Russia has more to offer than oil, says Charlemagne Capital

Julian Mayo is London-based co-chief investment officer at Charlemagne Capital, an emerging-markets asset manager that invests in three regions: Eastern Europe, Russia and Turkey. The firm has $3 billion in assets under management and runs three funds: Manulife Global Fund Emerging Eastern Europe (up 65.55% from January to October 31), MGF Russia Equity (up 69.61%) and MGF Turkey Equity (up 99.7%).

Before joining Charlemagne Capital, Mayo was with the Regent Pacific Group both in Hong Kong, as managing director for Asian portfolio management, and in London. Prior to that he spent 11 years with Thornton Investment Management (now part of Allianz Global Investors) in Hong Kong, Tokyo (where he opened Thornton's office), and London.

Mayo began his investment management career in Hong Kong with Schroders Asia in 1983.

What have capital flows been like for your fund in recent months, and why?

Flows have been positive based on the recovery in the market. There's an increased feeling that risk appetite has returned to market, notwithstanding the last few days of November [immediately after news of the Dubai debt crisis broke on November 26]. If you compare credit spreads in the region with six to 12 months ago, then markets do warrant a rebound.

Russian government bond 30-year yields had been around 5-6% since before 2006, then they spiked up to 13% in October last year, and now [in early December] they're back to around 6%. So the risk-free rate is back to where it was pre-crisis, as spreads have narrowed again. Turkey is also back to pre-crisis corporate CDS spreads of under 200 basis points, after spiking as high as 500bp post-Lehman last year.

Emerging markets are priced more tightly than US corporate debt now, which is justifiable. There is a feeling that emerging markets are the longer-tem place to be, because of the structural problems in developed markets.

If you're based in Asia, you're sitting on the doorstep of the world's most exciting markets. But you can also diversify. If I were based in Hong Kong, I'd put most of my investments in Asia, but would look to have some elsewhere too. Russia is a logical destination [for investment], for example, because it has what China needs.

Admittedly, if Hong Kong were my home base, I may not want to put my money in the US and Europe at the moment; you shouldn't diversify for sake of diversification. But where there are equal opportunities you should do -- and opportunities in Russia are in many ways as attractive as those in China.  

What are the benefits of investing in Russia at present and what kind of assets are you holding there?

Russia clearly benefits from its commodities, but there is also a diverse opportunity set both within its resources and beyond that.

We have funds in Gazprom, Lukoil and Rosneft, the big energy companies -- our biggest Russian fund investments are in those companies. And we have a stake in the third largest gold producer in Russia, Petropavlovsk.

We also have investments in Sberbank, the biggest bank in Russia by assets and loans, which with a price-to-book ratio of around 1x is one of the cheapest banks in world. The 2009 emerging-market average PBR for banks and financial firms is 2x. Sberbank is very conservatively financed and is increasing its market share in Russia.

There are also many smaller businesses -- for example in the IT services sector -- where we have exposure, plus in the mobile phone sector and in port operators, such as Novorossiysk. And any investment in Russia wouldn't be complete without a stake in vodka-related assets -- we have a holding in Synergy, the second biggest vodka producer in the country.

All these are 1%-plus stakes, and all the stocks are reasonably liquid, so are good long-term investments.

Another benefit of the RTS stock market it is still trading at a 40% discount to its all-time high in 2007 -- having fallen around 75% from the peak, before rising around 150% this year. Compared with Russian debt markets, equity is still very attractive.

And, even at $60 a barrel -- way below where it is now [around $75 in early December] -- Russia would still have a current-account surplus; it is not dependent on the oil price staying high, like the Middle Eastern economies.

And how about Turkey?

Turkey's a different economy, as a commodity consumer, but it still has diverse economy with good domestic-demand stories. [It has opportunities in the] financial sector, but also in discount retail -- that is, low-cost producers with high turnover -- and in the media and auto sectors.

It is also a market that has fallen sharply and where the currency has weakened, but has now started to strengthen again -- the MSCI Turkey index was down 64.6% in 2008, but was up 80.4% as of November 25.

They are two of the cheapest in the world from a price-earnings perspective, even when compared to Asian emerging markets.

How about elsewhere in the Eastern European region?

We also like central Asia, markets such as Kazakhstan, where we have investments. As in Russia, we hold gold-related assets there.

What should investors be wary of in any of the regions you've mentioned?

Global issues are always in the background. But Russia and Turkey are not heavily indebted like the UK or the US.

There are also some smaller countries -- like Hungary, which is 4% of our portfolio, plus Bulgaria, Estonia and Romania -- that one might be more wary of. But the latter three are not in our portfolio, as they are more stressed. And if Hungary goes bust, it's not a problem for Russia, but more for countries like Austria and others that lend to Hungary and other small Eastern European countries.

We also don't think there is a risk of contagion [for Russia and Turkey], as some people have talked about, following the emergence of the Dubai debt crisis emerging. None of the stocks we hold have exposure to Dubai in any direct way.

If oil were to drop below $60 a barrel, that would be an issue for Russia, but it is very unlikely.