Magazine Issues » Dec 2007-Jan 2008

EMERGING EUROPE: The right direction

Central and Eastern Europe has moved beyond its previous global status as an emergent backwater and the region is now a key player in the European fund scene. Fiona Rintoul considers the nature of the markets there and how they might move further forward still

07_12_cover_story_pic.jpgIn today’s Europe, the Central and Eastern European (CEE) markets are no longer emergent backwaters with a lot of potential. On the back of substantial local stock market growth and strengthening economies, the CEE countries are moving to a position where, if they are not exactly driving the European fund industry, you can see that they might in the future.

In recent months, the top five markets by estimated monthly net sales table, according to Lipper Feri,  has frequently featured Poland. The September table was dominated by CEE markets with Poland in second place, Hungary in third and the Czech Republic in fourth. Total assets under management may still be relatively small in the CEE markets – Lipper Feri puts the total at e68bn (June 2007) – but assets are growing fast driven by strong sales volumes.

“Assets have grown at a compound annual growth rate of 49% since 2001,” notes Lipper Feri in its October Fund Market Monitor on Emerging Europe. “In terms of European assets, the figure [e68bn] represents just 1% of the asset base, whereas strong flows in the region have led to a market share of approximately 5% of Europe’s sales volumes.”

Those figures are for the twelve months to June 2007. In recent months, sales volumes in the CEE markets have been even more impressive, with the region standing up much better to the sub-prime crisis than developed Europe.

“In June, the region accounted for 19% of Europe’s total flows and in August flows from Emerging Europe were positive at e54bn, against a total net outflow for the whole of Europe of e70bn,” notes the Lipper Feri Monitor.
In the climate of growth, the CEE markets have started to mature and to differentiate themselves from each other. They are no longer developing Europe, but individual markets with their own characteristics.

Regional differences
“It is difficult to define the region in one sweeping generalisation,” says Karine Hirn, managing director at East Capital, the specialist Stockholm-based CEE investment firm. “Conservative attitudes still largely prevail in Czech Republic, Slovakia and to some extent Hungary. By comparison, Poland with its relatively large local stock market and thriving fund industry has been a beacon of ‘how it can be’ in the region.”

Another phenomenon has also started to emerge – that of the local fund manager building a business entirely, or almost entirely, in Central and Eastern Europe.

Locally managed fund managers are a familiar concept in Russia, where home-grown operations such as Troika Dialog and KIT Finance not only dominate the mutual market, but have become known names in the West. Until recently, however, international firms tended to dominate in the other CEE markets.

“To take the Czech Republic as an example, the financial sector is extremely consolidated and was largely bought by Western institutions,” says Hirn. “Ninety-five per cent of the Czech market is in foreign hands with the largest four controlling 75%. Compare this with Russia which supports thousands of banks, still with very few in foreign ownership.”

To some extent the CEE markets closest to developed Europe may have suffered from the attention they received from large financial institutions when their markets first opened. Although this attention helped to get the local fund industries in these markets on their feet, it left little room for the kind of local enterprise that has been in evidence in Russia.

“In Russia, the fund market is coming from almost nothing, therefore many have recognised the huge potential that exists,” says Hirn.

Russia vs other CEE markets
Russia is, in any case, a more complex beast than most of the other CEE markets. The 1998 crisis in Russia sorted out the men from the boys with many foreign fund management firms leaving the country at that point.

Now they are coming back, but it is to a market that has already been carved up by local players, and where gaining recognition is an uphill task. Big international financial institutions expect brand recognition in Russia, suggests Pavel Teplukhin, chairman and CEO of Troika Dialog Asset Management, and when they don’t get  it, their enthusiasm for the Russian marketplace sometimes fades.

n the other CEE markets, things are rather the other way round. The big international firms have an established presence and an established brand, and it is the small number of local players now emerging that must fight for recognition.

We’ve all heard of Pioneer and Credit Suisse, but who has heard of OTP Bank, Parex Asset Management or EFG Mutual Fund Management Company (EFG MFMC)?

Local focus

Yet OTP leads the Hungarian market by assets under management and year-to-date inflows (see tables), and is building a business in surrounding markets. Parex Asset Management is the second biggest player in the Baltic region and is both expanding into surrounding CEE markets and, increasingly, selling its funds to investors in Western Europe. EFG MFMC has built a successful business in south-central Europe from its base in Athens.

What makes these companies different is their focus on the local region and their commitment to it. From its base in Latvia Parex Asset Management has expanded into the other Baltic republics of Lithuania and Estonia, as well as Russia, the Ukraine and Kazakhstan. EFG MFMC has leveraged its Luxembourg operation to expand into Turkey, Romania, Bulgaria and Poland. OTP Bank has set up local asset management companies in Romania, Bulgaria, Croatia and the Ukraine, and is looking at opportunities in Russia, Serbia and Montenegro.
“Our policy is to set up in those countries where we see potential,” says Gyözö Nyitrai, director of OTP Bank. “What is different in our case is that OTP has Central European knowledge.”

The knowledge
This is a fairly essential commodity if you’re operating in the kind of markets OTP is targeting. Without it, who would guess that the most popular products in Croatia are equity funds covering the former Yugoslavia? Or that a booming local stock market in Bulgaria means Bulgarian investors are mainly interested in high-risk local equity funds, whereas Hungarian investors, who have a longer experience with funds, prefer safe bond, money market and capital guaranteed products?

Similarly, Parex Asset Management has leveraged its local knowledge and presence to launch a range of funds few companies could replicate.

Niche products
“The way we differentiate our product is that it’s a bit more niche,” says Roberts Idelsons, president of Parex Asset Management. “We never launched a CEE equity fund. We launched a Baltic fund or a Ukrainian fund. We tried to be as specific as possible because currently these markets have different investment dynamics. We rely on our historical presence in the region to manage these funds in-house.”

These funds have now started to attract attention from investors in Western Europe, allowing Parex to expand its business into Switzerland and Germany, and set its sights on the Swedish and UK markets. “We realised that this expertise is appealing to an international clientele pretty much across Europe,” says Idelsons.

OTP Bank is not at that stage yet, though Nyitrai can envisage the company’s funds being registered in Luxembourg in the future for sale to international clients. For the moment, OTP Bank offers an ETF based on the Budapest Stock Exchange Index to international clients and otherwise focuses on its business in CEE.

OTP Bank is one of very few banks in the CEE region that hasn’t been gobbled up by an international player. A future hostile takeover can’t be ruled out, but the group obviously prizes its independence and is making good use of it to build a business in its own back yard.

In Hungary it manages its own funds and runs two co-branded products with UBS and DWS. It also has third-party distribution agreements with BlackRock Merrill Lynch and UBS, which allow it to sell about 80 foreign funds to its clients.

A question of timing
Further substantial expansion into open architecture is inhibited by a lack of funds registered for sale in Hungary. Only a couple of hundred funds are registered at the moment and non-registered funds are taxed at a much higher rate.

OTP Bank also hopes to sell the products it is setting up in markets such as Bulgaria and Romania back to Hungarian investors and to export its Hungarian funds and co-branded funds to investors in the new markets it is targeting. “We are thinking of registering our Bulgarian equity fund in Hungary,” says Nyitrai. “We try to use group cooperation to create synergies.”

The moment isn’t right yet because low liquidity on the Sofia Stock Exchange makes the Bulgarian product very risky. Ultimately, however, all of OTP Bank’s CEE funds could be sold in the markets where it is present – and even in markets where it is not yet present.

 are markets where we will not establish asset management right now, but third-party distribution is in the picture. For example, we will not necessarily enter the market in Serbia with asset management, but we will offer mutual fund distribution.”

Successful strategy

Something that is notable about both Parex Asset Management and OTP Bank is their willingness to embrace open architecture. They have, it seems, learnt from the mistakes of their Western European counterparts and have never even tried to go down the impossible route of being all things to all people.

“We started with open architecture straight away,” says Idelsons. “From day one, we offered funds from leading global fund managers.”

This strategy has allowed groups such as Parex and OTP to focus on the markets they know best, both in terms of investment and distribution. With developed Europe in the doldrums and Emerging Europe expanding rapidly – Lipper Feri predicts that assets under management will have grown to e80bn by the end of the year and that the region will maintain its strong pace of growth in coming years – it’s a strategy that might be about to pay rich dividends.

© fe December 2007 / January 2008