Cover Story: Delivering astounding returns

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on February 26, 2018 - March 04, 2018.

Hirsch is bullish on the aquaculture sector. He particularly likes a significant domestic salmon producer.

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For almost two decades, Charles Henri Hirsch has been quietly helping clients grow their wealth by investing in an equity market unfamiliar to many — Russia.

As chief investment adviser of Equinox Russian Opportunities Fund, Hirsch has been instrumental in the fund’s incredible total net return of 6,783% over the past 17 years (as at Dec 31, 2017). This equals to an annualised return of 26.5%. Between 2000 and 2007 alone, the fund saw a return of 8,025%.

Citywire, a London-based financial publishing and information group, ranks Equinox Russian Opportunities Fund as the top performer among its 48 peers, based on its performance over the last five years. Over a decade, it is ranked No 2 among the 35 other funds that invest in Russia.

As at the end of last year, the fund had US$48 million in assets under management. Its investors are mainly private banks and high-net-worth individuals from European countries such as Germany, France, Belgium and Italy.

Despite its impressive performance, the fund has not gained enough attention from Asian investors, says Hirsch. “We are based in Russia and Europe and don’t market ourselves aggressively. We used to have some Asian investors, but they pulled out in 2007.”

Last December, Hirsch spoke at the World Wealth Creation Conference in Singapore to share his investment journey and market views. He also talked about his wildly successful bet on 15 Russian electricity companies a few years before the turn of the century.

These companies, which were operating hydro and thermal power plants, were trading at very cheap valuations, he said. “As a result, the fund recorded a return of more than 8,000% from 2000 to 2007.”

In a recent phone interview with Personal Wealth, Hirsch, who is French, delved into greater detail about the strategies he had employed and companies he had picked over the years.


How to generate a return of 40,000% in 15 years

To understand how Hirsch made his successful stock picks, he provides the historical context of the Russian Federation. In 1991, Boris Yeltsin — its first president — vowed to transform the economy into a capitalist one. He implemented a series of reforms to privatise government assets to create a market economy.

“All houses and apartments owned by the government were distributed to the people. The government also distributed free vouchers to the masses, which allowed the people to exchange them for shares of public companies that were privatised in 1993 and 1994,” says Hirsch.

The distribution of these vouchers was known as the voucher privatisation programme, an effort by the new government to distribute the nation’s wealth to the general public. As the people had no knowledge of what shares and capitalism were all about at that time, they commonly referred to the vouchers as toilet paper, says Hirsch.

It was in these exciting and uncertain times that foreigners flocked to Moscow seeking their fortunes. The market reforms opened up new opportunities for businesses and investments.  “It was like the California Gold Rush. Some sold computers while others sold cars and Western suits. Many of them made a lot of money,” says Hirsch.

In 1989, like many others, he started a consultancy firm in Russia to advise foreign companies interested in doing business there. In 1993, he invested US$25,000 to buy some of the vouchers that had been distributed to the public.

Later, Hirsch exchanged them for shares of Gazprom, which owned about 25% of the world’s natural gas reserves at the time. Today, the company has the largest natural gas reserves in the world. According to Gazprom’s website, the company’s share of the global and Russian gas reserves amounts to 17% and 72% respectively.

Hirsch says investors know how much Gazprom is worth today, but many were unaware of the company’s real value at the beginning of 1990s. The Russian economy was just starting to gain momentum and there were very few brokerage firms in the country to produce research reports or allow investors to trade shares. Instead, the people exchanged the vouchers for shares at auctions.

Hirsch had travelled around the country and visited several oil and gas companies in northern Siberia. That was how he had a set of numbers on the amount of gas reserves Gazprom possessed. He computed them and came away with a strong conviction that the company was very much undervalued.

“Later, we went to the Vladimir region, situated in the northeast of Moscow, to attend the auction of Gazprom shares. There were not many people in the region and we ended up receiving 5% of the total shares allocated to the people of the region,” says Hirsch.

That stake made him a fortune 17 years later. Gazprom shares were valued at US$1 each in 1996. But by 2011, they were worth close to US$15 apiece. Hirsch had seized a once-in-a-lifetime opportunity by converting the vouchers into shares in 1994. The equity only cost him slightly more than one US cent per share.

“By 1996, I had made a return of 1,000%. And from 1994 to 2011 [when I sold off all my holdings], the total return was 40,000%. That was also when the Russian oligarchs, as termed by the Western media, made their fortunes [by exchanging the vouchers for shares],” says Hirsch.

Ironically, while the voucher privatisation programme was implemented with the intention of avoiding a concentration of wealth, its goal failed miserably. In the end, the wealthy and influential had snapped up these free vouchers and ended up controlling Russia’s new economy.

For Hirsch, the extraordinary returns he received prompted him to establish with a friend an asset management firm in 1995. Equinox Russian Opportunities Fund was launched a year later.


Betting on the Chubais reforms

After launching his fund, Hirsch saw the opportunity to invest in energy, mainly companies that possessed hydro and thermal power plants. These companies, which had been fully owned by the Soviet government, were poorly managed and losing money.

“These companies were basically instruments to fund the Communist Party. And when they were privatised, there was no money left to modernise or rebuild them,” says Hirsch.

He bought into these companies because the stocks were really cheap and the equities were grossly undervalued. “The assets of these companies were not worth much on the Russian government’s balance sheet. One example was the hydropower plants, which were built in the 1930s and 1940s by the prisoners of the Gulag [forced-labour] camps, where dissidents were sent to. These plants had been sitting on the government’s balance sheet for 60 years and were still not valued properly.”

Outside Russia, these hydropower plants were valued based on cost to build of its power capacity. A hydro power plant with a capacity of 1mw, for instance, was priced at about US$2 million. But in Russia, it was only priced at US$3,000.

“These companies had huge debts. Their liabilities were larger than their equity value and thus were considered bankrupt. They were also losing money. But we knew the assets were not valued properly. Also, we were betting on the privatisation and deregulation of the energy sector that would make the companies more competitive,” says Hirsch.

He was betting that Russian politician Anatoly Chubais would shake up the industry by privatising the energy companies and creating competition among them. A minister in Yeltsin’s Cabinet, he was in charge of the large-scale privatisation of government assets.

In 1998, Chubais was appointed head of the state-owned electrical group RAO UES, which controlled more than 70 energy companies and 40 power plants across Russia. He intended to follow in the footsteps of Margaret Thatcher, the British prime minister from 1979 to 1990, and privatise these companies to make them more efficient.

“When Chubais decided to reform and deregulate the electricity sector, nobody believed him. RAO UES was corrupt as it used to be a tool for funding the Communist Party. However, I believed him,” says Hirsch.

That was because Chubais had demonstrated that he could execute plans when he set his mind to it. After all, he was the key person in government to privatise more than 15,000 state-owned enterprises via the voucher privatisation programme from 1992 to 1994.

“It was all done within two years, which makes it the fastest privatisation process in human history. Chubais was mandated by the government to do it, and it was extremely tough, but he did it,” says Hirsch.

His bet paid off and some of the companies he invested in saw their value increase by 10,000%. “That was when we got the 8,000% return. We sold a hydropower plant company in 2011. In 2007, we sold a major position in a merged thermal power generator to an oligarch,” says Hirsch.


Not all plain sailing

Hirsch’s investment journey was not without challenges. Just like when China began transforming itself into a market economy and corporate governance was totally lacking, Russia faced a similar situation. More often than not, the rights of minority shareholders were ignored and many did not receive the value due to them.

“There was a total lack of ethics and corruption was rampant. The value of a company went to the management themselves via different ways. They were stealing the funds,” says Hirsch.

For instance, it was a common practice for companies to award jobs to subcontractors that would provide them with kickbacks. The money, of course, would end up in the personal offshore bank accounts of these company officials.

Many became instantly wealthy this way. They would use the company’s money to buy luxury cars and clothes and wine and dine at expensive restaurants, says Hirsch.

Later, these corrupt practices trickled down to the majority shareholders. Many of them, oligarchs who made their fortunes during the voucher privatisation programme, left no money on the table for the minority shareholders. “It was only when the minority shareholders raised their voices, banged their fists on the table and drove home their point that they should receive money in proportion to the profit generated by the business [did they get what they were entitled to],” says Hirsch.

Joseph Stiglitz says in his book, Globalization and Its Discontents, that the landscape occurred due to the “shock therapy” (referring to the rapid privatisation of the Russian economy) implemented by the government. In his view, a market economy will not function properly and do more harm than good if the fundamental infrastructure, such as the rule of law to protect private property and ownership, is lacking.

This seemed to be the case in Russia. When the country began to revamp its legal system to handle business and economic matters a few years later, many of the judges were found to be either inexperienced or corrupt. Some of them were politically connected and received orders from the government. Thus, the minority shareholders did not get the justice they deserved.

Nevertheless, Hirsch decided to invest in some companies. “We invested merely because the companies there were so undervalued. If a company is undervalued by 30 times, the investors would still end up with about 20 times upside, even though the majority shareholders should end up with much more than 30 times,” he says.

Hirsch says it is important to know the people behind the companies you invest in. He invested in state-owned companies at a time when they were controlled by reformists who were well respected by the international investment community, such as Chubais.

However, when these companies disregarded the rights of minority shareholders, Hirsch only invested in private companies that were run properly and protected the rights of minority shareholders. “The owners of these private companies also owned 50% to 70% of the shares. They were relatively rich and placed importance on the company’s reputation as they often used their company’s shares to receive loans and gain leverage. They run their companies professionally and ensure that the rights of minority investors are protected,” he says.

Equinox Russian Opportunities Fund experienced two major setbacks in 2013. The first was when Uralkali, a Russian potash fertiliser producer and exporter, exited its partnership with Belarusian Potash Company (BPC). The two companies had formed a cartel to control about a third of the global potash market, keeping potash fertiliser prices at high levels.

The dissolution of the partnership, which occurred overnight, caused potash fertiliser prices to collapse, from about US$600 to about US$300 per tonne. Urakali, which Equinox Russian Opportunities Fund had invested in, saw its share price plunge 85% at its lowest.

Hirsch says the fund also suffered huge losses when Russia attempted to invade Ukraine. The outcome was international sanctions imposed on targeted Russian personnel and businesses. As a result, foreign banks pulled out funds from Russia.

At that time, Equinox Russian Opportunities Fund had invested in Russian companies that were expected to benefit from government concession agreements to build public roads and bridges. Unfortunately, these projects fell through as the companies were unable to secure long-term funding.

“There was also some corruption in those companies. We decided to sell our shares in 2015 and took a loss of 65% from these investments,” says Hirsch.


Fertilisers, real estate and aquaculture

Today, the Russia story is not an easy one to pitch to global investors, Hirsch told participants of the conference in Singapore. Besides international sanctions, Russia suffered from the plunge in oil prices at the end of 2014. Its economy fell into a recession the following year, prompting the central bank to cut interest rates aggressively to strengthen the ruble and keep the economy remain intact.

Russia’s economy only started to turn around last year, expanding by an annual growth rate of 1.5%. “It is sliding back into a frontier market from an emerging one,” says Hirsch.

He says many foreign funds — mainly from the US and the UK — that specialise in Russia have shut down in the past three years. “There used to be about 50 of them. Now, there are only five.”

The number of research and analyst reports has reduced significantly as a result and companies’ information is not as well disseminated as before. “The investment environment is a little similar to how it was during the 1990s, when everybody left and very little research was available,” says Hirsch.

But instead of being worried and pessimistic, he believes there are always investment opportunities in growing sectors, even when the overall economy is down. Also, with foreign investors pulling out of the market, those who remain could bargain hunt and benefit from market inefficiencies, he says.

Hirsch is currently investing in some agricultural companies as the sector was the only one to experience fast expansion last year. “Russia’s GDP expanded about 2%, but the agriculture sector is up 15%. In fact, the country became the leading producer of cereal and agricultural products for the first time last year. There has been a boom and many large Russian corporates have been establishing subsidiaries to tap this sector,” he says.

However, it is not rice and cereal producers he likes as businesses such as these depend on the climate, which is beyond human control. Instead, Hirsch is focusing his attention on companies that produce fertiliser that contains phosphate, which originate from volcanic rocks.

Why? To put it simply, about 90% of phosphate rock produced worldwide — which is widely used by the fertilizer industry globally — contains cadmium, he says. It is a kind of non-nutritive metal that could affect human health, mainly causing kidney disease, cancer and other adverse effects.

In recent years, the governments of developed nations and non-governmental organisations around the world have begun efforts to reduce the cadmium content in fertilisers. “It is similar to what happened to cigarettes many years ago. People and organisations were showing proof that cigarettes impacted people’s health and were trying to stop people from using them while large tobacco companies were still pretending that cigarettes were safe,” says Hirsch.

He says the European Union recently imposed regulations on phosphate-based fertilisers that contain cadmium. Even though it is not an outright ban, it requires a gradual reduction of cadmium in phosphate-based fertilisers over the next 12 years.

As such, Hirsch foresees fertilizer with phosphate from volcanic origin that do not contain cadmium to be in high demand in the medium to long term. “There is an experimental technology that could enable producers to extract cadmium from the common sedimentary phosphate rock. But the cost is high, so their margins will be lower,” he says.

Certain companies in Russia’s real estate sector are also expected to perform well going forward. This is due to the historically low interest and mortgage rates in the country, says Hirsch.

The interest rate was at 8.5% in September last year. “This is the first time in Russia’s history that the interest rate is below 10%. Market players are expecting it to drop by another 200 basis points this year,” he says, adding that millions of Russians are expected to seize the opportunity to buy properties, which will benefit some real estate promoters.

Aquaculture is also another sector Hirsch is bullish on. He says there are fundamentally strong companies with the potential to provide “10 times upside” to investors over the long term.

For example, he likes a salmon farm operator that has suffered from low earnings in recent years due to a disease affecting its farms. Nevertheless, the company managed to achieve its targets for the past 12 months.

“The company also increased production by 97% and sales by 2.9 times in ruble terms while its earnings before interest and tax (EBIT) margin increased to 40% and debt was reduced by 46%. More importantly, its EBIT margin reached a level of US$2.5 per kg of salmon — one of the highest performances worldwide,” says Hirsch.

“The company recently announced the acquisition of a smolt (young salmon) factory in Norway … which should allow it to increase production sevenfold in the next five years, ranking it among the top producers in the world.”

He says the company, which is “the only significant domestic salmon producer” in Russia, could benefit from the country’s huge domestic salmon consumption demand of 60,000 tons per annum. “We believe there is significant upside to the company. Its current market capitalisation is US$213 million. By comparison, Norwegian Marine Harvest, which is mainly involved in the production, processing and farming of salmon, is currently valued at US$9 billion.”



Equinox Russian Opportunities Fund

Charles Henri Hirsch, chief investment adviser of Equinox Russian Opportunities Fund, says the fund is only offered to qualified investors and the minimum investment is US$250,000.

“We invest for the long term of at least three to five years and the portfolio is concentrated in a few holdings. Investors have to be patient to see results,” says Hirsch.

The fund utilises a value investment approach while focusing on event-driven and special situation strategies such as investing in one or more companies that are restructuring or consolidating.

Despite its long-term play, the fund allows investors to redeem their money at the end of each month by giving a three-month notice. “For instance, if you wanted to withdraw your money in April, you would have to give us notice in January. Then, you will be able to get your funds by the end of April. That is because the fund invests some of its money in relatively illiquid assets and the fund manager needs time to sell them off at an ideal price.”

However, Hirsch emphasises that investors’ money is only invested in public-listed companies mainly with market capitalisations of one to five billion US dollar. “In general, companies with a market cap of less than one billion rubles have too many corporate-governance concerns. And those with a market cap of more than five billion rubles do not have the 10 times upside that we want,” he says.

The fund charges an annual management fee of 1.5% and a performance fee of 20% with an individualised high water mark at the end of each fiscal year.