Balkan Emerging Frontiers Fund September Investment Commentary


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Following noticeable growth in June and July, value of indices of large stock exchanges in developed countries (MSCI World Index, measured in EUR) have on average not changed much (-0.06%) in August, while monthly value of indices in large emerging markets (MSCI World Emerging Markets Index) decreased for 2.83%.
Stock markets in Balkan Emerging Frontier Fund’s investment region have moved variously in August. The largest decrease of 1.82% was marked by Ljubljana Stock Exchange Index SBITOP while largest 3.31% growth was marked by Macedonian Stock Exchange Index MBI10. In same period BEF Fund has made positive monthly net return of 1.03% for you and thus the return in 25 months, since start of investing, sums to 53.38%.

Recent decisions of US’ Federal Reserve System (FED) and European Central Bank (ECB) had strong impact on financial world. FED announced new round of quantitative easing), while ECB agreed on unlimited buying of bonds of euro zone’s countries in trouble. Of great importance are also the outlooks of banking unions in Europe and Germany’s highest court decision on clearing the way for the permanent European Stability Mechanism to go ahead. Consequences of these decisions will be more money available globally, even lower interest rates and better financial stability of Europe. As we have already stated in our previous newsletters, larger amount of money circulating combined with low interest rates (already being at record low rates, as shown it attached EURIBOR movement chart) in certain time span always bring higher prices of stocks and other financial assets. FED’s chairman Ben Bernanke publicly stated that the main goal of their actions is to increase the value of financial assets.
Due to present fear and uncertain sentiment on the market the money is mainly still out of use on stock markets. However, once the craze is over and the money will again start to increasingly circulate, the price of stock shares will increase. We are certain that as long as central banks will flood the markets with relatively inexpensive money (for which we believe is at the moment and will be for some time the least bad alternative for solving present non-liquidity situation), the global stock exchanges will rise, amid minor corrections are possible. General stock price growth is all the more obvious to us, as there are still a lot of skeptics on the market holding majority of their wealth in bank deposits or bonds and thus having additional money available to spillover to stock markets. Even more so as multinational companies are in possession of record levels of money and with gradual fear decreasing, substantial increase of large acquisitions and mergers are expected. Higher demand naturally leads to higher prices. From historical perspective, monetary policies of central banks are on average followed by reaction of global stock exchange markets with three to six months delay. Increase of money circulating in EMU will definitely have a positive effect also on BEF Fund’s investment region, as majority of banking system in the region is owned by the banks from euro zone.

Stock shares on Frontier markets are on average still traded with 50% discount comparing to large global markets, while in BEF Fund’s investment region the discounts are even larger. Lately more and more investors are identifying this extreme investment potential, based not only on this discounts, but also on the fact that countries in these markets have much more growth potential than developed economies (iShares, the largest global provider of ETFs launched first ETF focused exclusively on Frontier market). This year some of these markets have experienced two digit growths, being much steeper than growth in large emerging markets. Stock Exchange indices of Turkey and Romania have thus grown for 25%, while indices in Pakistan and Egypt grew for more than 30% in 2012 so far. Considering noticeable price growth of stock shares in Turkey and Romania, we can see that capital inflow is nearing Western Balkans. Now it is only a question of time when this growth will move also to BEF Fund’s investment region. It is impossible to predict exactly when the growth will start, but once it does, it might soon be too late to reap the outstanding returns, as shown by past experiences. Due to current low liquidity and large appreciation of local currencies in the region and presently still favourable valuation of stock shares, the market will rapidly grow by 50% – 100%, before majority of potential investors get aware of it and properly react. Historical view of stock exchange markets, as clearly demonstrated in numerous cases, shows that the longer the stock market was declining, the larger was then the growth, once it gets going.

As majority of the investors are still focused only on short term returns, there will be (as usual) higher midterm returns by the investments that currently do not have much market attention. Majority of those targeting investments that have already grown might end up with inferior or even negative returns. Please find attached link on article about time horizon and catching »the opportune moment« with investments: »Long-Term Investing in a Short-Term World«.
For already some time we are expecting a wave of privatization of companies in Slovenia and the rest of region. Slovenia simply needs the money and so do the (government owned) banks, full of seized shares. Sales are inevitable. Situation is pretty much similar in other countries of ex-Yugoslavia. There have indeed not been so much leveraged MBOs that failed in the last stock stampede as in Slovenia, but these countries need additional money even more severely than Slovenia. We should mention here, that these countries are under pressure of International Monetary Fund and World Bank that helped them with loans, but now they call for privatization of countries’ assets.

In our view, most probable trigger event for start of growth in a region will be a large takeover or series of mid to large takeovers, similar as it happened in 2001 after takeover of Lek (part of Sandoz group now) in Slovenia, when large growth on Slovenian Stock Exchange started, followed by growth on other regional Stock Exchanges, even though global crisis was present after dot-com bubble burst in 2000. Actually such small to midsize takeovers are already taking place (Etol, Fructal, Droga-Kolinska) in Slovenia. We are certain that larger companies will be also sold-off soon.
Croatia will be full member of the EU on July 1st 2013, less than 9 months from now. Bearing in mind the development of events on Romanian and Bulgarian stock Exchanges at their inclusion to EU five years ago, it is highly probable that the Croatian (Zagreb) Stock Exchange will also experience substantial inflows of foreign investments prior and after the accession (country would become more visible on the investment horizon) increasing the value of local stocks significantly. Stock prices on Exchanges in Bucharest and Sofia have marked large growth already in months before both countries entered EU. Even the prices being pretty high at the time of accession to EU they have later grew further on substantially, sometimes to absurd high levels. We see Croatia’s inclusion in EU as a positive signal of European perspective for the whole region, as in midsummer Montenegro also started EU negotiation process. CEO of Erste Group has recently stated that Western Balkans is a group of countries with good prospects in the five decades ahead.

Even though most foreign portfolio investments will would initially come to Slovenia due to takeovers or to Croatia due to effects of country’s accession to EU, we expect that when it spillover of the money comes to countries south of Croatia, its effect on the value of stocks to be even larger. Main reason: stock valuation and liquidity on other regional Exchanges are even lower than in Slovenia and Croatia and any larger inflow of money will increase stock values stronger. It should also not be forgotten that the final strong growth of Balkan financial markets before the financial crisis was contributed mainly by Croatian investors. The growths began by investments from Slovenia, while for the larger part of the extreme growth at the end of 2006 and in beginning of 2007 cash flows from Croatian investors are liable, partially directly from Croatia and partially indirectly via Austrian and other foreign banks. Once the Croatian market will rise again, local investors will be once more looking for investment opportunities in the neighbourhood, with the viewpoint: “What has not risen yet?”.
As mentioned previously, after successful implementation of Montenegrin regulation on privatization investment funds at the end of last year we have stimulated and financed formation of ‘Association of shareholders of privatization investment funds in Republika Srpska’ in order to foster process of transformation of former privatization investment funds and to see to its best implementation. Foundation of association and other beginning costs were financed by BEF Fund’s Investment Manager company (not from the Fund’s assets) with goal of maximizing value of the Fund’s investment in these privatization investment funds in Republika Srpska (RS) and indirectly also in Federation of Bosnia and Herzegovina (FBIH), as we believe that regulation that will be accepted in RS will be similarly implemented also in FBiH. Association has been actively involved in preparation of new regulation. We evaluate the new act proposal that was already publicly presented as very good for BEF Fund and other minority shareholders.

We firmly believe that shares in this privatization investment funds offer one of the best investment opportunities, as they are quoted with large discounts (on average 35 % – 40% on NAV) on already undervalued assets in their portfolios. Hence they offer multiplying return potential, as in the future they will be quoted with lesser discounts on higher asset values. For the same reason they are also less risky than usual stock investment mainly for two reasons: 1. Risk is spread on large number of investments in their portfolio and 2. Regulation by Securities Commissions.
Our recap of the newsletter: Stock Exchanges in countries of former Yugoslavia certainly offer one of best investment potentials in the world, due to presently low liquidity and stock prices lagging most behind the whole world. It is the last region to enter EU in coming years and will thus attract a lot of globally released investment funds which will in turn have positive effects on the price of regional development and extensive rise of stock shares prices.
By the time everybody figures that out, it might be too late for them, while you will already reap superb returns.
Kind regards,
Your Balkan Emerging Frontiers Fund

Telefon/fax +41 22 518 02 39

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