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Secrets of Sovereign

In two decades Richard and Christopher Chandler's bold bets transformed a $10 million family fortune into a cool $5 billion. In an exclusive interview, Richard Chandler discusses his passion for business ethics, his penchant for unorthodox metrics and his new focus on Asia.

Richard Chandler prides himself on being a contrarian investor. Consider his plunge into Japanese bank stocks early this decade.

In November 2002, with Japan slipping back into recession after a decade of stagnation and with stocks at 20-year lows -- the Nikkei 225 index was more than 78 percent below its 1989 peak -- the country's banks were wallowing in bad debt. Chandler, chairman of secretive Sovereign Global Holdings, and his brother Christopher, the firm's co-founder and president, began snatching up shares in the sector, paying $570 million for a 5.1 percent stake in UFJ Holdings, which had posted a staggering loss of $9.3 billion in its latest year. The pair went on to buy more than 3 percent of Mizuho Financial Group as well as stakes in Sumitomo Mitsui Banking Corp. and Mitsubishi Tokyo Financial Group (which merged with UFJ in January). Altogether they spent about $1 billion on their spree.

"The banks were priced for a total wipeout of equity holders," says Sovereign's broker at the time at Nikko Citigroup, John Nicholis. "We were advising our clients to stay away from the sector."

The Chandlers are glad they ignored that advice. Japan's economy recovered in 2003, the Nikkei has doubled, and the country's banks have moved firmly back into the black. The brothers have so far made gains of some $2 billion in Japan and still hold the stake in Mizuho, the world's third-largest bank by assets.

By going into uncharted territory where most investors don't dare to tread, the Chandler brothers have, in the space of 20 years, grown a family fortune of $10 million into a cool $5 billion -- and they're still in their mid-40s. Along the way they have made waves by being among the first and biggest investors in such emerging markets as Brazil, the Czech Republic and Russia and playing an instrumental -- and controversial -- role in advocating economic reform and better corporate governance. They have waged, directly and by proxy, several bruising governance battles, most notably in Russia, where their militancy helped get the first independent director appointed at state-controlled gas giant Gazprom, and in South Korea, where their two-year campaign at refiner SK Corp. to oust chairman and CEO Chey Tae Won, who had been convicted of fraud, ended in failure last year. (The pair still pocketed some $728 million in profits on their SK investment.)

Sovereign's secretive ways and history of combativeness arouse fear and suspicion in many companies. In South Korea, SK portrayed the firm, with no small success, as a foreign predator interested only in short-term profits. The Chandlers' record has earned them a reputation as brilliant and daring investors whose extraordinary discretion falls just shy of reclusiveness. Intensely private, the native New Zealanders cherish their ability to maintain near-anonymity, assiduously shunning the limelight that success brings -- their names don't even appear on the Web site of Sovereign's main operating arm, Sovereign Global Investment (see box, page 45). They invest only their own money in a handful of long-term holdings, eschewing the frantic trading strategies favored by many hedge funds. As a result, they have attracted surprisingly little attention, even from investment professionals. They are unknown to all but a few in the world of finance.

Until now, that is. This fall and winter, in a series of exclusive interviews with Institutional Investor -- the first that he or his brother have given since founding Sovereign in 1986 -- Richard Chandler lifted the veil on the fund's incredible success story. Even in South Korea, where Sovereign's former chief executive, James Fitter, campaigned publicly for support from other shareholders during the SK battle, the Chandlers themselves never spoke or appeared in public. Why open up now? By discussing his motivations and methods with II, Richard says, he aims to give "management teams that shake when we show up on the share register a clearer, more balanced view of what we are about."

Chandler is passionate about ethics, but he insists that Sovereign's corporate governance crusades are a by-product, not a driver, of the brothers' investing strategy. "We do have altruistic motives that some investors who are looking for the path of least resistance find hard to understand," says Chandler, 47. "But we don't want to be defined by our corporate governance battles. We are value investors with a sense of responsibility, not activists."

Sovereign's foray into Japanese bank stocks is a case in point. "Japan illuminates the way we invest, the principles we adhere to and our contrarianism better than any other investment we've made," Chandler asserts. "There was no research, no price-earnings ratios, basically no standard road map or Global Positioning System for investors. The scientists were lost."

Richard spoke to II in his new Singapore office, which is decorated with fauvist-style oil paintings by his mother, Marija. He spends three winter months here, far from his Monaco home, to prospect for new investments. The brothers are searching for targets in India and China, believing that those markets stand to benefit as the world enters an Asian century. Three early finds in India: Housing Development Finance Corp., the country's largest mortgage lender, in which Sovereign has a 4.9 percent stake as well as a 4.9 percent holding in its fast-growing subsidiary, HDFC Bank; ICICI Bank, the country's second-biggest lender, in which Sovereign holds a 4.71 percent stake, and UTI Bank, operator of the country's second-largest ATM network, in which it has a 3.2 percent stake. The holdings together are worth a little more than $1.27 billion.

"I think Asia is the best place to be for the next 20 years," says Richard.

The Chandlers' success is the product of an eclectic but rigorous approach to investing (see box, page 50). They consider themselves first and foremost value investors -- Richard's idols include Warren Buffett and Sir John Templeton. Sovereign traditionally buys stocks at P/E ratios of 3 or less, although in light of current valuations and the fund's focus on hot Asian markets, it must sometimes pay far more. (The HDFC units, in which Sovereign has built up a $627 million stake, were trading at more than 22 times estimated 2006 earnings last month.)

The brothers also prize scale, believing that the way to achieve outsize returns is to make a few big bets -- Sovereign usually holds fewer than ten stocks -- rather than manage a diverse portfolio. The Chandlers favor large-cap stocks in big countries. "If you are invested in big companies in big countries, that means there is a ready audience of benchmark-following investors who must buy the asset," says Richard. "By buying big -- going narrow and deep, as opposed to diversifying -- you maximize your success."

The Chandlers stress the need to be creative in picking stocks and frequently use unconventional methods to value assets. This practice is important in what Richard calls the "delta quadrant" -- transition economies or distressed sectors where information is not easily available and standard metrics don't apply.

Earlier this decade, for instance, Japanese banks had no earnings on which to base multiples, and uncertainty about the extent of bad loans made it difficult to forecast a turnaround. So Richard and his analysts looked at market capitalization as a percentage of assets; on this basis they determined that UFJ and other megabanks traded at about 3 percent, compared with 15 percent for Citigroup at the time. The Chandlers concluded that Japan would have to nationalize the banks or reflate the economy with low interest rates, and bet -- correctly, as it turns out -- on the latter scenario.

"Most fund managers are focused on what can go wrong rather than on what can go right and were too afraid to make that call," says Richard. "We were not."

Additionally, the Chandlers prefer to operate at a distance from the crowd, steering clear of consensus views. One of Richard's favorite sayings comes from legendary value investor and Pioneer Investments founder Philip Carret, who said it is essential to "seek facts diligently, advice never." Explains Richard: "Money managers have to account for their actions to their shareholders, which means they have an undue fear of underperformance. We invest only our own money. Our investment decisions are driven by optimism, not fear."

The brothers maintain their primary office and residences in Monaco, not just for tax reasons but to avoid the herd of global investors based in London. (Sovereign is headquartered in Dubai, allowing it to take advantage of the emirate's low tax regime and midway position between the Asian and European time zones.) When the brothers were considering investing in Japanese banks, Richard says, "we specifically avoided visiting Japan while we made up our minds, since the despair and despondency of the place could have distorted our long-term view, even though that kind of distance is conventionally considered foolhardy."

The chandlers bring to investing a background that is anything but conventional. The brothers grew up in Matangi, a rural town outside the provincial city of Hamilton in the dairy farming country of New Zealand's north island. Their Chicago-born grandfather had emigrated to New Zealand in the early 1900s, gone into advertising and married his secretary. He died of an allergic reaction when his third son, Robert, was just one year old. Although he never knew his father, Robert was profoundly marked by the American success literature he had left behind, notably the books of Orison Swett Marden, an early-20th-century American journalist and author who inspired such proponents of "positive thinking" as Dale Carnegie and Norman Vincent Peale. Robert's sons were deeply influenced by this worldview as well. "We are great believers in the idea of having audacious goals, breaking out and doing something out of the ordinary," says Richard. "It's helped us turn what most people consider a mere profession into a vocation and, beyond that, an art, where we frequently put ourselves in harm's way."

Robert served as a lieutenant on a Royal Navy minesweeper during World War II. The conflict claimed his two older brothers, both Spitfire pilots who were shot down. After the war Robert went to work in a beekeeping business run by some friends: Edmund Hillary, who with Tenzing Norgay would later be the first to climb Mount Everest; Hillary's brother, Rex, and their father, Percy. Robert went on to establish his own beekeeping operation and launch a business building homes and apartments. In 1955, during a round-the-world trip with an old military buddy, he met his wife, Marija, the vivacious, independent-minded daughter of an anticommunist mayor and farmer in what is now Croatia.

Robert and Marija returned to New Zealand and spent the next 17 years leading a quiet life and raising three boys: George (now a retired accountant in Canada), Richard and Christopher. In 1972, with George at university and Richard and Christopher in boarding school, Robert and Marija launched the venture that would generate the family fortune and bankroll Sovereign. Against the advice of most of their friends but spurred on by Marija, Robert bought a beat-up two-story building in a depressed area of central Hamilton, putting 5,000 New Zealand dollars (then worth $5,975) down and taking out a mortgage of NZ$195,000. The couple renovated the building, erecting an elegant colonnade on the outside and a sweeping staircase inside. Then, to the surprise of stuffy, provincial Hamilton, they christened it Chandler House and launched what quickly became New Zealand's most upscale department store.

With Marija scouring Europe and Asia as chief buyer, the store sold everything from French Lalique crystal to Chinese rugs and helped transform the neighborhood into an exclusive shopping district. "People from all over New Zealand came to buy at the store, which became a tourist attraction and was New Zealand's equivalent of Neiman Marcus," says Margaret Evans, a longtime city council member and former mayor of Hamilton.

For the quiet, family-oriented Chandlers, the success brought visible wealth. It also opened up the world of business to Richard and Christopher, who is one year younger than his brother. When not at boarding school in Auckland, the siblings got involved in the business by selling in the store, discussing strategy at the dinner table and helping to reconcile the books on weekends. Most important, they traveled with their mother on buying trips. "My father is very values-driven and helped instill in us our ethics, but my mother is the most brilliant businessperson I've ever met and taught us many of the key principles we follow as investors," says Richard.

The first of Marija's principles was, Never buy something unless you know to whom you can sell it. The second was, Buy as much as possible in a narrow range of hot items. That way, when competitors ran out of stock, Chandler House could clean up. Marija "was able to identify the best opportunities and be the master of narrow and deep," says Richard. "With stocks, we do the same thing. We back our beliefs to the hilt."

Inspired by the success of the family enterprise, Richard went to the University of Auckland, where he obtained an accounting degree in 1979 and a master's degree in commercial studies two years later. There his keen intellect and passion for corporate governance blossomed. His master's thesis was a groundbreaking study on corporate board structure and accountability in New Zealand. Richard sent questionnaires to all listed New Zealand companies and 200 individual directors, and concluded that there was a dangerous, widening rift between ownership and control at most quoted companies. The growing clout of institutional shareholders could provide a way to close that rift, the paper added.

"As the son of entrepreneurs, Richard was fascinated by succession issues, the change from direct ownership to indirect ownership and how the boards and managements of formerly private companies that had listed could remain accountable to owners," says Brian Henshall, founder of the university's business program and thesis adviser to Richard, the first graduate on whom he had ever bestowed first-class honors.

The thesis had a lasting impact on Chandler's approach to investing. In a letter to his former professor in 2004, Chandler wrote, "While I did not know it then, our project was the first sign of what would become my vocation, a passion to see capital managed by the most competent, so that companies and countries could enjoy sustainable prosperity."

Christopher Chandler also attended the University of Auckland, earning a law degree in 1982. A technology buff, he built computers and wrote software programs in his spare time. Recently married and the father of an infant son, Christopher is balding, compact and less intense than Richard, a lanky bachelor with a head of wavy gray hair. Christopher, who declined to be interviewed, enjoys windsurfing, water-skiing and riding motorcycles, while Richard unwinds on the golf course (he has a 12 handicap).

Richard began investing the family's money in New Zealand stocks while in college, but he honed his skills by taking a job at accounting firm Peat, Marwick, now part of KPMG International, in London in 1982. He was assigned to a 50-person team under Douglas Flint that worked on corporate restructurings, takeovers, stock offerings and bank audits. "You can't imagine what the City of London was like for someone from the boondocks of New Zealand," Chandler recalls. "It was like walking around a Monopoly board."

Flint, now chief financial officer for HSBC Holdings in London, says he was struck by Chandler's "incredible intellectual capacity and enormous, almost unbelievable thirst for knowledge. He used every project we worked on as an experience to learn a new business model."

Chandler's London days came to an abrupt halt after less than a year when his father became ill and urged him to come home and run the family business. "It was a tough, tough choice, but the business was a going concern and a chance to do something on my own, so I said yes," he says.

With the New Zealand economy booming thanks to the tax and regulatory reforms of the country's then­Finance minister, Roger Douglas, Richard and Christopher aggressively expanded the business. They opened another Chandler House in Auckland, bought three clothing factories and launched a chain of eight upscale fashion stores across the country.

The business thrived, but the Chandler brothers weren't cut out for the rag trade. "It had three-month cycles, and we were living with our hearts in our mouths," says Richard. The pair decided that rather than expand overseas, they should sell the business and turn to investing.

"Basically, we said, 'Let's do something that we love to do, not just something that we are good at,'" recalls Richard. After persuading their parents to go along with the idea, they sold off the business store by store and in late 1986 launched Sovereign Global with a modest net worth of $10 million and enormous reserves of conviction and energy. They also decided to relocate to Monaco, bringing Marija and Robert, who was by then back in good health, with them.

The Chandlers made their first investment in Hong Kong, which both men had visited frequently on buying trips for the retail business. Spirits in the British colony were depressed because of the negotiations to hand the territory back to China, which would conclude in 1987. Real estate prices were roughly 70 percent below their 1981 peaks. "The feeling was China was going to take over Hong Kong, so most investors said, 'Who cares?'" remembers Richard. "We had read the treaty, and it promised the status quo for 50 years, and we believed it." Even more important, rents were rising, and rental yields exceeded interest rates by 5 percentage points, which guaranteed that any investment would more than pay for its financing costs.

Leveraging up, the brothers put almost all of the family fortune into four office buildings, beginning in February 1987, when they paid $27.6 million for D'Aguilar Place, a 22-story building in the central business district. They put down $5.8 million of their own money and borrowed the balance from the Hong Kong and Shanghai Bank. Then they took a page from their parents' playbook and renovated the building, allowing them to triple rents over three years and generate the cash to acquire other properties.

"The Chandlers were the most dynamic, creative clients we had," says Gerry Kipling, a Hong Kong real estate consultant who handled the brothers' account at property manager Jones Lang LaSalle at the time. Eventually, sentiment and property prices recovered: The Chandlers sold their buildings in 1991 for more than $110 million, boosting their wealth to just over $40 million.

The Chandlers also invested in stock index futures in Hong Kong and learned a valuable lesson. "The Hang Seng index was 60 percent property, so it seemed very closely related to our main investments," says Richard. Because of the volatility of the market, however, they set stop-losses to protect themselves from a downturn. On Friday, October 16, 1987, their broker informed them that their stops had been hit. After deliberating briefly the brothers ordered their positions closed. They were glad they did. The following Monday stock markets around the world collapsed, and the Hong Kong exchange shut down for three days. The Chandlers managed to get out with a $5 million profit and have not bought futures or other derivatives since. "We learned that if you get lucky once, don't press your luck," says Richard.

The experience also left the brothers with an aversion to leverage. Since 1990, Sovereign's debt has averaged less than 1 percent of assets; the fund has not borrowed since 1998. That enables the Chandlers to take a long-term view of risky markets, their key competitive advantage at a time when many investors, particularly highly leveraged hedge funds, invest with a short-term horizon. "We're just very much a plain-vanilla, long-only investment fund," says Richard. "We like investments where the risk is time, not price."

Seeking "to do well by doing good," another of Richard's favorite aphorisms, the Chandlers in the early 1990s began looking at emerging markets. "The fax machine was becoming very popular," Richard recalls. "We felt that value was moving from real estate to communications. So we researched it and found that Telebrás was the cheapest telecom company in the world."

Determining that value wasn't easy. Brazil's hyperinflation at the time had rendered P/E ratios meaningless, so the brothers turned for the first time to creative metrics -- in this case, market capitalization per access line. Telebrás, the national telephone monopoly, was trading at about $200 per line, compared with $2,000 for Mexico's Teléfono de México and an average cost of $1,600 for installing a line in Brazil. The brothers bet that the government of then­president Fernando Collor de Mello would liberalize the economy and open the country up to foreign investment.

Working with Mark Donegan, then head of the Latin American emerging-markets desk at James Capel & Co. and now a partner in the London hedge fund firm Altima Capital, Sovereign obtained government permission to invest in Brazilian equities. The firm put $30 million into Telebrás shares in late 1991 and a smaller amount into Eletrobrás, the electric utility. The Chandlers contend that the purchases made them the first foreign portfolio investors in Brazil. With Collor de Mello cutting the budget deficit and granting foreigners broader access to the stock market, Brazilian equities tripled in value between January and April 1992. But Collor de Mello was soon caught in a massive kickback scheme and was impeached that April. Stocks swooned, falling 60 percent over the next eight months. Most foreign investors fled the market, but the Chandlers sat tight. "As far as we were concerned, the shock was external to the fundamentals of the company," says Richard. "Telebrás had simply gone from extremely undervalued to outrageously undervalued."

Itamar Franco, Collor de Mello's former deputy, succeeded him as president and continued the government's liberal economic policies. By 1993 the market had recovered about two thirds of its lost ground. When the Chandlers sold out late that year, they had made a fivefold return on their initial investment and boasted wealth of more than $150 million, according to Richard. "We learned to build our emotional muscles, helping us make it through major market falls and grind through the trying times without losing our equilibrium," he says. Donegan testifies to the brothers' fortitude. "Once they've taken a view, volatility does not bother the Chandlers," he says.

Telebrás and Eletrobrás weren't the pair's only investment. Between 1991 and 1994 the Chandlers made $10 million trading Venezuelan power bonds, Argentinean Brady bonds, Cuban government bonds and promissory notes from the Central Bank of Nigeria. This trading would never amount to more than a minor sideshow to their big equity bets, however.

After exiting Brazil the Chandlers gravitated to Eastern Europe, attracted by the region's transition to capitalism. They bought an undisclosed stake in the Czech Republic's electricity monopoly, CEZ, within months of the company's official listing on the Prague Stock Exchange in January 1994. At the time, many Western institutions could not buy Czech shares directly, and many individuals were unable to access the market through their Western brokers. Working with Donegan, who was then at Morgan Grenfell, and his colleague Mark Foster-Brown, also now a partner at Altima Capital, the brothers designed the Czech Republic's first global depositary receipt program, with CEZ as the star offering. The GDR created new liquidity, allowing the Chandlers to sell their CEZ stake at the end of 1994 for a modest gain.

The early '90s also saw the brothers venturing into Russia. Beginning in late 1993 they bought Russian privatization vouchers, which had recently been introduced as a vehicle to buy stakes in privatized companies through special state auctions. (Russia didn't have a stock market until the June 1995 launch of the RTS exchange.) "For Richard and Christopher the Czech Republic was really just a stepping-stone toward understanding the kind of country risk and volatility that would be inherent in investing in Russian equities," explains Foster-Brown.

By the end of 1994, the Chandlers had snapped up enough vouchers to buy a 4 percent stake in Unified Energy Systems, Russia's largest electric utility; 11 percent of Mosenergo, the Moscow electricity distributor; 5 percent stakes in each of the three main production arms of Yukos Oil Co.; a 15 percent stake in Novolipetsk Metallurgical Kombinat, the country's biggest steelmaker; and a small, undisclosed stake in Gazprom, the world's No. 1 gas producer. The metric they used in each case was simple: The book value of assets vastly exceeded the companies' market capitalizations. With more than $194 million invested at the time, the brothers say they were the largest foreign portfolio investors in Russia.

When Mikhail Khodorkovsky's Menatep Bank took control of Yukos in early 1996 through a state auction, the Chandlers sold their stakes in its production companies and invested the proceeds in a further 10 percent of steelmaker NLMK, giving them a blocking minority stake of 25 percent plus one share. They used this to launch a governance crusade -- the first of its kind by a foreign investor in Russia. After armed guards prevented their representatives from attending the company's annual meeting in 1996, the brothers teamed with Sputnik Fund, which also held a 25 percent stake, and sued in the Russian courts for the right to appoint board members. "Russia is really the place where Richard and Christopher's ability to stomach volatility, their value-spotting talents and their rigorous adherence to principled investment first clearly came together," says Charles Ryan, chief executive of United Financial Group, the Moscow firm that advised the brothers.

Sovereign and Sputnik sought to end alleged transfer pricing practices, which they suspected NLMK was using to sell steel at below-market prices to export agents they believed were owned by the company's managers. Lending credence to their allegations, NLMK's profits fell from $480 million in 1995 to just $40 million in 1996, despite strengthening world steel prices. Although the investors won a series of court cases in 1997, Sputnik -- an outfit controlled by Russian financier Boris Jordan and backed by, among others, Soros Fund Management and Harvard Management Co. -- sold its NLMK stake at a profit before the appeals process was finished. A decade later Sputnik's actions still rankle Richard Chandler. "We would have hoped that Soros Fund Management and Harvard would have recognized the opportunity to set up Novolipetsk as a model of good corporate governance in Russia," he says.

Jack Meyer, former chief of Harvard Management, declined to comment about NLMK or the Chandlers when contacted by e-mail. An aide said George Soros would not comment.

"By taking principled and well-publicized positions regarding corporate governance at NLMK, the Chandlers advanced the level of dialogue and understanding regarding shareholder rights in Russia," says Jim Dannis, a retired former head of Eastern European investment banking at Salomon Brothers who advised Sovereign and other dissidents at NLMK. "They were left to fight this battle alone after every other investor sold out."

Ironically, the Chandlers did better than their erstwhile allies, selling their NLMK stake in 1999 for more than the $50 million that Sputnik received and making an undisclosed profit. They left a lot of money on the table, though. Novolipetsk Steel, as the company is now known, made a secondary offering of 7.5 percent of its shares on the London Stock Exchange in December, raising $649 million and valuing the company at $8.7 billion.

The Chandlers' timing on the sale of their two largest investments in Russia proved a much greater coup. Concerned that the country's burgeoning market for Treasury bills, which were known as GKOs and carried interest rates of as much as 100 percent, was little more than a pyramid scheme, they sold their 4 percent stake in UES and their 11 percent stake in Mosenergo over the summer of 1997, at the height of the first Russian stock market boom. The amounts they received -- $700 million and $300 million, respectively -- produced a profit of 416 percent.

As jitters over the GKO market increased, Russian shares lost 50 percent of their value between August 1997 and February 1998. Believing that the country had had a sufficient fright to pull back from the brink of default, the Chandlers plunged again into the Russian market that February, investing nearly $1 billion for slightly less than 5 percent of Gazprom. Among private investors, only Germany's Ruhrgas, which had a little more than 5 percent, held a larger stake.

Sovereign's optimism proved premature. Gazprom's market capitalization, which had plummeted to about $20 billion from $47 billion at the end of August 1997, collapsed to a low of $4 billion after Russia defaulted on its debt and devalued the ruble in August 1998. That meltdown left the brothers sitting on an estimated loss of close to $800 million.

"I could have said to myself, 'I'm a bad investor, I got it wrong,'" says Richard. "Instead, I said, 'We got in a bit early, but the value is still there.' Just because the market deserted Russia, it did not mean that Gazprom was a bad company. It was a great company supplying 25 percent of Europe's gas." Indeed, Gazprom held natural-gas reserves worth a stunning $2.9 trillion.

It was not a profitable company, however. Gazprom posted losses of $7 billion in 1998 and $2.8 billion in 1999, while amassing debts of $9 billion. The reason, the Chandlers suspected once again, was transfer pricing. The utility was selling vast quantities of gas at below-market prices to a little-known company called Itera Group that Sovereign and others believed had close ties to Gazprom chief executive Rem Vyakhirev and other company directors, who held five seats on the 11-person board. (The government, which then held a 38 percent stake, had five seats and Ruhrgas, which voted with management, one.) Gazprom also transferred control of many of its most profitable production subsidiaries to Itera and gave management allies interest-free loans that an independent audit committee of the Duma, Russia's legislature, estimated in 2000 totaled $850 million. "It was a company that was rife with investor abuse," says UFG's Ryan.

To combat the abuses and release the company's value, the Chandlers backed a campaign by Ryan's partner, UFG chairman Boris Fyodorov, to gain a seat on Gazprom's board and oust Vyakhirev. A former Finance minister and one of Russia's most prominent reformers, Fyodorov asserted that the company was plundering corporate assets for the benefit of third parties.

Their stance wasn't without risk. Fyodorov's Siberian husky was killed by a rare form of cyanide, and Ryan was repeatedly questioned by tax authorities, according to people close to the two financiers. These sources say both men believed they were the targets of a Gazprom-inspired campaign of terror. Neither Fyodorov nor Ryan would comment on the alleged intimidation. To calm his nerves, Richard took up golf in 1998 and began to make annual two-month trips to Florence to learn Italian.

By December 2000, Gazprom had recovered from its lows, but its market cap still stood at just $6.2 billion, leaving Sovereign with a sizable paper loss. Chandler and others familiar with the situation contend that management allies repeatedly offered to buy Sovereign's stake at a price that would have given them a profit.

"If we were in it simply for the money at Gazprom, we would have just taken the money," says Chandler. "But it was not about the money. In Russia we believed we could change a culture of fraud by going after the big fish, and that was Gazprom."

At the company's annual general meeting in July 2000, Sovereign and other minority investors succeeded in getting Fyodorov elected to the board over a management candidate. By teaming up with the five government appointees, who were sympathetic to complaints about management abuses following the election of President Vladimir Putin in March 2000, Fyodorov changed the balance of power at Gazprom. In May 2001 the board removed Vyakhirev as chief executive, kicking him upstairs to the largely ceremonial position of chairman, and installed Alexey Miller, then deputy Energy minister, as his replacement. Vyakhirev stepped down a year later, replaced by current chairman Dmitry Medvedev.

With Miller, a confidant of Putin who remains CEO, stopping much of the transfer pricing, Gazprom's share price rebounded. Sovereign sold off its stake between late 2002 and mid-2003, posting a 12.5 percent total return on its investment over nearly four and a half years. It was not the kind of result that the brothers were used to, but in unseating Vyakhirev they had made a point -- and saved the fund from a significant loss. "We finally left after nearly ten years in Russia because we felt we had done as much as we could in corporate governance and in shareholder rights," Richard explains.

With assets totaling nearly $1.4 billion, the brothers in late 2002 made their move into Japan's tottering banking sector. But even as they were putting the bulk of their funds into UFJ, Mizuho and other banks, the Chandlers decided in March 2003 to invest $168 million in SK Corp., the flagship company of SK Group, South Korea's third-largest chaebol, or conglomerate. The investment gave them a 14.82 percent stake in the oil refining company, just below the threshold that would have obliged them to make a takeover offer. The Chandlers paid little more than 1 times expected 2004 earnings. The reason? They bought just days after government auditors announced that SK had fraudulently boosted profits at its trading and gas station affiliate, SK Networks, by $1.2 billion. It later turned out that the unit had covered up a staggering $5.6 billion in losses.

"SK Corp.'s main business was solidly in the black, so we thought there was very little chance the problem at SK Networks would be big enough to bring the whole group down," says Richard, explaining the decision to invest.

The Chandlers also believed that SK Networks' creditors would help force the resignation of chairman and CEO Chey, who had been arrested on charges of illegal stock trading in February 2003 and was later charged with accounting fraud. Chey was convicted and imprisoned that June. Notwithstanding that conviction, Chey and his team of executives won creditors to their side by agreeing to swap $878 million in debt owed by SK Networks to SK Corp. into equity. Chey was released on bail in September pending an appeal, and a court subsequently suspended his sentence, enabling him to return to management. The company contended that Chey deserved to retain his posts because he had inherited the fraud when he took over the group in 1998 from his uncle.

Angered by the company's stance, the Chandlers embarked on a long and bitter campaign to oust Chey. They proposed a series of resolutions that Sovereign's then­chief executive, James Fitter, who left the firm last year to manage his own wealth, presented at SK's annual meeting in March 2004. The resolutions would have banned convicted criminals from holding any position at SK, required a majority of the board to be independent and created a committee to oversee all third-party transactions, to prevent SK from using refining profits to subsidize money-losing affiliates like SK Networks.

The Chandlers rejected a compromise negotiated by Jang Hasung, an economics professor at Korea University in Seoul and a leading shareholder rights activist, under which Chey would have resigned as chairman, given up his board seat and accepted most of Sovereign's resolutions if he were allowed to stay as CEO. Jang, who went to Monaco to pitch the plan directly to Richard, argued that a concession was necessary for Chey to save face, but Chandler dismissed the proposal, saying it smacked of "situational ethics" and would not ensure real change at SK.

"When I saw that a compromise was not possible, I washed my hands of the whole affair," Jang tells II. "The meeting illustrated the principles but also the arrogance of the Chandlers."

Chey defeated Sovereign at the 2004 meeting and remained as chairman and CEO. The Chandlers continued to campaign for Chey's removal but failed to block his reappointment to the board in March 2005. Facing a legal ban on reintroducing defeated resolutions for three years, the brothers sold their stake for $896 million in July 2005, a more than fivefold return on their investment.

Sovereign's efforts weren't entirely in vain. After the 2004 meeting, Chey adopted some of the fund's key demands to placate shareholders. Seven out of ten SK board members are now independent, and over the past two years, SK has done more than its peers in terms of raising its dividend, reducing debt, issuing transparent monthly financial reports and establishing a committee to oversee third-party transactions, according to analysts. "Those are all very positive changes, and I don't think they would have happened without the pressure from Sovereign," say Marc Goldstein, head of Asian research at Institutional Shareholder Services in Tokyo.

Nevertheless, the SK experience was a bitter one for the Chandlers. Sovereign had spent $4 million on a campaign with the slogan "Stand Up! Korea," arguing that its proposals would have improved corporate governance for the benefit of the country.

The brothers themselves stayed out of the public eye during the campaign. "We felt that if the whole issue had been about who we are and our performance rather than the principles we advocate, then the world, being lazy, would just latch on to how much money we make," says Richard. "What we wanted people to focus on was the development of economies, property rights, capital allocation and the good corporate governance principles that are meant to be creating prosperity for everyone."

In the end, however, Sovereign was vilified by the local media, politicians and many domestic shareholders as a rapacious foreign raider. It is largely to combat that caricature, Richard says, that he decided to speak with II.

Today the brothers' main exposure is in Japan, where Sovereign has some $3 billion invested. Its biggest holding, believed by people familiar with the fund to be worth at least $2.7 billion, is its stake in Mizuho, the world's third-largest bank, which has more than $1.3 trillion in assets and a market cap that has soared from $10 billion to nearly $91 billion since the Chandlers first began investing in it. President and CEO Terunobu Maeda has spent the past three years integrating the three institutions that merged to form Mizuho -- Dai-Ichi Kangyo Bank, Fuji Bank and Industrial Bank of Japan -- laying off one fifth of the combined staff and building up the retail business to complement existing strengths in corporate lending. Analysts expect Mizuho to post record earnings of nearly $6 billion in the year ending March 31, a dramatic turnaround from the $19.4 billion loss three years earlier.

In addition to their Indian holdings, the Chandlers also have dabbled in Chinese oil stocks over the past year. Richard is cautious about China, however, contending that growth won't necessarily translate into investment returns because of legal uncertainty and poor corporate governance. "China still has a long way to go to create trust in the Chinese capital markets," he asserts.

The ultimate irony is that after two decades of blazing trails in emerging markets and out-of-favor sectors, and becoming fabulously wealthy in the process, the Chandlers now find themselves heavily invested in some of the most fashionable markets on earth. So have they lost their appetite for risk and gone mainstream? Richard insists not.

The adoption of orthodox economic policies has transformed many emerging markets and reduced risk over the past ten to 15 years, he acknowledges. Asian markets no longer offer many great value plays, but he believes there is still great potential for investors who can identify the companies that are likely to profit from the region's extraordinary growth and become global leaders.

"Our talent is to understand the long-term potential of a business," Richard says. And when they do, the Chandlers will back their hunches 100 percent.

The Sovereign method

Sovereign Global Investment has built a staff of about 20 professionals as its portfolio has blossomed to some $5 billion, but the firm is at heart a two-man partnership. Richard and Christopher Chandler generate most of their investment ideas in private discussions that cover everything from technical analysis and market psychology to macro trends like the transition to capitalism in Eastern Europe and the rise of Asian economies. Richard likens their working relationship to that of another celebrated pair of investors, Warren Buffett and Charlie Munger.

"I do the analysis and develop the concept," he says. "Then I take the concept to Christopher and ask him, 'Hey, is this crazy or not?' A sense of value ultimately comes down to being able to project a future and see where a business case really goes in five or ten years. No one I know is better at that than Christopher."

Since 1991, when they turned to equity investing, the brothers have retained at least two full-time analysts to research potential targets. Frequently, given the distressed state of some of the markets and companies in which Sovereign invests, the analysts have to resort to what Richard calls "creative metrics." Brazil's hyperinflation in the early 1990s made price-earnings ratios virtually impossible to calculate, so Sovereign looked at market capitalization per access line to evaluate the national telephone monopoly, Telebrás, and found it was dirt cheap at $200 per line, compared with $2,000 for Mexico's Telmex.

The fund's staff of researchers, traders, lawyers and accountants are a group of mostly 30-something professionals hired from leading financial services firms. President David Mapplebeck joined Sovereign in 2004 after working in the enforcement division of Britain's Financial Services Authority and as European general counsel at Charles Schwab Corp. Chief trader Pekka Johnson, whom Richard Chandler calls his "eyes and ears'' in the markets, worked in Asian equity sales in Hong Kong for nine years, most recently as an executive director at UBS, before joining Sovereign in May 2005. Investment manager Derek Sheeler, who also came to the firm last year, had worked variously as an analyst and portfolio manager at Saudi investment firm Olayan Group in New York, Gabelli Asset Management and Wellington Management. The staff like to kick around ideas over espresso at the well-appointed canteen of Sovereign's headquarters on the ninth floor of the Dubai Convention Center.

Sovereign usually holds fewer than ten equity positions at any one time. Though it typically holds its larger positions for two to five years, the firm regularly trades in and out of some stocks to test the waters and take advantage of price movements. In a recent nine-month period, Richard Chandler says, Johnson has traded some $6 billion worth of stocks. That includes the sale of Sovereign's 14.82 percent stake in South Korean refiner SK Corp. and the purchase of stakes in ICICI Bank and Housing Development Finance Corp. in India, as well as trading smaller positions in a few Hong Kong­listed oil companies.

Once they've done their homework and decided to make an investment, the Chandler brothers like to move fast. "The market gives you the opportunity to arbitrage what the emotional investor will pay or sell at versus the fundamental value of a company, but you've got to pull the trigger promptly without hesitating," says Richard. "We've disciplined ourselves mentally and prepared ourselves in terms of information, as well as relationships with brokers, to do that." --D.L.

Stepping gingerly into the light

Although Richard and Christopher Chandler say that social obligations lie at the heart of their investing activities, the two brothers have remained remarkably private individuals.

On its Web site (www.sov.com), the brothers' Sovereign Global Investment proclaims its goal to be nothing less than seeking "prosperity for all by promoting effective capital allocation and good corporate governance." The firm lists its core values as honesty, integrity, justice and mutual respect and vows to live by the golden rule: "to treat others as we would like others to treat us." But the site avoids any mention of the Chandlers themselves, saying only that Sovereign was founded by two New Zealanders.

Richard Chandler acknowledges that the brothers' secrecy might seem at odds with their self-proclaimed social mission and devotion to transparency in corporate governance, but as custodians of only their own wealth, they have until now felt no obligation to speak publicly.

That stance may have cost them in South Korea, where their effort to force management changes at oil refiner SK Corp. were successfully blocked. SK's spin portrayed Sovereign as being interested solely in short-term profits. Michael Breen, a journalist and the author of The Koreans, says that Christopher Chandler had him flown from Seoul to Sovereign's Dubai offices to discuss ways to boost the fund's image in South Korea. Breen's advice: "Meet with and court the Korean press." The brothers, protective of their privacy, never followed it.

It was partly as a result of that experience, and partly in response to the efforts of Institutional Investor Staff Writer David Lanchner to dig up the Sovereign story, that Richard Chandler agreed to give his first-ever interview. His aim, he says, is to explain Sovereign's history and the importance of its investing principles. But he declined our request for a photo shoot and instead forwarded a few polished shots by Singapore photographer Russell Wong (see Inside II, page 5). "We are not perfect," say the Sovereign duo in their Web site manifesto. "We seek progress, not perfection." Still, it seems they'd rather not risk any blemishes or flyaways.

Although they can seem uncompromising and painfully earnest to some who have dealt with them, friends say the Chandlers have a lighter side. "They are extremely serious when it comes to moral convictions, but they don't hit you over the head with them," says Mark Foster-Brown, a partner in London hedge fund Altima Capital, who has known the Chandlers since trading for them at Morgan Grenfell in the '90s. He and his partner, Mark Donegan, who also has handled trades for the Chandlers in the past, bring the brothers and their father, Robert, to London's Twickenham Stadium whenever New Zealand's rugby team, the All Blacks, play against England. "It's a moment of pure relaxation," says Foster-Brown.


A few big bets

Over the past 15 years, a mere five investments have generated 90 percent of Sovereign's gains.

Stock

When

Amount Invested

($ millions)

Exit Price ($ millions)

Return (%)

Mosenergo1993-­'97$62$300383%
Unified Energy Systems1993-­'97132700430
UFJ Holdings2002-­'045701,460156
SK Corp.2003-­'05168896433
Mizuho Financial Group2003-­present6002,720* 353
*Current value of holding.
Sources: Sovereign Global, Institutional Investor estimates.