Bill Browder, the co-founder of Hermitage Capital Management, said there’s one message to take from investors who now are in a mad dash to sell their Russian securities, even if they incur a total loss: Stay out of corrupt countries or you’ll lose your money.
“All these people who hold Russian securities are going to more or less sell them at zero,” Browder told Institutional Investor. “They’re going to end up with a total write-off because Russia won’t even let people take out more than $10,000.”
Few investors know Russia better than Browder, who in 1996, founded the Moscow-based hedge fund firm Hermitage, which, at one point, managed $4.5 billion, including the assets of the largest foreign investment fund in the country. As the largest foreign investor in Russia at the time, Browder began to work as a shareholder activist, exposing corruption in some of Russia’s largest companies, including Gazprom, a Russian state-owned energy company.
Last week, Russian troops invaded Ukraine from the north, east, and south and have since attacked the country’s major cities, including Kyiv, Kharkiv, and Kherson. Only Kherson has been overcome. Following the initial invasion, asset owners — including Norway’s $1.3 trillion system, the world’s largest sovereign wealth fund — have announced and initiated divestments from Russian assets. Canada’s second-largest pension fund removed all its Russian positions, and Australia’s sovereign wealth said it will wind down allocations to Russia.
In the U.S., state officials in Georgia, New Jersey, Colorado, New York, Rhode Island, and Illinois proposed complete divestment from Russia, which includes state pension fund portfolios.
Despite the divestment push, it will be difficult for sellers to find buyers in the market or protect themselves from near total losses.
“It’s a reminder that if you do business in countries without a rule of law, you could lose everything,” Browder said.
Perth Tolle, founder of Life + Liberty Indexes and creator of the Freedom 100 EM (Emerging Markets) Index, reiterated Browder’s conclusions: “The time to divest from Russia was when it could be divested from,” Toll told II. “Now, it's more like a write-off. Nobody's buying it.”
Tolle’s index fund uses a process it calls freedom weighting, which uses country-level freedom scores from third-party data providers to calculate a country’s weight in its allocation.
The country's weight depends on the level of freedom in that country based on measures like the country’s quality of governance, rule of law, private property rights, civil procedures, and criminal procedures. Freedom weighting also factors in the strength of each country’s institutions — its monetary policies, the presence of checks and balances on its government, and the nature of elections. The index fund awards higher weight to “higher freedom” countries and lower weight to nations on the other side of the freedom spectrum.
As a result of freedom weighting, Tolle’s fund has no allocations to China, Russia, and Saudi Arabia — all countries the freedom weighting process deemed autocratic — or “low freedom.” But, this isn’t the standard approach. In fact, Tolle said many emerging market funds have up to 40 percent dedicated to China, 3 percent weight in Russia, and 2 percent devoted to Saudi Arabia.
“Not all investors care about autocracy risk,” Tolle said. Some investors are even buying the dip, she said.
For investors and managers with longer investment horizons, the Russia-Ukraine conflict may do little to change their process. Dan Suzuki, deputy chief investment officer at Richard Bernstein Advisors, said the impact of the conflict on managers’ portfolios depends largely on that manager's time horizon. Managers with shorter investment horizons will need to pay close attention to the details of the conflict while managers with longer-term goals can evaluate whether or not the conflict will have long-lasting effects on the fundamentals of businesses.
“Typically with geopolitical events, the market reactions tend to get reversed over time,” Suzuki told II. “For us, the direct impact on corporate profits overall is probably going to be very small.”
Suzuki believes the lesson for managers is that the more dependent a company is on the government and governmental policy, the less it is going to be driven by “typical fundamentals” like profits, liquidity, and valuation sentiment. Suzuki said managers need to put these riskier assets at a discount based on the “reasonable risk that government actions are going to overwhelm those fundamentals.”
However, Tolle said it’s best for owners to completely steer clear of these types of environments altogether.
“What’s more fundamental than your market being investable?” Tolle said. “You cannot discount this. It is unquantifiable, it's unpredictable.”
Browder would agree. In 2009, his lawyer Sergei Magnitsky, who helped expose the corruption and testified against the officials involved, died in a Russian prison.
After Magnitsky’s death, Browder realized justice in Russia would be an impossible feat and began a lobbying campaign in the U.S. that led to the adoption of the Sergei Magnitsky Rule of Law Accountability Act in 2012. The act barred the officials involved in Magnitsky’s death from getting visas to the U.S. and froze their assets in the West.
“He was arrested, tortured, and killed,” Browder said in the interview. “I made it my life’s work to go after the people who killed him and make sure they face justice.”