Monday, February 6, 2012

Financial Times: A Romanian national fund unlike any other

By Phil Davis

Fondul Proprietatea is a national fund unlike any other. It was set up in December 2005 to compensate people whose assets were confiscated under Romania’s Communist regime and has no equivalent elsewhere in eastern Europe.

Moreover, investment management has been outsourced to a single fund manager, Franklin Templeton, which manages about €3.3bn of Romanian state assets.

Strangest of all, perhaps, the closed ended fund has become an aggressively activist fund and is currently suing the government that created it.

All in all, not your average investment fund.

And yet foreigners are starting to buy into it. Since its listing in January last year to allow restituant claimants to sell their shares, at least three institutional investors have taken the plunge, including Elliott Associates, the US activist hedge fund that has made its name suing emerging market governments around the world and is not known for throwing its money away.

So why the interest?

First, there is the allure of Franklin Templeton’s Mark Mobius, a legendary emerging markets investor who has spent the past 25 years travelling the globe unearthing investment opportunities.

Then it is a play on the energy sector, with most of the 75 companies in the fund connected to energy in some way. This is attractive to institutional investors seeking new ways to increase their allocation to commodities in the expectation that prices will rise over the long term.

In addition, the fund has become more transparent and liquid after its listing on the Bucharest stock exchange. Perhaps most significantly, its shares languish at a 60 per cent discount to net asset value, attracting deep value investors.

Nevertheless, investing is still a leap of faith. It is a play on the Romanian economy, on the willingness of the Romanian political elite to enact reform and on whether Franklin Templeton can guide the state-run companies to higher levels of corporate governance.

The signs are that progress is being made: the daily demonstrations that scar Bucharest are an indication that change is real and sizeable.

In truth, there was little option for the government but to act. In the lead-up to Romania’s accession to the European Union in 2007, it overspent wildly, raising pensions and benefits, while awarding public sector workers 25 per cent pay rises three years in a row. The International Monetary Fund was forced to intervene in 2009 with a €13bn credit line and strict financial targets.

A series of cutbacks – including a 25 per cent reduction in public sector wages – has combined with reforms of the budget process and governance to produce startling results.

GDP, which plunged by 6.6 per cent in 2009, was up 4.4 per cent in the third quarter of 2011. The budget deficit is expected to fall from 7.3 per cent in 2009 to 1.9 per cent this year and inflation has stabilised at 3 per cent.

Tonny Lybek, the IMF representative in Romania, says: “The ship has been turned round. The key now is to accelerate growth with greater use of EU structural and cohesion funds.”

But the IMF is not the sole agent of reform. With meaningful minority stakes in many of Romania’s state-controlled enterprises, the fund has been able to exert pressure on boards to focus on growth and profitability and eliminate waste.

One measure involved vetoing an R&D project led by Romgaz, the country’s largest gas supplier, to recycle carbon dioxide emissions. “The project would cost €1bn and would have been NPV [net present value] negative for the three companies involved,” says Adrian Cighi, a Franklin Templeton analyst. “We voted against it.”

Boards that pursue pet projects or other strategies that destroy shareholder value may think twice in future. Fondul Proprietatea has shocked Romania’s corporate elite by suing individual directors who vote for value-impairing measures. Grzegorz Konieczny, FP’s manager, says: “We introduced the idea of personal responsibility. It sends a message that we are watching companies, boards and individual directors.”

Little by little, corruption, cronyism and inefficiency are being squeezed out of state-owned businesses.

Petrom, the oil and gas conglomerate that is Romania’s largest company, is a poster child for change. Since OMV, the Austrian energy company, acquired a 51 per cent interest in 2004, Petrom has exited non-core and lossmaking businesses, trimmed its labour force from 60,000 to 22,000, created a supervisory board of independent directors and completely overhauled its corporate governance.

“We don’t just follow the new stock exchange rules covering independent directors and so on,” says Mariana Gheorghe, Petrom’s chief executive, “we have instilled business ethics into the fibre of our organisation and generated a whole change in mentality.”

The hope is that Romanian companies will become more efficient and profitable and that many will eventually list on the stock exchange, creating value for shareholders including Fondul Proprietatea. A number of listings would provide transparency to the fund’s unlisted portfolio and undoubtedly narrow the discount of share price to NAV.

But the huge discount to NAV also reflects investors’ concerns about the exposure of the fund to political tinkering. Under pressure from the IMF to reduce its deficit, the Romanian government last year accepted a €100m “donation” from Romgaz.

Fondul Proprietatea was furious. Not only did the move reduce the value of one of its key portfolio companies, it sent a terrible message about governance in the country.

“It was not a huge financial hit to the fund, but it set a bad precedent that could have scared off foreign investors,” says Mr Mobius.

The fund is suing the government to retrieve the Romgaz assets.

However, Mr Mobius thinks the opprobrium heaped on the government over the Romgaz “donation” makes it unlikely it will repeat the trick again.

And the veteran investor insists that Romania compares favourably with other emerging markets.

“Romania is developing much as other eastern European countries have done,” he says. “But I have a feeling it will leapfrog many of those countries in coming years.”
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