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East Capital Russia Portfolio comments 4Q 2019 East Capital Russia East Capital Russia returned 12.7% in 4Q 2019, below the benchmark, which Strategy information returned 14.3%. The strong quarter capped off an excellent year for Russia, Launch date 18 May 1998 which was the best-performing market in the world in USD terms based on the Benchmark MSCI Russia 10/40 main index. East Capital Russia returned 43.7% in 2019, in line with our Number of holdings 37 benchmark index, which returned 43.8%. Active share 38.9% There were three major factors behind “Normandy format” summit since 2016 took Russia’s strong performance in 2019. Firstly, place, where Presidents Putin and Zelensky Performance* we saw a resurgent rouble, which returned met for the first time. We asked President 12% after a weak 2018 where it had sold off 17% Putin about the Ukraine relationship at an Strategy Index due to sanctions fears, which almost com- investor conference in November – he YTD 43.7% 43.8% pletely evaporated in 2019. This led to confirmed that the ball is now in Ukraine’s domestic names bouncing back from a very court; the key outstanding issues are elections 1yr rolling 43.7% 43.8% weak 2018. For example, our preferred in the Donbass region and the level of 3yr rolling 48.3% 43.4% retailer, X5, returned -32% in 2018 and 46% in autonomy that Donbass is subsequently given. 2019. The third specific factor was idiosyncrat- Any decision will require a huge amount of Since inception 2,333.8% 784.6% ic rerating stories. The most visible example political capital, and it is not clear what Mr *Gross of fees in USD. was Gazprom, which added USD 45bn to its Zelensky himself is prepared to do. However, market capitalisation. It returned 102% due to on a positive note, the countries agreed to a drastically increased dividend, a new prolong the gas transit agreement, which Top 5 holdings dividend policy and expectations of improv- removes a potentially significant risk for the ing corporate governance. The most remark- Russian market. Generally, the improving Strategy Index able example, however, was highly non-trans- relationship is positive for the region, and it Lukoil 9.2% 9.2% parent oil company Surgutneftegas, which also signifies the first steps in the potential returned 116%, purely on rumours that the removal of EU sanctions on Russia. Gazprom PJSC 8.7% 9.4% company will start to use its USD 50bn cash Sberbank 7.8% 7.4% pile, potentially to acquire a stake in competi- It is important to stress that in Russia, the tor Lukoil. bottom-up story also remained solid, with our Tatneft 6.8% 4.5% key active positions performing well across X5 Retail Group 6.6% 4.4% On the macro side, 2019 confirmed our the board. For example, leading children’s long-held thesis that the Russian economy is retailer Detsky Mir grew 3Q 2019 revenues by one of the most stable globally, albeit 19.3%, driven by a 64.5% increase in online unexciting, with GDP growth expected to be sales. The company carried out a welcome Top 5 sectors around 1.3% for 2019, accelerating to 2.0% in SPO in November, with the improving 2020. We expect a budget surplus of around liquidity driving interest in the stock, which Strategy Index 1.9% for 2019, with a current account surplus returned 23.9% in the period. The company of around 5%. This “twin surplus” is very rare still offers an 11% dividend yield for 2020, Energy 30.8% 42.4% globally, and one of the main pillars of the which is fairly unique given its growth profile. Materials 18.9% 28.3% Russian investment case. Inflation finished up Financials 14.5% 11.9% 3.0% y-o-y for December, well below the Our largest overweight name, tech company central bank’s target of 4%. This allowed Yandex, fully resolved its issues with the state. Communication Services 12.6% 4.8% 150bps of rate cuts in the year, and we expect The government’s concern that the stake of Consumer Staples 7.1% 8.9% at least another 50bps in 2020. As a result of the founder (who owned a majority voting this, and falling debt costs globally, corporate stake together with other Yandex employees) debt costs came down considerably. The might fall into foreign hands was resolved reduction in the discount rate that this implies through the creation of a public interest can explain at least 14% of the total return of foundation. The foundation will have golden the market. share and veto rights over certain transac- tions representing more than 10% of the On the geopolitical front, we saw material company’s economic or voting rights. Q3 improvements in Russia’s relationship with results confirmed that these discussions Ukraine, as newly-elected President Zelensky hadn’t impacted the fundamental perfor- committed to work on ending the conflict in mance, with revenues up 37% y-o-y, and Eastern Ukraine. In December, the first revenue guidance for 2019 upgraded for Strategy performance gross of fees in USD. This document is for professional investors only (as defi ned under the MiFID II Directive) investing for their own account (including management companies (fund of funds) and professional clients investing on behalf of their discretionary clients). Not to be distributed to the public. Portfolio comments 4Q 2019 East Capital Russia -3.4% a second time, to 36-38%. In addition to the Yandex.taxi IPO, which is due in 2020, we It is remarkable that despite the strong 2019 performance, the market expect that the market will start valuing the company’s other overlooked subsidiaries, trades at a forward dividend yield of around 7%, with many of our key such as self-driving cars. The stock returned holdings still paying double-digit yields, supported by equally strong 24.2% in the period. free cash flow generation. Our largest alpha attributor for the year was Tatneft, which returned another 27% in Q4. The main reason for the alpha creation is that we only own the preferred shares, which at We also continued our engagement with around 7%, with many of our key holdings the start of the year traded at a 30% discount Tatneft regarding a more balanced board. In still paying double-digit yields, supported by to the ordinary shares, which are in the October, the company appointed one of the equally strong free cash flow generation. benchmark. We thought this wasn’t reason- existing independent directors as head of Something we are focusing on in 2020 is local able, especially as the shares receive the same climate change issues, something that is a investment flows. With nominal deposit rates dividend. Moreover, we had much higher first for Russia and will hopefully be an around 4% for most liquid accounts and 1-year dividend expectations than the market. This example that other energy companies will Russian treasury yields at 5.4%, the incentive played out well during the year, as the follow. We plan to meet this director early in for the USD 400bn in retail and pension discount reduced to below 4%, and the 2020 to better understand his approach and savings to move into equities is increasing. preferred names returned 88.9% in the year, experience with climate issues. Anecdotally, we hear stories of local funds generating 3.7% of alpha. Remarkably, the receiving millions of dollars of inflows daily, name still trades at an 11% dividend for 2020. During the quarter, our main trades involved something we expect to see accelerate going adding high dividend players, as yield is a into 2020. We expect that the high yielding, It was another busy quarter for us on the theme we expect will be in focus in 1H 2020. liquid names are likely to be the main engagement front. We met 43 Russian This included communications company beneficiary of these flows, and this is companies and 10 government officials. MTS, which pays around 11% in dividends, something we have reflected in our position- Sustainability issues featured in most of these supported by FCF, and Halyk Bank, a ing going into 2020. meetings, with companies themselves high-quality Kazakh bank, which offers a interested in understanding our approach minimum 10% dividend yield for 2019, rising and expectations. We initiated a priority to 15% in 2020. There is further upside if they engagement with X5 by highlighting our manage to convince bondholders to pay out expectations regarding single-use plastics more than 50% of net profit already for 2019. directly to the board. We recommended that We financed these trades by reducing the company sets tangible metric targets for a lower-yielding names, and by trimming our reduction in single-use plastics, focussing on retail exposure, as we expect 1H 2020 will be plastic bags to start with, and we provided a challenging period for the sector due to examples of what we see as best-in-class exceptionally low food inflation, pressuring global examples. The impact of such a change like-for-like sales numbers. would be considerable given that the company enjoys over 5 billion store visits a Going forward, we maintain our high level of year. The company responded that they will conviction for Russia. It is remarkable that consider our proposals as part of the detailed despite the strong 2019 performance, the plastics policy they are working on. market trades at a forward dividend yield of Important information: Every eff ort has been made to ensure the accuracy of the information in this document but it may be based on unaudited or unverifi ed fi gures or sources.
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