Nevsky Capital explains in its letter, why it is planning to shutdown the Nevsky Fund.
via Zero Hedge
Readers can find the entire PDF below for download – it is a great read!
As the final newsletter for the Nevsky Fund (”the Fund”) the format will, not surprisingly, differ from our usual quarterlies. It will also (I apologize in advance) be somewhat lengthy. In order to make it easy to read (or indeed skip through) it will be split it into the following sections:
- Market commentary
- An explanation as to why we have decided to cease managing the Fund
- Our current view on the global investment outlook
- Nevsky Fund and career performance statistics
1. Market commentary
2015 proved to be a continuation of 2013 and 2014 for emerging market equities, with more red ink and a fall of 15% in USD terms as concerns relating to slowing Chinese growth and falling commodity prices continued to dominate. Developed markets fared better and fell only marginally, by 0.9%, with minor gains or losses in USD terms in most major markets. The Fund achieved a small positive return of 0.4%.
2. Why have Nevsky Capital decided to cease managing the Nevsky Fund?
The decision to stop managing the Fund, after just over fifteen years, has been a very difficult one. This decision has been driven by a growing recent awareness that certain features of the current market environment, which we believe might persist for a considerable period of time, are inconsistent with the achievement of our goal of producing satisfactory risk adjusted absolute returns for you, our clients.
Over our twenty-one year investment career we have always invested using a broadly unchanged process. This process marries the top down forecasting of key macro-economic variables with the bottom up forecasting of company earnings; initially just in Eastern Europe, then across the Emerging World and finally on a global basis from 2003 onwards.
For this process to work we have consistently needed the following criteria to be met:
— Access to transparent and truthfully compiled data at both a macro and a company specific level, which is made available on a timely basis to all market participants. This allows us to construct and maintain detailed top down economic forecasts and bottom up company models.
— Logical decision ma king by macro-economic policy makers.
— An ability to achieve a clear understanding of the positioning of other investors in the market so as to be able to come to a view as to what is ’in the price’ and what is ’fair value’.
— A reasonable level of divergence in equity prices between different geographies and sectors and the existence of constantly evolving, but logical, inter-relationships between these different asset classes.
— Manageable ‘fat tail risk’
[drizzle]— A reasonable spread of uncorrelated potential investments across time zones.
Unfortunately, global trends over the past couple of years have begun to militate against these preconditions for successful fundamental investing. Namely:
Data quality has deteriorated
— Data releases have become much less transparent and truthful at both a macro and a micro level. At a macro level the key issue is the ever increasing importance of China and India. China is the world’s second largest economy, but already much larger than the US in a broad swathe of sectors. India will be the world’s third largest economy within a decade. Unfortunately their rise is increasing the global cost of capital because an ever growing share of the most important data they produce is simply not credible. Currently stated Chinese real GDP growth is 7.1% and India’s is 7.4%. Both are substantially over stated. This obfuscation and distortion of data, whether deliberate or inadvertent, makes it increasingly difficult to forecast macro and hence micro as well, for an ever growing share of our investment universe.
— At a micro level corporates have also responded to greater market scrutiny since the GFC todisclose less not more, on the basis that the less they reveal the less often they can be proved wrong by regulators, investors or law courts. This means the cost of capital relating to holding large company specific exposures has risen as the ’headline’ risk of being proved wrong with regard our earnings projections is now commensurately higher.
The transparency of decision making has also declined
— Assuming we can obtain trustworthy data we then apply logic to produce our forecasts. The validity of this process becomes questionable if economic policy makers do not themselves apply economic logic and in a transparent manner. Obviously we accept politics can trump economics and political analysis has always been a very big part of our process, but surely never has so much of the world been governed by leaders where the logic of that peculiarly parochial yet multi headed beast – nationalism – trumps all (China, India, Russia, Turkey, South Africa, Malaysia etc. etc.). Almost by definition the path of logic within nationalism is difficult for ’outsiders’ to follow with any confidence, leading to highly unpredictable and potentially dysfunctional modelling outcomes.
— At the start of our careers we spent much time being forced to try and decipher the indecipherable – the moods and subsequent decisions of Boris Yeltsin. This ’Kremlinology’ was truly the definition of banging your head against a proverbial brick wall. Fortunately this and similar masochistic macro-analytical tasks then gave way to the logical joy of the Washington Consensus which was adopted almost without exception across the Emerging World following the multiple devaluation crises in the mid-1990’s. Unfortunately though the Washington Consensus, having been severely wounded by the GFC is now stone dead. Kremlinology, with an additional nationalist twist, is back – and it is now the norm, not the exception, for most countries in the Emerging World. We are not convinced that knowingly continuing to bang our heads against these newly erected brick walls would be a sensible decision.
Equity markets are also less transparent
— The unintended consequences of those new regulations introduced as a result of the GFC, which have largely removed the market making role of investment banks from global equity markets, has coincided with the recent massive increase in market share of both ’dumb’ index funds and black box’ algorithmic funds to create a situation where equity market volumes have fallen sharply and individual stock volatility has risen dramatically. An initially badly executed order can now inadvertently create a price trend (because there is no longer the cushion to price moves which was in the past provided by market maker inventories) that, as algorithmic funds feast on it, can create a market event even if the initial order was a simple innocent error. Truly – to mix metaphors – butterflies flapping their wings now regularly create hurricanes that stop out fundamentally driven investors who cannot remain solvent longer than the market can remain irrational.
— In such a world dominated by index and algorithmic funds historically logical correlations between different asset classes can remain in place long after they have ceased to be logical. More butterflies.
— Index and algorithmic fund maneuverings also make it very hard to ascertain what the markets clean’ positioning is at any given time. All of which pushes up the cost of capital.