Ignis International HEXAM Emerging Europe Fund outstrips peers

The Ignis International HEXAM Emerging Europe Fund has been the top-performing fund in its sector this year, returning 47.74% compared to a 13.96% average return for its peers.

Stuart Richards, manager of the fund, explains the drivers behind the strong performance.

"The portfolio only contains stocks in which we have high conviction. Within our three investment pillars of Russia, Turkey and Central Europe, we have the freedom to invest where we see the best opportunities and can move quickly to capture them. All our recent country and asset allocation bets have paid off, including the contrarian call to significantly overweight Russia, adding to our positions during the downturn. The fund has also remained fully invested throughout the recent crisis while most of its peers have held 5-10% cash."

Russia continues to thrive

The fund moved to a substantial overweight position in Russia in the fourth quarter of last year, a period in which some investment commentators claimed the country was ‘bust'. HEXAM believed the sell-off in certain stocks was indiscriminate and largely unjustified. Exposure to the country was, therefore, increased to approximately 10% overweight, having been 10% underweight earlier in 2008. Since its low point in October 2008, the MSCI Russia Index has risen 74%. "Relative returns suffered initially because positions were added during the turmoil but we have let those positions run this year, with little turnover in the portfolio, and have made significant profits," explains Richards.

Commodity supercycle remains intact

The fund is slightly more cautious following the recent strong rally but remains positive on the market, particularly given the commodity story. At the sector level, the decision to move significantly overweight in commodity stocks, predominantly in Russia and Kazakhstan, has been particularly positive for performance. Oil and copper suffered indiscriminate selling in the final months of 2008 but have since rallied, with crude oil breaking the $60 a barrel level in May. "Perhaps we moved a little too early but we knew the strength of these companies' balance sheets; that they could withstand the credit market freeze and that they stood to gain in any turnaround," explains Richards.

Russia and China's reciprocal relationship

China has provided significant support to the commodity cycle and to emerging markets in general, with its ongoing loose monetary policy and fiscal spending. March data showed that new loans created totalled a staggering RMB1.9trn, bringing first quarter loan creation to almost 95% of the entire lending in 2008. This led analysts to upgrade GDP growth forecasts for the country back towards the critical 8% level for 2009 and boosting commodity prices.

"If you believe in the China growth story then you have to believe in Russia, as it is the latter that will provide the resources," says Richards. "It will continue to invest in infrastructure even if the rest of the world slows and that will significantly increase their share of global demand for oil, coal and metals."

Avoiding Central Europe

The fund retains a significant underweight position in Central Europe where the markets are more reliant on a pick-up in developed markets. "There is too much entanglement between developed market banks and Central European banks," says Richards. "With a large proportion of pre-crisis lending by banks conducted in euros rather than domestic currencies, volatility in emerging market currencies could lead to a high level of non-performing loans and defaults. The region still offers long term opportunities but near term returns could be higher elsewhere."

In contrast, the HEXAM fund retains significant exposure to banking in Turkey, which has relatively one of the strongest banking sectors in Europe. "Following the country's own crisis in 2001, the government brought in restrictions to prevent banks taking active currency positions, so all lending must now be matched by foreign exchange deposits and banks lend to local retailers in lira," explains Richards. "This provides valuable protection in the current conditions."

HEXAM's strategy has remained constant over recent months and portfolio turnover has, therefore, been low. "The fund is focused on stocks that were ‘oversold' but compelling, especially those that are linked to emerging market spending," says Richards. "We remain convinced of the strong long-term potential of emerging markets, especially on a two- to three-year view and on this basis valuations are currently very attractive."