might happen if any good news were to come out of the region.
I don’t expect any near-term improvement, given how deeply entrenched the status quo is. In fact, I suspect that US-Russia relations, despite their already dismal condition, could conceivably get worse before they get better. But if we look back at history, there have been several periods when the two powers seemed doomed to senseless and destructive confrontation – only for tensions to ease suddenly and open up a period of detente.
If you are a long-term investor, perhaps topping up your pension fund with a view to retiring in a decade or two, it is worth considering that the current rulers of both Turkey and Russia are now in their mid-sixties and are likely to retire on a similar timescale. Whoever replaces them will need to consolidate their own popularity and hold on power, and will need to at least consider the possibility of changing course to some extent. After all, the current approach is showing some signs of wear. The long-serving presidents still enjoy high approval ratings, but the trend is downward as voters begin to show frustration at the lack of progress in improving living standards in recent years.
Dissatisfaction is currently at manageable levels, but this may not be the case in a few years’ time if the trajectory continues. The responses seen so far – “tightening the screws” domestically and taking a tough stance internationally – have bought some time, but ultimately neither system can function properly unless it is able to keep a large enough chunk of the population materially content. In the long run the only sustainable way to do this is to pivot towards the kind of policies that might generate better headlines – and much higher valuations for regional equities.
It’s certainly a nice dream – but as we have seen with the rising dividend payout ratios and share buybacks in Russia, dreams sometimes do come true for investors! And as we wait patiently for the clouds to lift, collecting handsome dividends each year, it is still possible to make excellent returns in Emerging Europe – despite, and sometimes thanks to, the horrid headlines!
Past performance is no guide to the future.
Fund performance data is calculated on a NAV to NAV or bid to NAV basis dependent on the period of reporting; all performance is net of fees with net income reinvested. Source: FE, Jupiter Emerging European Opportunities Fund I Acc, in GBP, to 31/03/2019.
Past performance is no guide to the future.
Fund performance data is calculated on a NAV to NAV or bid to NAV basis dependent on the period of reporting; all performance is net of fees with net income reinvested. Source: FE, Jupiter Emerging European Opportunities Fund I Acc, in GBP, to 31/03/2019.
Risks
The fund invests in emerging markets which carry increased volatility and liquidity risks. The fund invests in a small number of holdings and as such carries more risk than funds spread across a larger number of holdings. This fund invests mainly in shares and it is likely to experience fluctuations in price which are larger than funds that invest only in bonds and/or cash.
The Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. This fund can invest more than 35% of its value in securities issued or guaranteed by an EEA state.
Important information
This content is intended for investment professionals and is not for the use or benefit of other persons, including retail investors. It is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. Past performance is no guide to the future. The views expressed are those of the Fund Manager at the time of writing, are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given. Company examples are for illustrative purposes only and are not a recommendation to buy or sell. Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM), registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ are authorised and regulated by the Financial Conduct Authority. No part of this content may be reproduced in any manner without the prior permission of JUTM or JAM. 23607