This year has brought little in the way of good news for emerging markets investors. The MSCI EM Index drop of 6.48 percent in the first quarter following a strong sell-off was precipitated by the United States Federal Reserve announcement that it plans to taper quantitative easing. And while growth has dropped off significantly in emerging markets, currencies have also plummeted. This weakness is increasing, giving investors an incentive to look for an alternative. And frontier markets are at the top of the list.
Frontier markets are the next natural step for an emerging markets investor. They are smaller and less liquid, but also offer exciting growth opportunities, albeit in possibly even more obscure settings. Kazakhstan, with its rich resource base, has long been on the radar of frontier investors.
So EdgeKz spoke to some leading investors and asset managers about investing and managing Kazakh assets.
Harvey Sawikin and Ian Hague, managers of the New York City-based Firebird Fund, have been investing in the former Soviet Union and Eastern Europe since the 1990s. “Firebird has been investing in Kazakhstan’s oil, banking and metal sectors since 1996,” Sawikin told EdgeKz.
“At the time, the country was planning to privatize a number of its blue chip companies and develop its stock exchange. Unfortunately, the crisis of 1998 derailed those plans and the privatization program was abandoned. Our portfolio of Kazakh equities stagnated for several years until the early 2000s when a number of Kazakh companies were listed on the London Stock Exchange. Local shares were converted into Global Depositary Receipts (GDRs) in London, and the fund began to generate solid returns,” Sawikin said.
At the same time, other companies included in the blue chip privatization program of the 1990s were never converted into the GDRs, and either never obtained a listing on a local exchange or were delisted. “We got stuck with shares of a couple of companies with very significant governance problems; KazChrom, an ENRC susbsidiary, being one of them,” said Sawikin. “Others, such as Kazakhmys, we bought and sold and bought back and still managed to make a good return on our investments in these names. Several of the delisted companies that we still hold have become quite profitable. We hope that some of them will be re-listed eventually. Others we would like to sell when the time is right. We are a very patient investor. After 17 years in Kazakhstan, we have learned to be patient. It took several years for anything to happen, but when it did it was worth our while.”
Despite the profitability, frontier investing, including in Kazakhstan, presents some significant challenges.
“We have learned what works and what does not work in the country from our successes and failures,”Sawikin said. “Kazakhstan is not that dissimilar from other frontier markets we have invested in. You really need to understand who the important groups are, how they work together and with the state. And just like in many frontier markets, there is an uneven application of law and incentives structure.”
“The rule of law is not well established when it comes to protecting the interests of minority investors,” he continued. “Foreign investors in particular don’t always feel that they can enforce their rights in a court of law. We have been involved in numerous litigations, including several going on right now. For one, we want to be heard by the person(s) against whom we litigate. We also know that we have better chances of prevailing in the higher appeal courts [where] they apply the law more objectively. Generally, we have done well in larger companies where our interests are aligned with interests of majority shareholders.”
“Overall, our successful investments in Kazakhstan so far have more than paid for our failures there. It’s a very attractive market with huge potential and world-class assets. And despite all the talk of the corruption, we never experienced it first hand,” said Sawikin.
“Of course, Kazakhstan could do better. It’s still a society where the common belief is that business people can sit down and negotiate, but it does not work well when one side has the power and the other does not. Still, Kazakhstan is more advanced than, say, Russia in a number of ways. Its banking regulation is better than in Russia. We have never been asked for a bribe or considered paying a bribe. And, by the way, we have come across issues with the application of the rule of law pretty much in all the markets we have invested, and lost litigation in Latvia, Estonia and Romania. We have lost everywhere,” chuckled Sawikin. “It’s a part of frontier markets development. … We currently have $150 million invested in Kazakh equities and have been steadily adding to our Kazakhstan portfolio. It’s a very attractive market with huge potential and world-class assets. The country is well positioned from the growth perspective. Valuations are as attractive as in Russia, but the macro picture is a lot better.”
International Consilium, a Fort Lauderdale investment management company has a dedicated frontier markets fund with $200 million in assets under management (AUM) and has been investing in Kazakhstan since the late 1990s.
“We invested in sovereign and corporate debt (BTA Bank) in the late 1990s and early 2000s but have become a pure equities player in Kazakhstan since,” Jonathan Binder, portfolio manager for International Consilium, told EdgeKz. “Our current Kazakhstan exposure is limited just to one name, [Karaganda-based] Steppe Cement, and makes up about 5 percent of our frontier markets portfolio. We like the management and trust them. We don’t currently have exposure to Kazakhstan’s mining or banking sectors, largely because of our concerns for protection of minority shareholders coupled with corporate governance issues. It’s hard to summon enthusiasm for investing in a sector when the government controlled bank (BTA) defaulted on its debt obligations.”
“We do like Steppe Cement’s management,” remarks Sergey Dubin, an analyst with International Consilium. “I travelled to Karaganda to meet with them. They are competent, committed to the company and are genuinely interested in growth and increasing shareholder value. The company has low cost capacity and generates sufficient cash to pay dividends to its investors, always an attractive feature for an institutional or retail investor anywhere.It’s a story of structural growth of the cement market in the country and Steppe Cement is very well positioned to benefit from this growth.”
Brad Lindenbaum, portfolio manager at Neon Liberty Capital Management in New York City does not share Binder’s concerns for corporate governance issues in Kazakhstan. Neon Liberty focused on emerging and frontier markets and has $800 million assets under its management. “We have never experienced anything egregious with corporate governance in the country,” said Lindenbaum. “We have been investing in Kazakh London listed GDRs and locally listed companies for over seven years. Kazakh companies make up for about 2-3 percent of our portfolio and it has historically been around that number. We hold oil, telecom and banks. What else is there to own?”
What else? Enter Emil Milushev who manages a $40 million investment portfolio with the Almaty based Jazz Capital but is planning to launch a close-end real estate fund with his partners. “We want to offer a viable and attractive investment alternative to investors and at the moment there is no real estate investment vehicle in Kazakhstan.”
At the projected 25 percent internal rate of return over the course of 2.5-3 years, it certainly sounds like an attractive investment. Milushev and his partners hope to raise half of the targeted amount domestically and half-abroad. The fund will invest in developing land for residential construction in Aktau on the Caspian Sea.
“Banks are sitting on piles of underperforming loans and are not lending money to anyone. They often are not in a position to give you a loan because of tightened capital requirements. We expect to raise $20 million from our existing clients domestically and at least as much in New York or London by the end of the year,” said Milushev, who recently visited New York and had several preliminary meetings with potential investors. He is confident that the goal will be achieved and the fund will be launched by the end of 2014 or the beginning of 2015. He has built a solid client book and gained trust of his investors at home, and believes they will follow him to his next venture. After all, Milushev has made money for his clients by investing it in Kazakh and foreign stocks alike. Tesla, FB, Groupon and Google have all performed well and gained solid weight in his investment portfolio. His confidence is based on his track record and knowledge of the local real estate market. “The fund will be a successful investment vehicle,” Milushev predicted.
So with an understanding of the local market, its complexitiesand advantages, asset management and frontier investing in Kazakhstan is proving a challenging, yet profitable alternative.