Sunday, 30 April 2017
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Apr 19 2013 | 2:10pm ET
Kazimir Partners, launched in 2002, was one of the first true hedge funds in Russia and a success story by any measure, generating roughly 450% for investors from inception to the end of 2008 when founding partner Dimitri Kryukov left the firm. A year later, Kryukov launched a new venture, Verno Capital, whose flagship fund—a long-biased, fundamental, long-short hedge fund—employs the same strategy that proved so lucrative at Kazimir.
Verno manages about $240 million and last year returned 16.7%. Kryukov spoke recently with FINalternatives about his new business, the sectors he's most excited about and the changes he's seen in the Russian capital markets since his early days as Credit Suisse First Boston's lone Russian analyst.
Tell me about your background.
I started working in the Russian capital markets in 1994, when I joined Credit Suisse First Boston as a research analyst. At the time, I was the first analyst for the bank to cover Russia, and that entailed doing pretty much everything. In 1995, I was among the group of professionals that left CSFB to start the new investment bank, Renaissance Capital, moving from equity research to equity trading and eventually becoming head of equity trading. I went through the Russian 1998 default and devaluation crisis, which was an interesting and expensive experience. I then spent a year trading the pro.p book for a Russian bank, which was a good transition for me to go from the sell side to the buy side. Then in 2002, together with a partner, we started Kazimir Partners, one of the first hedge funds in Russia.
We had a very strong focus on capital preservation, because while Russia is an extremely attractive market it is also very volatile. When we launched we had just gone through the 1998 crisis, when the major indices were down 80%-plus and the math in my head was pretty obvious: If you manage to preserve capital on the downside, if you manage to sidestep half of that volatility and you're down 40%, your job is substantially easier. The first 14 or 15 months we didn't have a down month and the market was all over the place.
We were lucky in that we started the business at the start of the very protracted emerging-markets bull market, and the RTS index went up by a big multiple between early 2002 and early 2008, when it peaked. But in 2008 the Russian index was down 72.5% and our fund was down about just under 40%—so we managed to preserve a lot of the capital on the downside and that helped us generate some pretty good returns.
Then I started Verno with the same premise: that, while there are a few Russian hedge funds, and some of them actually do trade like good hedge funds—as in, they short stocks and try to preserve capital—I still thought that we had done it better than anyone else.
And you run the same strategy as Kazimir?
Correct. And in addition to the hedge fund, at Verno we also run a long-only fund that aims to beat the Russian equities index.
So, how do you preserve capital in a volatile market?
One way is to get out of the market when the market starts falling a lot, and the second is to short something that will make you money on the downside. And we do both. We do allocate to cash aggressively at times of uncertainty and we do hedge by being short the indices and/or individual names, and thus generate positive returns on the downside to offset the losses, if any, on the long positions. And thirdly, we try to pick the stories for the long side that will perform well over the long-term.
Where do you currently see opportunity in the Russian market?
On the long side, we tend to analyze the individual stocks rather than looking at the sectors, although we look at the sectors sometimes to generate some themes. For instance, a couple of years ago we noted a number of positive macro developments in Russia when the ruble stabilized, the central bank started cutting interest rates and the real incomes of the population were rising. We took the view that this would be very supportive for the real estate market, so we looked at the universe of real estate stocks and made some allocations.
Right now, the ideas that we like are primarily the consumer-driven or the domestic-driven stories and/or some restructuring and improvements in corporate governance stories.
We like the telecom and internet space in Russia. The real story is the difference between voice traffic and data traffic. I met someone from the telecom industry today who said the penetration of smart phones in Russia is only at about 30%. Obviously, as that grows the demand for data traffic will increase and the cellular companies are very well-positioned to take advantage of that. Voice traffic in Russia is growing mid- to low-single-digits year to year, but data traffic is growing in excess of 25%. And that will continue to drive the growth, as smart phone penetration improves and as the companies invest more into infrastructure to capture this growing trend. And the Russian cellular companies pay a very attractive dividend yield of 6.5% to 7.5%, so you're being well-paid for waiting while this mobile internet trend unfolds.
How has the Russian market evolved since 1994?
My very first company was a steel mill in the center of Russia, and we at CFSB had a client who had a large stake. They arranged to meet me at the factory, they took me to the executive floor and they locked me in a room. Two guys came back and said, "Okay, who are you? Why are you here and what do you want?"
I was a 22-year-old analyst. I'm said, "I work for this bank. And we have a client who is a big shareholder in your company." And they said, "Yeah, right. You must work for our competitors. Now tell us what you want!" Eventually, we became friends, and we had some drinks after that, but that was the kind of reception that you would get at the average large Russian company back then.
Nowadays, Russian companies have an army of investor-relations people, report audited financials from the Big Four, management does roadshows in London and New York, there are independent directors on boards. The amount of disclosure and the level of corporate governance—even though people still complain about it—has come a very, very long way.
Secondly, market infrastructure and property rights. Back in 1994, we often had to send a person out to the regions with the paperwork and he went to the local registrar and had to wait in line, sometimes for days, to get the transactions registered and recorded. Back then, the biggest scare was records either disappearing or being corrupted in the share registry, in which case you would have lost your ownership of the assets. Now, you have a government-backed central depository with technology that ensures that this is not happening.
Back in 1994 the whole concept of the securities market was new. A lot of people forget, when they criticize Russia’s market infrastructure, the market is only about 20 years old and we've come a long way. That's not to say that everything is perfect, it's just that things are moving in the right direction and they're moving very fast.
What has not changed is that the Russian market still trades at a discount in relation to other markets globally, and that is something that I find puzzling. Many people say, "You guys are highly reliant on oil and gas." But that's not necessarily a bad thing, right? I view this as a good opportunity. I think this is a misprice that will go away at some stage and we will be here to benefit.
What has been the impact of the crisis in Europe on the Russian economy?
At the level of the real economy and the companies it's been relatively limited. There are a few companies that have assets in Europe and have suffered declining demand. And we are seeing to some extent the softening of the natural gas market which could be attributed to the economic slowdown. But I think the real impact is psychological. Worries about Europe and what happens to European debt have decreased investor’s risk appetite substantially, and therefore Russian assets have declined in value just because investors viewed them as relatively more risky. Capital has left Russia (along with other emerging markets) and gone into U.S. government bonds and the U.S. equity market.
What do you see as the advantage of being based in Moscow?
I strongly believe that people who invest in regional markets should invest with someone that is on the ground. The information flow advantage that you get is really invaluable. Just by being here, I can meet with companies on a regular basis, I have friends working at different companies and we exchange news and views—I can ask them what's happening with their competitors or consumers, how they're seeing the market develop, any government moves that could affect them.
At the same time, being local doesn’t prevent us from using the best Western standards in terms of compliance, documentation, checks and controls. We’re trying to provide the best of both worlds.