The Next Energy Plays
By Maike Currie, 04 May 2012
The last time I spoke to FMG, a specialist emerging markets fund manager, we were talking about Iraq. Henrik Kahm, an investment analyst with the group, was touting its Iraq fund. This single-country open-ended investment company (Oeic) was launched in May 2010, on the premise that the country had bottomed in terms of the postwar era, with the catalyst for change being revenues from growing oil production. Today his uncle, Johan Kahm, co-founder of FMG, is telling me about another commodity/energy play: Mongolia.
As with the Iraq fund, my immediate reaction is: "no way, far too risky." Mr Kahm agrees: "We don't want any client in this fund unless you can afford to lose the money." For those who can afford to lose their money, he suggests a holding of no more than 2 -3 per cent of total assets and a very, very long time horizon.
Despite the risks and esoteric nature of the investment, Mr Kahm is adamant that this is an opportunity that wealthy investors (with the mandatory appetite for risk) cannot afford to miss. He and other partners at FMG started the Mongolia fund with their own personal money. In fact, Mr Kahm claims to have 100 per cent of his equity holdings tied up in frontier and emerging markets on the basis that: the growth there will far surpass that of the developed world; the valuations are cheaper; and that, in 20 years' time, we will witness a massive shift in power to these regions.
His views aren't new or groundbreaking, but the markets he is excited about – Mongolia and Iraq – are as unexplored and unloved as they come. He views the Bric economies (Brazil, Russia, India and China), Africa and the Middle East as somewhat old-hat and believes it is these undiscovered plays that investors should be looking at.
"It will be Russia in 1995 all over again," he says about Mongolia, pointing to the fact that, back in the 1990s, the thought of investing in the economy of Russia scared many potential investors. The Russian RTS index then traded at 100. Today, this index trades around 1600.
He believes a similar opportunity has arisen in Mongolia and Iraq, with the main driving force the 'real' assets of these two countries. Iraq's estimated oil reserves match both those of Russia and Saudi Arabia, yet the total stock market capitalisation is only around 1 per cent of these two economies. Mongolia, meanwhile, boasts the world's largest reserve of coal along with large deposits of copper, gold, uranium, iron ore and rare earth minerals. Of course, both economies also come with massive political and corporate governance risks. But Mr Kahm's argument is that even the most crooked establishment will struggle to make mineral wealth disappear overnight: "You have a big, concrete asset – it's there – it can't be 'stolen'." Some might beg to differ with him, but he continues: "These are assets with huge value. I can understand if an investor is nervous about Vietnam where there are no assets. Yes, that market is cheap and benefiting from exports but it won't last forever and then what's left to support the growth story?"
Given his enthusiasm about the natural resource wealth of Iraq and Mongolia you would expect both funds to be heavily weighted in commodities. But they're not. The Iraq Fund's biggest weighting by far is in financials (71 per cent) with only 2 per cent invested in oil and energy. The fund's top five holdings are Middle East Investment Bank, Baghdad Soft Drinks, North Bank, Bank of Baghdad and Commercial Bank of Iraq, all viewed as good plays to take advantage of the growth derived from postwar reconstruction and massive oil production expansion.
The Mongolia fund has a heavier weighting in mining stocks (42 per cent), although it has almost as much in consumer stocks (39 per cent). While Mongolia's population is tiny (3m) and mostly nomadic, Mr Kahm is backing the sector as a leveraged play on China. Landlocked between the so-called 'Beast of the East' and Russia, Mongolia has access to the end consumer in these countries at the lowest transportation cost of all commodity producers. "The nearest rival is Australia, markedly further away. If China continues on its growth trajectory it will continue to rely on Mongolia's abundance of resources. Mongolians will get wealthier and there will be a spillover of people from Russia and China (and who knows where else) into the country," explains Mr Kahm.
FMG has focused on domestically listed stocks that have a very low correlation (if any) to global markets, deciding to steer clear of offshore companies for now. "We're not saying we will never hold offshore companies, but these are the stocks that suffer the greatest volatility in the commodity market and the impact of speculators," says Mr Kahm and he points to mining company Ivanhoe as an example. The company, regarded by many as the biggest story in Mongolia, has seen its share price fluctuate significantly since Rio Tinto took over management control last month.
The holdings in the Mongolia fund's portfolio include APU, the country's largest brewer, and Talkh Chikher, a national manufacturer of bakery and confectionery products. Another key holding is Tavan Tolgoi, the second-largest mining investment in Mongolia after Oyu Toltio, the world's largest undeveloped copper-gold project, viewed as a major driving force in the economy. The mine will start operations in 2013 and is expected to return $61bn over 27 years. Mongolia is already building railways from the mine directly to China and Russia to maintain the heavy supply demands coming from these high-consumption neighbouring economies.
There is no disputing that opportunity knocks, but getting access is challenging and Mr Kahm warns that liquidity remains a major issue. If you want to get your money out of the Mongolia fund you will have to contend with a 45-day notice period. While there are 317 listed companies on the stock market only 47 of these names are trading, with trading volume on low days only around $20,000, although there are expectations that the impending IPO of the Tavan Tolgoi mine may see the Mongolian stock exchange double in size this year.
Despite these drawbacks, Mr Kahm believes his fund is the best way to access opportunities in Mongolia. "You can buy Ivanhoe and pray to the Lord or opt for a generalist emerging market fund, which is nothing more than a miserable hugger of the benchmark and won't deliver magnificent growth in the long term. This is a clean product. You're taking a bet on the country and we're buying the good stuff, stepping aside and waiting. We're not trading – you can't in this market. Buy this fund for your children and then forget about it."
If you agree, the minimum investment for retail investors is $10,000 (there is no sterling share class, although the Iraq fund does offer a sterling share class). Both funds are Bermuda-domiciled – and levy a performance fee. The Iraq fund is structured as an Oeic, while the Mongolia fund is a segregated accounts company – an asset linked to the segregated account will be separate from other accounts and the company at large.
Bermudan-domiciled funds enable investors from all over the world to participate in a fund and can allow a wide variety of investment strategies. Funds can be approved and listed in a short time (as short as two weeks) but there are still rules that the funds and their investors need to comply with, for example money laundering.
To see the article on the official website, please click http://www.investorschronicle.co.uk/2012/05/04/funds-and-etfs/the-interview/the-next-energy-plays-yQAXgkHamMpjOqS3Llj5KK/article.html.