Ukraine: Investing Where Others Fear To Tread

Via The Economist, an interesting look at the controversial strategy of a bargain-hunting international bond trader:

WHEN the second world war broke out, Sir John Templeton, one of the founding fathers of Franklin Templeton, a big asset manager, made a shrewd bet. Convinced that the best time to invest was “the point of maximum pessimism”, he bought stakes in every NYSE-listed company whose shares were selling at a dollar or less, including 34 that were in bankruptcy. In 1945, when the war finally ended, he sold them for a 400% profit.

Michael Hasenstab (pictured), who manages $190 billion of government debt for Franklin Templeton, is Templeton’s philosophical heir. Soft-spoken, measured and publicity-shy, Mr Hasenstab is the antithesis of “bond king” Bill Gross, but with an equally impressive record. The main fund he manages has returned 8% a year for the past decade, double the average for funds that invest in sovereign bonds.

Big, contrarian bets have become Mr Hasenstab’s trademark. Since 2010, he has been investing enthusiastically in Ukrainian government debt, and now owns $8.8 billion of the country’s $16 billion of international bonds. In April, as eastern Ukraine descended into war, Mr Hasenstab appeared in a promotional video from Kiev, touting the great potential of Ukraine’s economy. His funds are also the largest single investor in Ghanaian, Hungarian, Iraqi, Irish, Philippine, Sri Lankan and Uruguayan government debt, according to Ipreo, a market intelligence firm. Even the “safer” elements of his portfolio—big holdings of Malaysian, Mexican and South Korean debt—are relatively exotic.

Such bets can be lucrative. Over the course of 2011 Mr Hasenstab spent over $11 billion on Irish government bonds. The country had been downgraded to junk status amid fears of default; panicked investors were dumping their bonds, allowing Mr Hasenstab to buy at yields as high as 14%. Ireland’s skilled workers and lack of Greek-style civil unrest, he thought, would stand the country in good stead in the long run. And so they did: within 18 months he had earned well over a 50% return.

Mr Hasenstab argues that, with interest rates likely to start rising after a 30-year bull run in government debt, the only way to make money in bond markets will be to find other countries that the market is mispricing. So his international research team of 20, many of them with doctorates in economics, searches constantly for out-of-favour countries with hidden promise. They mostly ignore indices, benchmarks, ratings agencies and newspapers, focusing instead on data and first-hand research. Mr Hasenstab himself has visited 25 countries this year. Taking a long view is an essential part of the strategy: he asks investors to judge his performance over a minimum of three years.

Yet whereas Mr Hasenstab attributes his success to independent-mindedness, thoroughness and patience, others see it as moral hazard on a grand scale. His Irish investment, for instance, only did so well thanks to the country’s bail-out by the European Union and the IMF. In the same vein, he added to his holdings of Ghanaian bonds last year, despite a budget deficit of 10% of GDP, a weakening currency and a warning from the IMF that the country’s borrowing was unsustainable. The investment lost value until August, when the IMF announced that Ghana had requested a bail-out and prices jumped.

Ukraine is another spot where Templeton’s business and that of the IMF may be intertwined. Mr Hasenstab says he was initially attracted by Ukraine’s relatively low debt (below 40% of GDP when he started buying, in 2010), its vast agricultural potential and double-digit yields. He saw the turmoil that surrounded the ousting of Viktor Yanukovych earlier this year as an opportunity to buy on the cheap. “The universal consensus was that it was not going to work,” he says in his cheerleading video. Yet that is still the consensus, even after a rescue package from the IMF. The hryvnia has lost half its value against the dollar this year, Ukraine’s reserves are dwindling and the economy is contracting. Most observers assume another bail-out is only a matter of time.

Meanwhile, Templeton’s huge holdings of Ukrainian debt give it enormous influence. Some accuse it of delaying needed reforms by sparing the government a sobering debt strike. It could certainly precipitate a crisis by selling. It could also block any voluntary restructuring of Ukraine’s debts. “We don’t take political sides. We’re really all economists just looking at the macro side,” Mr Hasenstab says. Yet critics question whether that is possible when investing on such a scale.

Mr Hasenstab says of the IMF: “Their presence or lack of presence does not solely direct our investments.” His funds’ success does not hinge on a Ukrainian bail-out: his investments there make up only 4.5% of their holdings. He points out that he has done well in lots of places where the IMF was not involved at the time, including Hungary, Indonesia, Lithuania, Mexico and South Korea, and that he has avoided places where bail-outs seemed inevitable, such as Greece. He would certainly have no interest in precipitating a crisis, in that it would hurt his returns. And his funds always keep a big cushion of cash, to avoid forced sales if there are unexpected redemptions.

Mr Hasenstab says his critics are mainly vulture funds, jealous of his success. They are certainly inconsistent: another complaint is that his success derives in large part from propping up nasty regimes by buying their debt, which is hard to square with the notion that he is merely chasing bail-outs. But it is also hard to accept the idea that his returns are due solely to macroeconomic insight.

This entry was posted on Monday, December 1st, 2014 at 3:53 pm and is filed under Ukraine.  You can follow any responses to this entry through the RSS 2.0 feed.  Both comments and pings are currently closed. 

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