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The turbulent events over this past weekend in Russia have once again underscored the high beta risk/reward dynamics inherent with investing in emerging markets (EM). We’ve been investing in eastern Europe since the mid 2000s – this includes the post privatization era in Russia when optimism was high, foreign inflows were large and deals were coming fast. That said, the EM returns were phenomenal when compared to the S&P 500 (below). Though we’ve experienced and/or participated first hand in monumental transactions such as OGK-4/E.ON, Sberbank/Volksbank AG, Uranium One/UrAsia Energy or the Rosneft IPO in London, as a matter of principal however, our CEE fund exited from all direct exposure to Russia, shortly after the unjustified invasion of Ukraine.
Fast forward to today, if you think Kazatomprom (KAP) shipping uranium via the Trans-Caspian route may be problematic, we’ve seen this all before by way of KazMunayGas bypassing Russia and shipping oil to international markets via Azerbaijan and Georgia in the late 2000s. Speaking of Kazakhstan and given the recent company specific events, we’d be a bit concerned if we were Cameco (CCJ) pondering the future reliability of Inkai production ...but we'll leave that specific discussion for another day.
The point with emerging markets is that understanding the underlying geopolitical environment is more important than a theoretical DCF model with all the fancy bells and whistles. What matters in EM investing is knowing how deals get done and who the power brokers are. From cultural history to nationalizations, sovereign wealth funds, privatizations and spheres of influence, these country specific concepts are of paramount importance. Want to invest in a resource company in Mongolia ? Look at a map - you better first understand what the Russian or Chinese point of view may be and how that may fit in your underlying thesis. From the former Yugoslavia to SE Asia, north Africa or Russia- revolutions tend to (eventually) happen when despots are motivated by empire building while not reinvesting or caring about the underlying population. In Russia’s case, the current leadership is solely focused on weakening the US and NATO while attempting to resurrect the Soviet Union. All this while the underlying Russian economy has barely been modernized during the 20+ years post-Boris Yeltsin era. To this day, Russia still relies on just two basic industries: resource extraction and the military industrial complex. There has barely been any innovation in Russia and now with the Western sanctions, things have become even bleaker. Outside of Red Square and central St Petersburg, there is no middle class. Russia is a fundamentally poor country- this has not changed since the 1917 revolution.
As to some context for the events of this past weekend: Wagner PMC getting within 200km of Moscow compares to the Nazis in WW2 getting within 30km and Napoleon getting within 10 km in 1812. Unlike the aforementioned two marches on Moscow, Wagner’s march this past weekend was largely uninterrupted- this is significant and points to a despot losing both control and influence. A political coup is the ultimate game of chicken with leverage drawn out well in advance given negotiated side deals from back channels. Once a despot starts looking weak domestically and internationally, it may likely signal the beginning of the end.
Borders matter and most importantly, the rule of law matters. The Russian turmoil (and sadly the Ukrainian occupation) is still not over. As evidenced from this past weekend, things can change quickly. We may eventually revisit our Russian investment thesis some time in the future- however certainly not if any of the two unsavory characters active this past weekend remain in the picture.