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Putting Unloved Russia Back into the “BRICs”

June 2012 Florian Fenner, Chief Investment Officer UFG Asset Management [email protected]

Presentation Overview: Goal – to Give Investors a Better Understanding

Though nascent and volatile, Russia represents a unique combination of: • physical

• financial • and intellectual assets that warrants inclusion in any truly diversified international portfolio Putting Unloved Russia Back Into the “BRICs” Confidential & Proprietary – Not for Distribution

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Biographies – UFG Asset Management Public Markets Principals Florian Fenner joined UFG Asset Management as Managing Partner in July 2002. He is an experienced investment manager who has directed investments in Russian securities for over 16 years. Prior to joining UFG, from 2000 to 2002, he was Head of the Unifund’s Moscow office with responsibility for its Russia portfolio. From 1996, Mr. Fenner served as Deputy Head of Research at Brunswick Brokerage, one of Russia’s leading investment banks and, in 1997, he became a Russian equity Portfolio Manager for Brunswick Capital Management. Before joining Brunswick, he worked as an investment banker for Schroder Munchmeyer Hengst Co. in their Frankfurt office. Mr. Fenner is a charted financial analyst and holds a degree in banking from Industrie-und Handelskammer in Frankfurt-am-Main (1992-1994).

Dr. Maxim Tishin, PhD, Joined UFG Asset Management in 2003. Prior to joining UFG, he studied for a Ph.D. in Economics from the Finance Academy of the Government of the Russian Federation. Mr. Tishin holds a MSc in Applied Mathematics from the Moscow State University.

Ms. Polina Minkina joined UFG Asset Management as Portfolio Manager in 2007. She holds a BSc degree in Computational Mathematics and Cybernetics from the Moscow State University. Her studies focused on optimal portfolio hedging strategies. Prior to joining UFG AM, Polina worked as a Portfolio Manager for the Russian asset management company Portfolio Investments, where her responsibilities included derivatives strategies implementation.

Putting Unloved Russia Back Into the “BRICs” Confidential & Proprietary – Not for Distribution

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UFG Asset Management – Organization Chart

 UFG is the only major investment group in the Russian region which is part of a fully diversified alternative asset management

business with over $1.20 billion in AUM (sans $0.47 billion domestic retail business sold to Deutsche Bank in Nov 2011).

Putting Unloved Russia Back Into the “BRICs” Confidential & Proprietary – Not for Distribution

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Investing in Russia: Three Main Takeaways from UFG 1. Russia is Austere, Cheap, Petro-charged, but Volatile

• 12% sovereign debt to GDP, zero capital controls, low flat tax rates • Equities 4.5x P/E, 0.7x book, at trough valuations; consumer-related offer growth • Caveat: Susceptible to external and internal event risk

2. Hedged Equity and very long-term PE/RE portfolios are Best Option • • • •

Focus on exposure management, capital preservation, dividends Use of derivatives to capture beta, deep analysis to generate alpha Real Estate and Agriculture are bureaucracy-laced, but offer rewards Private Equity allows control, transparency; excellent historical returns

3. Russian Assets Have Multiple Catalysts

• Credit upgrade, foreign inflows due to structural decline in inflation, elevated oil prices, and stabilization in politics following March elections, May inauguration • Realization vs. 2008 that de-levered Russia truly “is different this time” • WTO, 2014 Sochi Olympics, 2018 World Cup - impact on Investor Perception

Putting Unloved Russia Back Into the “BRICs” Confidential & Proprietary – Not for Distribution

The Russia We All Know: Backing the Economy – Natural Resources 25

Russia’s % share of world total

20

Reserves Production Consumption

15 10 5 0 Gas

Coal

Share of world production (%) Gas Nickel Oil Uranium Gold Silver Scrude Steel Oiron Ore Coal

19.6 18.4 12.4 8.2 6.7 5.7 5.4 5.1 2.8

Oil

Source: BP Statistical Review of World Energy June 2009; British Geological Survey; Goldman Sachs

•

Russia has nearly 25% of the world’s natural gas reserves

•

Russia has nearly 15% of the world’s coal reserves

•

Russia produces over 12% of the world’s crude oil

•

Russia produces almost 20% of the world’s nickel

•

Russia is the largest producer (12.4%) and second largest exporter of oil in the world

25%

World Natural gas Reserves

Putting Unloved Russia Back Into the “BRICs” Confidential & Proprietary – Not for Distribution

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The Real Russian Economic Miracle: A Decade of Surpluses in the Bank Federal Budget Revenues & Spending, $ bn

$513bn

Central Bank Reserves April 2012

9 straight years of surpluses

Source: Otkritie, Troika Dialog estimates

Putting Unloved Russia Back Into the “BRICs” Confidential & Proprietary – Not for Distribution

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What Makes Russia Different: 12% Debt/GDP, No Capital Controls, Low Taxes Record Low Benchmark Rates, Even Amid Euro Woes

Yield 3.86% 10%

Average Volatility

Source: Troika Dialog, Otkritye

Putting Unloved Russia Back Into the “BRICs” Confidential & Proprietary – Not for Distribution

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Russian Equities: Far Greater Performance Last Decade than Most Realize World Stock Market Returns, 2000-2012 (USD) Russian Stocks:

+626%

31 Dec 1999 – 25 May 2012

Source: UFG Asset Management, Bloomberg

Putting Unloved Russia Back Into the “BRICs” Confidential & Proprietary – Not for Distribution

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Russian Equities: At 4.5x P/E, Over a Standard Deviation from Historical Norm ** Russian shares currently trade at over 65% discount to EM peers **

- 67%

Source: Deutsche Bank

Putting Unloved Russia Back Into the “BRICs” 10

Russian Equities: At 0.7x Price/Book , Near Trough Levels of 2009

Deep Value 0.7x Book Putting Unloved Russia Back Into the “BRICs” 11

Russian Equities: Look Even Cheaper Given Inflation in Secular Decline 2008: Kremlin defended rouble until its eventual peril 2009-11: Floating rouble allowed to absorb inflation, keep rates steady in crisis 2012: Floating rouble policy has served Russia well in crisis

2012 forecast:

5.8%

Source: Bloomberg

Putting Unloved Russia Back Into the “BRICs” 12

Russian Equities: Once at Premium, Now at Steep Discount vs Brazil

75% of Brazil’s P/E

Source: Troika

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Russian Equities: Levered to Oil & Inflation, But Prone to Volatility… History repeating?

2002 p/e: 8x 2007 p/e: 11x

2012 p/e: 4.5x

40%

Average Volatility 2000s

All returns driven by EPS growth

What if Russia truly changes??? Source: Bloomberg

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Politics: Does Western Media Overstate Risk? Could Putin 2.0 Surprise? Multiples Ignoring Olympics/World Cup, 2010-11 Political Breakthroughs with USA & Ukraine, 2012 WTO Membership, Rosneft-Exxon & Novatek-Total JVs, Commitment to Privatization •

•

History often marred with judgments at odds with equity investors, West, democracy… – Examples: Gazprom ringfence; Yukos destruction; VimpelCom, Mechel tax sagas; Hermitage troubles – Georgian conflict 2008: Kremlin hardliners overreached, brought Western condemnation, isolation – December, 2011 rigged Duma elections: Middle-class street protests across country, market feared worst – Spring 2012 oligarch-led assaults on foreign stakes held in BP-TNK and VimpelCom ...but from a longer-term perspective, Putin-Medvedev has made significant progress – Flat tax 2001; Gazprom ringfence collapse 2005; correction of VimpelCom, Mechel, Uralkaliy tax targeting – Creation of stabilization fund, 2005; capital account liberalization in 2006 – no capital controls in Russia – July 2009 Medvedev-Obama summit akin to fall 2001 Putin-Bush détente; clear thaw developed after America scrapped Eastern European missile defense shield plans & Russia reciprocated fall 2009 – Spring 2010 Russia-USA START treaty and Ukraine gas agreements brought further tailwind to lower ERP – Quick resolution to “spy scandal, sacking of Moscow Mayor, Libya “abstain” vote key 2011 developments – Post-Duma election fraud: peaceful protests allowed, constructive dialogue begun, regional governors again to be voted on by people (not by Putin appointment); Kudrin the bridge between Putin and protestors?

•

Little international adventurism expected ahead of 2014 Sochi Winter Olympic Games, 2018 FIFA World Cup

•

Privatization: Recently reaffirmed commitment clear positive, rise in State-run co. dividends underway (Gazprom)

•

Putin re-election and inauguration has been met with muted levels of civil protest, widespread acceptance

•

Dec 2011 WTO accession confirmed; Rosneft-Exxon, Total-Novatek JVs eventually will help lower political risk Section II: Opportunities in Russia and CIS 15

The Power of Hedging: Leading Russian Fund Exposure Levels, Performance

Use of Derivatives Key to Protecting Capital while Running With Rallies • Emergence of London EDX Exchange

Source: UFG Asset Management

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The Power of Alpha: Uncovering Value Destruction, Creation in Russia

Gazprom

Rosneft 2010A Oil Price, $/bbl EBITDA, $bn CapEx, $bn FCF, $bn

78 19,096 (8,817) 7,342

2012E 100 19,923 (15,500) 1,788

2011A Oil Price, $/bbl

2012E

78

100

EBITDA, $bn

63,000

54,600

CapEx, $bn FCF, $bn

-43,800 5,200

-26,500 18,200

•

Stagnant or quasi-stagnant portfolios such as ETFs fail to catch major changes in corporate behavior

•

Rosneft was one of Russia’s greatest-managed State assets – but new management pales in comparison

•

Gazprom historically has been Russia’s worst-run asset – but just cut capex and raised dividend massively Source: Troika Dialog, Otkritye estimates

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Speaking of Dividends… Yield on MSCI Russia Crossing Long-Term USD Debt

4.8% 4.4%

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The Power of Alpha: The Other 70% of GDP, Russia’s Fast-Growing Consumer Sector Russian per capita spending on goods and services, $/year

2009-15E CAGR 16.6%

BRICs #1 GDP/Capita: $15,000 Combined with… • 13% flat tax • exceptionally high level of home ownership (gratis during 90s privatization) … Means ~75% of Russian income is disposable

•

Coca-cola Russia makes 3x the profit of its Chinese unit – on one third of the sales; Pepsi’s 40x p/e M&A

•

Russia is GM’s #1 market worldwide in terms of market share and profit; Ford enjoying superprofits now Source: Rosstat; Renaissance Capital estimates

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Russian Private Equity: Superior Historical Returns - Double BRIC Average Russian PE 10-Year Returns vs. Fundraising “Success” Compared to BRICs and EM Average

23.8% IRR Russian PE, 2000-2010

Comparative End-to-End Returns by Region* Index

Ten Year return, %

Emerging Markets PE & VC

11.96

Asia (ex-Japan) PE

12.81

CEE & Russia PE

18.33

Russia and CIS Survivors*

23.83

Latin America & Caribbean P

3.61

MSCI Emerging Markets

16.54

US VC US PE Western Europe PE

1.25 11.34 19.33

*as of 30 June 2011 **funds sponsored by EBRD which will raise a follow-on fund, as of 31 December 2010

Source: EBRD, EMPEA

Putting Unloved Russia Back Into the “BRICs” Confidential & Proprietary – Not for Distribution

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Russian Real Estate: Moscow - an Attractive Commercial Market Capitalization rates in European cities

•

2011 was a record year for Russian real estate with $9.5bn in transactions, an 80% increase vs. 2010 levels.

•

Due to increased investor interest, market pricing expectations on the sell-side have hardened and yields for quality premises have compressed, though yields are still high when compared to other European capitals.

•

Foreign capital participation in Russian real estate has expanded over the past year, from 16.9% in 2010 to 28.2% in 2011. Investor origin – foreign capital starting to come back

Source: Cushman & Wakefield 2012

•

Vacancy rates continue to drop in all sectors due to the swelling demand for premises and low volume of new space.

•

Rental rates in office sector increased 30% YoY; warehouses rental rates grew 22% and 12% in retail.

•

Russian indicators have not yet recovered to pre-crisis levels. As a result Russia has a clear upside to bounce back, offering very attractive investment opportunities. Source: Cushman & Wakefield 2012

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Russian Agriculture: Main Advantages, Size, Scale vs BRICs, World Top Five Countries With Agricultural Land Supply, 2007 200000 180000 160000 140000 120000 100000 80000 60000 40000 20000 0

Russia’s main agricultural advantages: • Only country where acquisition of large tracts of land is still possible (among countries with largest agricultural land areas) • Russia recognizes private ownership in land • Experienced and low cost farm labor • Abundance of water supply & fertilizer/potash

20000

2010 Average Agricultural Land Values, $USD

18000 16000

USA

India

China

Russian Federation Arable Area, 1000 Ha

Brazil

7% of US agricultural productivity/yield level $800/hectare for incredibly fertile land

14000 12000 10000 8000 6000 4000 2000 0 UK

Source: FAO Global Food Outlook, December 2009

US 1 Hectare

France

Russia

1 Acre

Putting Unloved Russia Back Into the “BRICs” Confidential & Proprietary – Not for Distribution

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Russian Catalysts: Who’s Risky Now? Moscow Next in Line for Upgrade Credit Quality: Diverging Trends (S&P Rating) 2000 Emerging Markets China India Brazil Turkey Russia

Developed Markets Japan Italy Ireland Greece USA

BBB BB B+ B+ B-

2005 ABB+ BBBBBBB-

Other Factors: 2010 A+ BBBBBBBB BBB

2011 AABBBBBB BB BBB

2012 AABBBBBB BB BBB

• • • •

AAA AA AA+ AAAA

AAAAAAA A AAA

AA A+ AABB+ AAA

AAA BBB+ CC AA+

AAA BBB+ CC AA+

• •

Rouble now more freely floats Banking sector healthier with foreign assets > foreign liabilities Geopolitical position now materially better (no risk of Georgia-type conflict) Russia more committed to improving investment climate via privatization & international M&A Sustained High Oil Prices Political reform following March Presidential elections?

Source: Bloomberg

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Russian Catalysts: Realization That It Truly “Is Different This Time” Russia Less Vulnerable to External Shocks: Corporate Debt, 2008 vs 2012

Source: Deutsche Bank

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Russian Catalysts: Multiple Events to Open Russia to World, Change Perceptions Takeaway: Russian asset multiples set to expand, Kremlin “ambitions” kept in check WTO Accession

• Should boost medium-term GDP growth rate toward +5% • Rules-based trade framework a major weapon against corruption, could provide productivity increase

2012 APEC Summit 2014 Sochi Olympics 2018 FIFA World Cup

 Total $77bn special gov’t

infrastructure spending 2012-18 Putting Unloved Russia Back Into the “BRICs” 25

Summary: Three Main Takeaways from UFG 1. Russia is Austere, Cheap, Petro-charged, but Volatile • • • •

12% sovereign debt to GDP, zero capital controls, low flat tax rates Equities 4.5x P/E, 0.7x book, at trough valuations; consumer-related offer growth Rouble debt yields high and mainly investment grade Caveat: Susceptible to external and internal event risk

2. Hedged Equity, Short-Term Debt and PE/RE portfolios are Best Option • • • •

Focus on exposure management, capital preservation, dividends Use of derivatives to capture beta, deep analysis to generate alpha Real Estate and Agriculture are bureaucracy-laced, but offer rewards Private Equity allows control, transparency; excellent historical returns

3. Russian Assets Have Multiple Catalysts

• Credit upgrade, foreign inflows due to structural decline in inflation, elevated oil prices, and stabilization in politics following March elections, May inauguration • Realization vs. 2008 that de-levered Russia truly “is different this time” • WTO, 2014 Sochi Olympics, 2018 World Cup - impact on Investor Perception Putting Unloved Russia Back Into the “BRICs”

UFG AM: Born as Boutique, Built Beside Deutsche, Now Independent Again Founded 1996 as Investment arm of Russia’s Leading Local Brokerage, United Financial Group • •

UFG Investment Bank founded 1994 by Charles Ryan and late Boris Fedorov; sold to Deutsche Bank, 2005 UFG Asset Management established 1996; offered money management services to domestic investors – Launch of Pyotr Stolypin Fund, 1996 – one of Russia’s oldest mutual funds, currently over $125.0m AUM – UFG Russia Select Fund, begun 2002 - long-short, blue-chip monthly liquidity equity risk-managed strategy – UFG Russia Debt Fund, launched 2005 – short duration local debt-focused, rouble-hedged high yield – UFG Russia Alternative Fund, inception 2006 – mid-cap equities, heavy long-bias “best ideas” portfolio – UFG Credit Opportunities Fund, started Jan 2009 – pure USD quasi-sovereign fixed-income mandate – UFG Debt Fund, launched Nov 2009 – high credit rating focused local currency strategy targets rouble carry

Allied with Deutsche, Able to Withstand & Expand Amid Worst of Global Malaise; Now Fully Independent • • •

• •

UFG sold its retail/pension domestic asset management business to Deutsche Bank in November 2011; all other UFG businesses (hedge funds, private equity and real estate) remain independent and in control of the founders. AUM is nearly $1.2 billion firm-wide (30 April 2012); UFG AM has raised $650m+ since 2008 crisis Hedge Fund Group able to launch two new strategies amid worst of global credit crunch: – UFG Credit Opportunities Fund: successful $100m fund launch, January 2009 – UFG Debt Fund: successful $100m fund launch, November 2009 UFG Real Estate raised second, $82m investment vehicle in June 2009 and $120m co-investment in 2011 – Spinning off UFG AgroPartners, 28,000 hectare grain farm in southwest Russia along Ukraine border, 2012 UFG Private Equity: major investors including the EBRD backed up $225m UFG PE II Fund in June 2010 – UFG PE II is 74% committed into six investments– and already paid out 63% via two exits; 128% IRR Putting Unloved Russia Back Into the “BRICs” 27

Contacts

[email protected] Pauline Gerasimenko 5 Petrovka Street 107031 Moscow Russia Tel. +7 (495) 662 3030 Fax. +7 (495) 721 1210

Victoria Angelatova Cornish 55 Market Street 01938 Ipswich, MA USA Tel. +1 (617) 755-6577 Fax +1 (617) 356-6256

www.ufgam.com

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