How Russia-focused Balchug Capital kept a cool head as markets “overreacted” to pandemic

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Russian specialist Balchug Capital has navigated a path through the pandemic crisis by believing in the fundamental value of its “best ideas” emerging markets-focused equities positions, according to founder David Amaryan.

“We hardly sold any of the positions that we had going into the crisis,” says Amaryan, whose flagship fund holds many names in the dominant oil and gas sector in Russia.

Moscow-based Balchug Capital manages around USD250 million in assets for mostly high net worth and family office investors, and has invested in event-driven  and value situations with a focus on Russian and other emerging market equities since its foundation in 2009.

“We started reducing our exposure to equities in January and late December, as we were getting uneasy with valuations, so we entered the market with about eight or nine positions which we believed in. The companies we held had strong balance sheets, so there was no risk of a serious decline. Even if they went down 20 or 30 per cent, we viewed this as only temporary,” Amaryan explains.

Amaryan started his investment management career at AllianceBernstein in New York, later joining Citigroup in Moscow in 2004, and then moving to Russian investment bank Troika Dialog the following year, where he developed and managed investment products for its high net worth clients.

With Russia now reporting the third highest total cases of Covid-19 across the world, Amaryan says that the company’s enthusiasm for Russia hasn’t changed.

“I think that we view Russia with a little more optimism than foreign hedge funds focusing on Russia. The reason is that Russian companies are better prepared for the crisis than most people believe – most companies people here have been in crisis mode since 2014,” says Amaryan.

Having suffered recurring crises in 2008 and 2014, Russia has built up large liquid reserves to protect against future volatility and potential sanctions. This means that the country has so far been able to cope better with the latest crisis than others.

“Russian companies are used to lack of cheap liquidity, which means they have accumulated significant reserves. Going through the last several crises has significantly improved their efficiency.”

The biggest losers of the pandemic crisis worldwide have so far been the transport and travel sectors, as country-wide lockdowns have stopped people travelling. Amaryan notes that services and tourism is not as important for the Russian economy as it is for many developed countries, and that the biggest damage has so far been dealt to SMEs, which represent a much smaller segment of Russia’s economy. Since Russia is dominated by large, state-owned companies, Amaryan says that these firms will likely receive government support.

Despite negative oil prices in March, Balchug continued to hold many of its historic positions, “which are the ones we really like”, including in Russian oil major Tatneft, which Balchug has held for four years thanks to a robust dividend yield.

On average, Amaryan says the fund tends to hold positions for a year to a year-and-a-half.
“We don’t usually make fast decisions,” he explains. “Generally, we like to be very concentrated and hold up to 15 positions at one time, and this is because we want to concentrate on our best ideas.” 

Balchug manages the risks of such a concentrated portfolio by keeping its event-driven positions between four to six in number, while holding the rest in value situations that pay high dividends.

Nevertheless, volatility means opportunity, and Balchug grabbed some opportunistic success in March when it shorted global casinos exposed to Macau. Amaryan says Balchug did this “immediately once we started seeing issues in China, before it had got to Europe and US”, realising that the tourism and entertainment businesses would get hurt, and closed these shorts within a month with 60 to 70 per cent profit.

But Amaryan cautions investors against the risks of passive investing, and says that the world is entering times where active managers can really prove their worth: “The next 10 years will be the years when active managers should be doing better than passives, especially in Russia, which is less efficient compared to developed markets. Even more so now, I believe that this is not a moment when you would buy a broad ETF or an index. I would say there has been a market overreaction globally.”

And not all active managers will be immune, since, as Amaryan says, many portfolios run the risk of being “over-diversified”: “If you hold over 50 different assets, I would consider this over-diversified. You can’t call yourself an active manager and charge the fees if you do this – you should be honest with your investors and tell them to just buy the index.”

Amaryan concludes that Russia’s equity market, which pays some of the highest dividends among the emerging markets, will continue to attract cash from investors after the crisis abates.

“Even before this crisis, Russia was undervalued – there is definitely more room for it to grow. I think that this is what we saw last year, and we will continue to see the pattern this year, of more domestic investors paying attention to our equity market. This is because the bond yields are coming down, and bank deposits are going down, and so we have already seen pension funds and institutions are switching from government bonds in Russia to equities.”