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Portfolio > Economy & Markets

Julian Mayo of U.S. Global Eastern European Fund

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Quick Take: While investors remain wary of the volatile emerging markets, the performance of Russia and Eastern Europe cannot be denied. Julian Mayo, investment director of Charlemagne Capital Ltd., a London-based asset manager specializing in emerging markets, sees compelling reasons to invest in these blossoming countries.

For the one-year period ended in March, the $222-million US Global:Eastern European Fund (EUROX), subadvised by Mayo’s firm, soared 109.9%, versus a robust 77.1% for the average regional market/emerging market portfolio. For the three-year period, the fund gained an average annualized 48.8%, versus 16.7% for the peer group. Andrew Wiles and Stefan Bottcher serve as the fund’s portfolio managers. Charlemagne has overseen the fund since its inception in March 1997.

Though the portfolio has exhibited somewhat lower volatility than its peers over the past three years, risks still remain. The fund invests only in a handful of transitional countries that can still be subject to political risk and market selloffs. As a result, it behaves differently than a diversified Europe or emerging markets portfolio. While performance has been impressive, turnover is significantly higher than the competition, and expenses run at 2.90%, versus 2.13% for its peers.

The Full Interview:

S&P: Can you describe your stock selection process?

MAYO: We are bottom-up stock pickers with heavy emphasis on fundamental analysis and risk-reward profiles. Although there are thousands of public companies trading in Eastern Europe and Russia, the universe of stocks that can be invested in is considerably smaller, given the illiquidity of many equities. We select stocks from a pool of about 150 names.

We are primarily value investors. We like buying stocks that are trading at a 30% to 40% discount to full value. We visit companies in the fund four times a year. The bulk of our investments are in Russia, Hungary, Poland and the Czech Republic. We consider macroeconomic factors, including currency rates, GDP growth, interest rates, and political stability.

S&P: When do you sell a stock?

MAYO: We typically sell or trim back a holding when we think its price has reached full value. We will likely dispose of a stock entirely when its fundamentals deteriorate, or something happens to invalidate our original investment premise.

S&P: What are your largest holdings?

MAYO: As of March 31, our top ten holdings are Cesky Telecom A.S., the principal telecommunications operator in the Czech Republic, 6.8%; CEZ AS, a Czech electricity generation company, 6.7%; JSC MMC Norilsk Nickel, a Russian nickel mining firm, 6.5%; Sberbank RF, a Russian savings bank, 5.9%; OTP Bank Rt., the largest retail bank in Hungary, 4.8%; Bank Austria Creditanstalt AG, an Austrian bank, 4.4%; Vimpel Communications (VIP), a Russian wireless telecommunications provider, 4.3%; Mobile TeleSystems OJSC (MBT), a Russian mobile cellular communications services provider, 4.2%; Sibneft, a Russian integrated oil producer, 4.1%; and Sibir Energy PLC, a U.K.-listed oil and gas company with all of its operations in Russia, 4.0%.

These ten holdings represent almost 52% of the fund’s assets. They reflect our willingness to place big bets on our favorite picks.

S&P: What are your top sectors?

MAYO: As of March 31, our top industries were integrated telecom, 12.4%; diversified financial services, 11.8%; banks, 10.9%; integrated oil & gas, 10.6%; metals & mining, 9.5%; wireless telecom services, 8.4%; oil & gas exploration & production, 7.1%; electric utilities, 6.6%; and consumer finance, 5.9%.

S&P: What are your top countries?

MAYO: As of March 31: Russia, 43.5%; Czech Republic, 16.4%; Poland, 11.3%; and Hungary, 6.7%.

The fund is typically highly diversified by sector and country, but these are purely a residual effect of our bottom-up stock-selection process. We don’t impose any limits on our allocations. In fact, the fund is deliberately run with a high tracking error relative to the market.

S&P: What makes Russia an attractive place to invest?

MAYO: Russian companies, like gas producer Gazprom, are increasingly enacting structural reforms. Russia enjoys strong macroeconomics. For example, GDP is expected to grow 5% in 2004, and in 2005. Inflation is expected to decline to 11% this year, and 9% the next. Despite huge gains in recent years, Russian equities remain undervalued relative to their Western counterparts — some on the order of 30% to 50%.

S&P: Is your Russian exposure primarily tied to oil companies?

MAYO: No. In fact, we are underweight in Russian oil and commodity stocks. We cut back in names like Lukoil since we felt the valuation was too stretched. Though strength of the Russian economy is heavily dependent on high oil/commodity prices, there are other sectors we are excited about, including banking and telecommunications.

Ironically, the continued high price of oil could actually hinder the development of the remainder of the economy because the currency will remain too strong. We hope the price of oil gradually returns to more normalized levels, allowing other segments of the Russian economy to become more competitive.

S&P: What about liquidity and corporate governance in Russia?

MAYO: Liquidity is actually more of a problem in Central Europe than in Russia, where it is improving. Corporate governance remains a significant concern in Russia, as exemplified by last year’s arrest of the head of Yukos, the oil giant. However, outside of the oil industry, corporate governance is getting better.

S&P: What are some of your favorite Russian stocks?

MAYO: Russia has a relatively low level of mobile phone penetration compared to other countries with similar GDP. Vimpelcom and Mobile Telesystems, which are already growing 30% to 40% annually, are in a very good position to deliver further growth and profitability over the next couple of years.

Sberbank is Russia’s principal savings bank, and will benefit from a potential increase of lending in the country. The Russian economy is still under-banked, and the consumer loan business is just getting started. The company’s balance sheet can increase enormously in the coming years. The stock remains very cheap compared to Western banks.

S&P: How will convergence with the European Union benefit Central and Eastern European economies?

MAYO: When Portugal, Spain and Greece joined the EU, they all underwent economic improvements, sharp gains in stock prices, and declines in interest rates. We think the same benefits will accrue to the ten new entrants. Convergence, we believe, will lead not only to GDP growth, but also declining inflation and attractive stock returns.

However, not all industries in Eastern Europe stand to profit from convergence. Banks, with access to cheaper finance, will benefit, but export businesses and manufacturers may be hurt by increased competition.

S&P: What is your outlook for Eastern European/Russian markets?

MAYO: Stocks in these areas remain cheap relative to the more developed economies, and we see much room for further upside. However, we probably won’t see the magnitude of high returns as in recent years.


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