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A Russian Nightmare

Posted by Red Notice
on 05 Feb 2015 | 0 comments
Tagged in: Red Notice, Sergei Magnitsky, Hermitage

By Sam Dale, HFM Week, 5-11th February 2015

Hedge fund manager turned human rights campaigner Bill Browder wanrs that too few managers factor in physical risk alongside financial calculations

Bill Browder has been talking for almost half an hour about an ordeal that has turned him from high-profile hedge fund manager to human rights activist. In an interview with HFMWeek, the 50-year-old American-born British citizen explains how he has become, in his view, one of Russian president Vladimir Putin’s biggest enemies.

In the early 1990s, as an ambitious emerging markets trader in London working for investment bank Salomon

Brothers, he saw huge opportunities in post-Soviet Union Russia. After successfully trading in the region for Salomon, he could sense the huge rewards on offer at a time when much of the country’s industries were being de-nationalised and in 1996 he co-founded Hermitage Capital Management.

The fund had its ups and downs – including losing $900m in the economic crisis of 1998 – but it tapped into post-communist privatisations and swelled to $4.5bn. Browder and his clients made hundreds of millions of dollars. Everything changed in the early 2000s when Browder started criticising rampant corruption in the companies he invested in. He earned the wrath of the Russian state, which ultimately led to his visa being revoked in 2005.

Browder’s Russia-based offices were then raided by police who seized documents they said were being used to orchestrate an alleged $230m tax rebate fraud. Browder’s lawyer Sergei Magnitsky was enlisted to fight the tax fraud allegations on Hermitage’s behalf. When he testified against the officials involved in 2008, he was then arrested by the same officials and tortured for 11 months by Russian authorities before dying in a prison cell.

The Kremlin has refused to investigate the death and instead tried and convicted Magnitsky of tax fraud posthumously, alongside Browder who was sentenced to nine years in absentia. Russia has made repeated attempts to extradite Browder with Interpol rejecting the latest effort just two weeks ago. Magnitsky’s death profoundly affected Browder, who felt responsible for putting him in harm’s way, and he began a campaign to bring his killers to justice. Browder says he lives with the constant threat that the Russian authorities will try to kill him or other Hermitage employees.

“The human body doesn’t have the ability to live in constant fear,” Browder says. “You grow used to it and then it is no longer fear anymore. There is a realisation that you have to be more careful than other people. You have to look at situations differently.”

His book, Red Notice: How I Became Putin’s Enemy Number One, is published this week. It reads like a spy novel as Browder is subject to trumped-up charges and sinister threats, and his colleagues’ lives are put in jeopardy.

It has been banned in Russia. It is little surprise that Browder is in talks with Hollywood directors and actors about making it into a film. His campaign has been extraordinarily successful, with the US Magnitsky Law passed in Washington in 2012 to impose restrictions on those suspected of Magnitsky’s murder and other human rights abusers.

Browder says his journey should be a cautionary tale for other hedge fund managers looking to make their fortunes in certain emerging markets.

“The one lesson for managers, in my experience, is that the risk goes beyond financial risk,” he says. “The risk can be a physical risk for yourself and your people as it was for Sergei Magnitsky and me. This is not just a virtual game of moving pieces around on a board. It is very real.”

Despite his own personal financial success in Russia, Browder says certain emerging markets with weak and unstable political structures are over-priced. He points to Saudi Arabia, Indonesia and even Turkey as examples of unstable areas.

“Emerging markets are not trading at a big enough discount to justify those risks today,” he says. “When capital was freely flowing into emerging markets, people were just focusing on the numbers. They were not looking at the political, economic and property risks.”

He says the situation could be even worse for smaller managers who would struggle to attract the attention of

Western governments in the way Hermitage did when things went wrong.

“It’s all very exciting” he says. “When I started my career, in addition to the professional excitement of being in an interesting market, I wanted the adventure of travelling the world.

“But I wouldn’t do it again. I would gladly give up the entire experience to not have the responsibility of someone being killed on my shoulders and having the Russian Government coming after me.”

Browder says managers can be guilty of simply looking at countries on paper and not assessing the political risk properly. Russia, he says, looks great on paper with low debt to GDP, high central bank reserves and a balanced budget.

But politics plays a key role. The Russian encroachment into Ukraine last year caused political outrage in Western Governments leading to broad economic sanctions from the EU and US.

“If you scratch the surface you realise the country is run by a madman,” says Browder. “Russia has $650bn of corporate debt and once sanctions were put in place none of those corporations could refinance.

“With one decision – invading Ukraine and the resulting sanctions – it has led to a complete binary outcome in terms of the viability of Russia.

“The more concentrated power is and more undiversified the economy is then the more likely it is that one single event can ruin everything.”

The sanctions issued in reaction to Russian military action in Ukraine is only part of the equation, with the plummeting oil price also devastating oil-dependent public finances in Moscow.

The HFRI Emerging Markets Index for Russia and Eastern Europe fell 25% in 2014 with big drops coming in the final few months of the year. Russian hedge funds dominated the biggest losers of 2014, according to HSBC’s data on hedge fund performance, with funds invested in the region the worst three performing funds. The Russia

Prosperity fund was down 43.99%, the Kaltchuga fund was down 42% and the Freebird New Russia fund was down 34.59%.

Data from Preqin shows the Russian hedge fund sector is mainly made up of international firms with Moscow offices but there are 14 Russia-based hedge funds today with 26 funds and $4.8bn AuM. There has been a sizeable jump in fund values since last January, when there were 13 Russian-based hedge funds with 26 funds and $3.9bn AuM. Preqin believes the jump is down to a global increase in AuM at hedge funds in the last year despite Russia-based fund values falling significantly.

In December, the Bank of Russia increased interest rates to 17% – cut back to 15% last week – as the rouble weakened significantly. Next year the economy is expected to shrink by up to 5% as deep recession threatens to grip the nation. Some big investors have recently speculated that the heavy stock market falls could present a buying opportunity but Browder is not convinced.

“The economic situation will significantly deteriorate. We haven’t even begun to see the real meltdown which is yet to come,” says Browder. “They will impose currency and capital controls, which means you can’t get your money out. It will be like Argentina and Venezuela.”

Browder predicts an exodus of capital that will see Putin searching for money and nationalising major incomegenerating companies.

“I look at some of my old friends running money in Russia and I feel sorry for them because it is a hard decision to give up on the country you are fully committed to,” he says. Other managers still see opportunities to invest in Russia but are becoming more wary of the political risks. Michael Nicoletos, managing director at Appletree

Capital, made money shorting Russian stocks in the last six months but is now concerned about the possibility of a further Russian invasion of Ukraine.

He says: “My fear is not valuations, it’s politics. I am waiting to see how things evolve and then buy. “I wouldn’t buy a Russian bank right now because if the pressure [through sanctions] continues then outflows will increase, the recession will be steeper. It is not a time to be rushing in.”

Browder says sanctions on 1,000 of the richest individuals in Russia would be more effective at forcing change than broad sanctions that hurt the entire country. After 20 years Browder quit managing other people’s money last year to focus on his human rights campaign. Hermitage now manages his own personal money but is only invested in Western Europe and North America.

“Running a hedge fund is a grinding business after 20 years,” he says. “Any moment when the markets are open you’re exposed. You’re exposed even if you’re not invested. There is always a cost – sometimes it feels good and sometimes bad.”

He says running a hedge fund is “very, very intensive” and describes it as an obsession where you are “sucking in as much information as possible”.

“To be a successful fighter against Vladimir Putin, you need the same qualities. You have to watch his every move, look for opportunities, duck and dive, dodge and weave. It’s an obsessive thing.” 

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