The discount on the Blackrock Emerging Europe investment trust is set to close over the next year as it approaches the end of a five-year period whereby investors can exit at NAV, but fund manager Sam Vecht warns they would risk doing so at the end of a “lost decade”.
The emerging and frontier markets manager, who reveals his own investible assets are solely in cash and his own funds, currently favours Greece and Russia as emerging Europe remains well below its all-time highs from October 2007.
The investment trust currently holds 60.4 per cent in Russia compared to 52.8 per cent in the MSCI Emerging Europe 10/40 index, while Greece accounts for 8.6 per cent of the portfolio, 3.5 per cent more than the index.
“I don’t know how many times we’ve hit all time highs in the FTSE or the Dow or the S&P this year,” Vecht says. In contrast it would take an “almighty rally” for emerging Europe to reach its pre-financial crisis peaks.
“It’s not like everything is disastrous in these countries. We’ve had a lost decade of performance,” Vecht says, pointing out this is true across emerging markets, but particularly so in Europe.
The fund has returned 22.1 per cent over the last year compared to 12.6 per cent in the index, but over five years it has only returned 2.7 per cent. The index has fared much worse losing 16.5 per cent over the period.
There is a five-year life on the investment trust, which allows investors to exit at NAV. “At that point one would think the discount that historically we’ve traded at should be removed for investors,” Vecht says, pointing out the current period ends in June 2018.
“Investors could get out if they wish to, but we think it would not be a good time to get out after this lost decade.” If the trust follows in the footsteps of the Blackrock Frontier Markets investment trust, which Vecht co-manages with Emily Fletcher, it will repeat the five-year life when the current period expires.
‘Greece is the word’
The investment trust is feeling positive that Greece will reach an agreement with creditors. “If that’s the case, going back to earlier discussions, Greece is trading far too cheap. There could potentially be significant upside,” says investment trust director Chris Colunga.
The fund takes a top-down bottom-up allocation, Vecht explains, adding that he is more likely to focus on the former in a bull market and in more developed economies.
“Correlations increase in a bear market and therefore one has to be more top down.
“Secondly, as countries develop you can afford to be more bottom up. In a country like Poland, which is arguably more developed than Turkey or Russia, one can afford to be more bottom up.”
The trust will up its allocation to Greece depending on the individual stocks it can find.
“There are quite a range of companies listed in Greece. You’ve got banks, you’ve got a lottery operator, you’ve got a telecom, a utility, you’ve got a Unilever-type company we saw there, consumer discretionary, retailers. At the right price and with the right risk-return profile I think all of those would be under consideration.”
Even in the face of a strong euro, salaries in manufacturing have fallen so much that one company the investment trust met with was moving jobs from Romania to Greece.
Vecht defends investing in countries like Russia and Turkey despite concerns about the regimes currently in power.
“Our job is to look for interesting investment opportunities in a moral and legal way. The fact that I may not happen to like the politics of Donald Trump does not mean I should stop investing in the United States if that were my mandate.
“The same fiduciary duty applies whether or not I personally like Tayyip Erdogan or Vladimar Putin.”
Stewardship of the Russian economy, Vecht argues, is among the most orthodox going as sanctions and the oil price force discipline.
“Russian bond yields have been going down very nicely and steadily. Inflation has been falling very nicely and steadily.
“The Russians reacted in the right way to an external shock. That external shock being the oil price halving. They let the pain be taken through the currency.”
Money where his mouth is
Emerging Europe should be part of a “calorie-controlled diet” and Vecht says he wouldn’t recommend anyone have 100 per cent of their wealth in the region, although he says that all shares he owns are in his own investment trusts.
“I have a very diversified portfolio that goes as follows: I have some cash, I have a house, which I have a mortgage on, and the rest of my entire wealth is invested in my own funds. I have no other investments,” Vecht says.
The fund manager argues long-term risk-reward in emerging Europe is superior to many other parts of the world.
The forward P/E ratio is 8.1 in the MSCI Emerging Europe index, compared to 12.5 in the Emerging Markets index and 17.3 in the MSCI World.
Vecht says “free money” in developed markets has pushed people up the risk curve and down the liquidity curve without fully appreciating the risks.
“I also find it funny when people think they should have 90 per cent of their wealth in the US and UK. That’s an equally strange asset allocation decision just because it happens to be part of some arbitrary benchmark.”