In January the Fund appreciated +20.43%, producing a result far ahead of any comparable market index. In the same month, the MSCI Emerging Markets Europe Index appreciated +14.67% (resulting in the Fund outperforming by 39%), the MSCI Russia Index rose +14.23% (the Fund outperforming by 44%), and the RTS Index increased by just +13.31% (outstanding 53% outperformance). This monthly result, combined with a strong December performance of +4.55%, achieved during the then falling underlying market, produced for Diamond Age investors a stellar two-month return of +25.91%, while MSCI Emerging Markets Europe Index appreciated +13.25% (the Fund outperforming by 96%), MSCI Russia Index rose +11.76% (the Fund outperforming by 120%), and the RTS Index increased +10.80% (140% outperformance).
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In December the Fund appreciated +4.55%, demonstrating a remarkable resilience given that the underlying markets in its region tanked, scared by potential political upheaval following Russia’s parliamentary elections on December 4th. During the same reporting period, the Fund’s benchmark MSCI Emerging Markets Europe Index dropped -1.24%, the MSCI Russia Index fell by -2.16% and the RTS Index weakened by -2.22%. This significant outperformance of the Fund by almost 7% during a down month is attributable to selecting defensive stocks in Russia, owning well-performing stocks and commodities outside Russia (but related to Russia), and shorting selectively and opportunistically various instruments across asset classes, while well timing such shorts.
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After the Fund produced its best monthly performance since inception of +22.32% in October, its “risk on” portfolio succumbed to another bout of indiscriminate market sell-offs in November, ending with the last valuation date of the monthly reporting period on November 25th and producing a negative 22.84% return for the month… only to be followed by its best weekly performance since inception of +21.47% the following week, between November 25th and December 2nd. Thus, the November performance, ending with December 2nd valuation date, was actually -6.28%, which is in line with the -6.13% return for the benchmark MSCI Emerging Market Europe Index for the same period.
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In October, the Fund broke out of its losing streak with a positive bang: it appreciated +22.32%, its best-ever monthly performance since inception in February 2005 (the only other two similar monthly gains were in March 2009 +20.53% and April 2009 +20.86%). So, Diamond Age gained +22.32%, easily outperforming the +18.61% rise in the MSCI Emerging Markets Europe Index by 20%, the +14.73% appreciation in the MSCI Emerging Markets Index by 51% and the +11.71% performance of MICEX by 91%.
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The large sell off which ended September “felt rather surreal to me, as much of the economic data and comments from companies have been rather benign,” wrote Jim O’Neill, chairman of Goldman Sachs Asset Management and a long-time global analyst who coined the term ‘BRIC’ to describe the major emerging markets. “And yet, markets continued to explore the grimmer angles.”
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Memories are fresh – 2008 redux? Most likely no, but August 2011 was the 4th worst month ever in thehistory of hedge fund industry worldwide. The massive global sell-off and maximum aversion to the risk trade, commodities, high?beta emerging market equities and Russia-related assets, was unanticipated by the Investment Advisor. From recent peak to August trough the benchmark MSCI Emerging Markets Europe (MXMU) crashed -30.49% and Russian stocks (RTS) were slightly worse -31.06%. This resulted in a material performance setback for Diamond Age and the second worst-ever month (-26.65%) for the Fund since launch February 2005.
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Diamond Age produced a very positive result for the July period with a +6.17% return vs. +2.91% for the benchmark index MSCI Emerging Market Europe, +1.98% for global MSCI emerging markets, and +4.36% for the Russian Stock Market (MICEX), chart next page. Randy Newman is not the house favourite! In July the portfolio’s single best performing line item was a large short position in Frontline (FRO NO) Norway which declined -19.1% for the month and was subsequently closed out as the Fund squared the position at a near -60% decline (i.e. +60% gain for investors); and the often discussed and much publicised Mail.ru (MAIL LI) short also continued to produce stellar returns on the short side until covered at $28.35 early in the new reporting period.
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Having just read A Failed Global Recovery, “... a weakened global economy that is approaching its “stall speed” of around 3% annual growth – the relapse could turn into the dreaded double?dip recession. It will remain below its trend?line potential for over eight years in a row, through 2015,” by Stephen S. Roach, the highly respected non?Executive Chairman of Morgan Stanley Asia and author of, The Next Asia; the Investment Advisor was not remotely surprised when just three days later, the same Morgan Stanley raised their Asian and emerging market equity allocation.
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As Aristophanes said: “Let us call a spade a spade,” the May period was expensive for global investors and Diamond Age performance was even worse. As the benchmark index MSCI EME lost a powerful -9.25%, the Fund dropped a significant -13.14%. In the January monthly Letter to Investors published here, the Investment Advisor demonstratively abandoned its brazen, aggressive and bullish perception for performance outlook, taken in May 2010, when the skies were black, and has been “rewarded” by being dealt the business end of the five of clubs. One cannot truly portend to be right and at the same time lose money, regardless of correctly anticipating developments in the global macro and allocating investor capital accordingly.
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In a continuation of the near straight-line flat return over the first quarter 2011, investors received little surprise during the April period. The Fund advanced +2.42%, slightly underperforming the benchmark MSCI EME +3.68%, while convincingly beating the Russian Stock Market (MICEX), which declined ?3.20% for the month. Since calling the market bottom in March of 2009, investors are now up +218.24% in a little more than two years (chart on the next page), significantly higher than all meaningful indices.
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After a near straight-line flat return over the first quarter 2011, investors might be wondering if Diamond Age has adopted a new low-vol “capital preservation” strategy. And although it may appear that on or around January 1st, the Investment Advisor abandoned his pursuit of generating outsized performance, like the six month +57.77% return 2H 2010 or the +210.72% return since calling the market bottom just 25 months ago in March 2009; this is not the case.
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MSCI emerging market equities (MXEF) fell 2.38% in February and are now down 4.51% YTD. Diamond Age employs a global macro EM mandate with holdings in some 23 countries in multiple asset classes across 16 sectors at present. With emerging market equity weight of 130.80% gross AUM at month end; the Fund was not unaffected by falling share prices and declined 3.09% for the period, vs. a solid +2.25% gain for the benchmark index MSCI EME (MXMU). Russia continued to be the top performing major equity market in the world on a YTD basis. The Fund’s broad geographic dispersion, long-short multi-asset class portfolio construction, and significant underweight in Russia (25.14% of AUM) was simply not competitive, one-month-performance-wise in February, against a long-only, single-country, stock-only proxy such as the RTS which is 55% oil and gas.
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Following a world-beating +16.66% performance in December, the Fund returned an unremarkable +0.50% vs. +2.19% for the benchmark index, MSCI Emerging Markets Europe (MXMU) in January. In the final hours of a six month +57.77% advance, in which Diamond Age was the #2 performing of all Russia funds and Russian hedge funds tracked on Bloomberg, the Fund deleveraged the book. Over the course of the last three trading days of the year, the Investment Advisor sold down the Christmas rally.
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“To cripple an embryonic civil society, the mighty need only foster an environment where good people: see no evil, hear no evil, speak no evil. Power structures of the State from Prime Minister Putin to Patriarch Kirill are complicit.” Mizaru, Kikazaru, and Iwazaru – Three Wise Monkeys In December, “Das Boot” came in, all our Christmas gingerbread kisses and candy cane wishes came true. Diamond Age delivered a +16.66% December sugar plum pudding, just in time for the New Year’s goose. Exceptional yearend performance doubled the benchmark MSCI Emerging Markets Europe which advanced +8.44% for the period. Fund NAV beat the all time November 2007 high and stands at $267.80 per share while outperformance vs. all-comers expanded; now +214.97% from market trough 22 months ago.
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Diamond Age was flat in distempered November which saw the re-emergence of Bailey’s flavoured Euro contagion and yet another round of misplaced end-of-Chinese-commodity-demand fears. Performance was steady, in a month where the benchmark (MSCI Emerging Markets Europe) jack-knifed -9.86% from November 8th to month end and was -3.23% for the period and global hedge funds* dropped the most since the May 2010 “flash crash.” The Fund remains an enlivened +169.99% since crisis trough, having called the bottom in March 2009; 17% higher than the index (MSCI EME); 26% higher than the Russian stock index (MICEX), 46% than MSCI Emerging Markets, and 178% better than MSCI World for the period (chart below). *Global Macro funds +2.1% YTD and Global Multi-Strat funds +1.7% YTD.
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Leave it to the French: “The looming recession will spur a 60% drop in stocks. The unfolding liquidity driven EM and commodity bubble will burst just as it did in the second half of 2008.” Albert Edwards, Chief Strategist, Societe Generale SA – last week. Diamond Age delivered another strong +6.31% gain in October and is now an inspired +170.35% since crisis trough, having called the bottom March 2009. The Fund is 11.42% higher than the benchmark (MSCI Emerging Markets Europe), 32.34% higher than the Russian stock index (MICEX), 40.25% than MSCI Emerging Markets, and 171.34% better than MSCI World for the period (next page).
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Diamond Age advanced a powerful +12.14% in September, significantly outperforming the Russian stock market (MICEX) +5.09% and the benchmark (MSCI Emerging Markets Europe) +7.61%. Following the market crash and over the course of the last four months, the Fund reduced short exposure, raised leverage, added to highest conviction line items, increased net equity weight, held the course, and clawed back a jumbo-sized +27.38% from the July lows.The Fund is now +154.31% post 2009 restructuring and +21.86% TTM (trailing 12 months); significantly higher than the benchmark MSCI Emerging Markets Europe, the Russian Stock Index, MSCI Emerging Markets and MSCI World indices for both periods (chart below).
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Following a hot summer of burning skies in Moscow and extreme gyrations in global markets in which the benchmark (MSCI Emerging Markets Europe) fell a punishing -24% April 15th to July 5th; Diamond Age stood resolutely pat in August. On the heels of a market beating +7.7% July performance (vs. Russian stock market +3.7%), the Fund retraced an unremarkable -4.96% in August, largely in line with salient indices. Portfolio construction geared to broad-based cyclical expansion themes was adversely affected by renewed concerns that US unemployment and stalled GDP leading to a double-dip recession would derail the global recovery; a view of which the Fund assigns scant credibility.
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“Bullets over ladies” and a return to the winning hands: Diamond Age is now +138.60% post-2009 restructuring, 17 months ago. Following a modest (-2%) decline in June, performance reversed generating a powerful +7.7% return for the July reporting period*; soundly beating the RTS +6.6%, MICEX +3.7% and global emerging markets. The Fund remains significantly higher than the benchmark MSCI Emerging Markets Europe, Russian Stock Market, MSCI Emerging Markets and MSCI World indices for the 17-month period (chart on next page).
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Diamond Age is up +121% since its restructuring 16 months ago in February 2009; performance stabilised in the June reporting period and declined an almost bearable 2%. The Fund remains significantly higher than the benchmark MSCI Emerging Markets Europe Index, Russian Stock Market (MICEX), MSCI Emerging Markets Index and world indices during the last 16 months.
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Diamond Age is up 127% since its restructuring 15 months ago in February 2009, but retraced a powerful 21% in the May reporting period. The Fund generated significantly higher performance than the benchmark MSCI Emerging Markets Europe Index and salient indices (such as MICEX, MSCI EM, MSCI World), during the last 15 months, with superior Sharpe Ratio, i.e. higher risk-adjusted return. The Investment Advisor is neither shaken nor stirred… From October 2009 and through each of the prior reporting periods, the Fund was anticipating and willing to assume a correction of perhaps 20% or greater in order to capture further extraordinary returns on the long uneven road to still higher elevations. In retrospect, the Diamond Age astutely called “The Bottom” for Russia and Russia-related assets in March of 2009 and then proceeded to engineer a near 200% climb from the abyss, to within a breath of the pre-crisis November 2007 NAV. Per April Letter to Investors: Air-pocket!
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Diamond Age is up 188% since its restructuring in February 2009, but posted a modest +1.02% return in April. The return is slightly below the benchmark although the Fund remains well ahead of this year’s Russian stock indices and MSCI EME benchmark. The Fund’s 2010 YTD result is +11.44% and trailing twelve months (TTM) with 97.64% increase.
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Garlands for believers: even after this most powerful of rallies, the benchmark pre?crisis top of December 7th, 2007 remains 72% higher than the closing level at month end March 2010 (chart next page), while the Russian stock market (MICEX Index) high of May 21st, 2008 is nearly 40% above the index month end close. Diamond Age shareholders however, have been rewarded for their extraordinary vote of confidence in the darkness of some 13 months ago. With shareholder returns as the preeminent priority, the March strategy piece with focus on a discussion of performance. Why invest?
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Diamond Age produced a truly exemplary result in the month of February; one which convincingly validated the Fund’s aggressive 71% portfolio rotation in the prior period. Pro-active management stole a positive gain from the maw of a decisively falling market: MSCI Emerging Markets Europe -6.24% (benchmark) and RTS Russian Index -5.67%.
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Diamond Age quietly rang in the New Year with a modest decline of 0.79% in January on the heels of a +8.64% December, representing a gain of greater than +150% for the 11 month period following the Fund’s March bullish repositioning. The Fund has measurably outperformed the benchmark by 2,354 basis points since 2009 Fund restructuring DA: +156.30% vs. MXMU 132.76%. January performance: MSCI Emerging Markets Europe (“MXMU”) +1.79% and RTS +2.02%.
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Diamond Age closed out a most remarkable year with a +8.34% December rise representing a +158.35% cumulative return for the ten-month period following the Fund’s March bullish repositioning. The Fund again out?performed both the benchmark* and the Russian index** by a powerful 400 basis points. December performance: *MSCI Emerging Markets Europe (“MXMU”) +4.04% and ** RTS+5.07%.
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November delivered another strong result with a gain of +3.66% for the month and a +138.47% cumulative return for the ninemonth period following the Fund’s March bullish repositioning. Diamond Age again out?performed both the benchmark* and the Russian index** by a powerful 180 basis points. November performance: *MSCI Emerging Markets Europe (“MXMU”) +1.88% and ** RTS+1.96%.
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Diamond Age concluded an exemplary month with a gain of +10.24%, a +130.04% cumulative return for the eight-month period following the Fund’s March bullish repositioning. Once again investors out-performed both the benchmark* and the Russian index* by 700 basis points marking the second best outperformance of 2009 and of the top since Fund inception 18 February 2005. *October performance: MSCI Emerging Markets Europe (“MXMU”) +3.08% and Russian MICEX (“INDEXCF”) +3.34%.
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They have swallows of San Juan Capistrano but in Moscow we have crows. All?in the Russian stock market (MICEX) finished the month of September at 1,197.20, just 1.39 points below where we were all the way back in the beginning of summer, June 2nd, 2009. But while the raven has returned to roost, Diamond Age finished another stellar month with a gain of +18.41%, representing a +108.68% cumulative return for the seven?month period following the Fund’s March bullish repositioning. For the month of September, Diamond Age investors out?performed both the benchmark* and the Russian index* by a powerful 900 basis points.
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Within an exceptional +76.24% cumulative return for the six?month period following the Fund’s March portfolio repositioning; Diamond Age posted a steady +1.93% contribution for August. In spite of such powerful numbers; it is curiously difficult to be satisfied with these results. It is as if it were perfectly clear that Russian capital markets are “underperforming” the economic realities of the present. The warm vibe envelops us, we imbibe of the Krug, the glitterati seem vaguely impressed with the floral arrangements, and yet everyone is missing the party.
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After outperforming the Russian benchmarks* in June by the largest margin since 2005 Fund inception, Diamond Age closed out July again ahead of the RTS, bringing the cumulative return for the 5?month period beginning of March – end of July to +72.90%. Fortunately investors avoided an unanticipated selloff which saw the RTS drop -15.34% (from 987.02 to 835.61) in the first two weeks of trading. This precipitous fall was only the second leg of the much larger straight?line retreat from 1,180.56 starting June 2nd equalling a six week plunge of -29.22% from peak to trough (see chart on the next page). In spite of extremely adverse market conditions and perhaps the Fund’s own overly constructive expectations, Fund performance remained strong and with an absolute minimum of volatility.
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Within days of the: “Far from a dead cat bounce…” proclamation, the Moscow Diamond Age branch office was encircled with pitchforks and torches. By classic definition, Russian stocks promptly swanned off into a bear market as the MICEX dropped by greater than 20% in three weeks from the YTD high on June 1st. Doubtless the timing on this pronouncement gave pause for some embarrassment. But drawing ourselves back up off the turf and with no less conviction than four short weeks ago; Diamond Age maintains that the 2009 – (2014?) bull market has only just begun.
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In the month of May the Diamond Age Russia Fund appreciated +18.71% (+72.93% three months), while the MSCI EME Index rose +23.0% and the MSCI EM Index appreciated +16.7% for the period. While difficult to structure a defensible portfolio model on the “Sell in May ~ Go away” adage, there is no shortage of fund managers in Russia attempting to do exactly that. For better or worse it seems the bulk of the Moscow smart?money collective has been out of the market, watching stocks trade higher and hoping for the inevitable correction. One well respected manager recently volunteered that he was waiting for $30/bbl oil before venturing back in (levels not seen since February 2004). When cursory field research yielded little more in the way of investment rationale than the “Because the rally has to end” maxim; Diamond Age posed the question, why?
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In the month of April the Diamond Age Russia Fund appreciated 20.86% – the best monthly performance since inception after 20.53% achieved in the previous month – while the MSCI EME Index rose 23.08% and the MSCI EM Index appreciated 16.27%.
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In the month of March the Diamond Age Russia Fund appreciated 20.53% – the best monthly performance since inception – while the MSCI EME Index rose 17.52% and the MSCI EM Index appreciated 14.15%. After an extremely challenging 2008 and the first two months of 2009, the Fund is now down 5.29% year-to-date, while the MSCI EME Index is down 6.91%, S&P 500 is down 11.67% and MSCI World Index is down 12.50%.
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By the fourth quarter of last year, “the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have never before witnessed. The U.S. – and much of the world – became trapped in a vicious negative?feedback cycle. Fear led to business contraction, and that in turn led to even greater fear.” Warren Buffett’s 2008 Letter to the Shareholders of Berkshire Hathaway Inc., which posted a fifth-straight profit drop, the longest streak of quarterly declines in at least 17 years, while the fourth-quarter net income fell 96 percent (http://www.berkshirehathaway.com/2008ar/2008ar.pdf).
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The Diamond Age Russia Fund fell 8.69% in August, compared with a 15.83% decline in the RTS Index and a 12.86% drop in the MSCI Russia Index (please note that performance is reported from 25 July to 29 August, i.e., from the last Friday of the prior month to the last Friday of the current month). The Russian equity market over the past few months has been exceptionally difficult to navigate, with sentiment and shares swinging wildly in a matter of minutes on the back of a range of unpredictable events (most recently, the war in Georgia). In August the Fund registered its third-largest monthly drawdown since inception, amidst what is an unprecedented correction in absolute terms in the Russian equity market, with the MSCI Russia index falling 34% over the summer.
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The Diamond Age Russia Fund fell 13.09% in July, compared with an 18.07% decline in the MSCI Russia Index (Please note that performance is reported from 27 June 08 to 25 July 08, i.e., from the last Friday of the prior month to the last Friday of the current month.) Votality and uncertainly on the global front continued to poison Russian market sentoment during the month - a slow bleed that turned into critical trauma on July 24, whan word of an anti-monopoly investigation on the coal and steel produser Mechel dented investor confidence in Russia.
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The Diamond Age Russia Fund fell 7.02% in June, as global markers were treated to a fresh cocktail economic growth, subprime, and inflation fears. The MSCI EM Index declined by 10.35%, while MSCI EME Index dropped 7.31%.(Please note that performance is reported from 30 May 08 to 27 June 08, i.e., from the last Friday of the prior month to the last Friday of the current month.)
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In the month of May the Diamond Age Russia Fund appreciated 9.17% – the third-best monthly performance since inception – while the MSCI EME Index rose 11.09% and the MSCI EM Index appreciated 1.55%. After an extremely challenging first four months of 2008, the Fund is now roughly flat (-0.10% year-to-date), while the MSCI EME (-0.90%) and the MSCI EM Index (-2.97%) are slightly down. (Please note that performance is reported from 30 April 08 to 30 May 08, i.e., from the last Friday of the prior month to the last Friday of the current month.)
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During April the Diamond Age Russia Fund was up 3.03%, while the MSCI EME Index rose 2.83% and the MSCI Russia Index appreciated 2.78%. Although the Fund is still in negative territory year-to-date, it has outperformed MSCI EME Index, which is down 10.79% year-to-date as of the end of April. (Please note that performance is reported from 28 March 08 to 30 April 08; it is generally reported Friday-to-Friday at month-end, with the 30 April valuation replacing the regular last Friday of the month valuation, due to the Russian holidays.)
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During March the Diamond Age Russia Fund was down 3.48%, while the MSCI EME Index fell 2.23%; the MSCI Russia Index depreciated 2.06%; and the MSCI EM tanked 4.70%. (Please note that performance is reported from 29 Feb 08 to 28 Mar 08, Friday-to-Friday at month-end). The month of March was characterized by record volatility throughout asset classes and across geographies. Within the emerging markets, the peak-to-trough intra-March index movements were stomach-churning, with a 7% drop in MSCI Russia and MSCI EME indices (12 – 20 March), and a whopping 10.5% drawdown for global emerging markets measured by the MSCI EM Index (29 February – 17 March), to which the Fund has exposure via non-Russia domiciled companies with a significant Russia and CIS business focus.
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“As the financial markets recover from this period of stress, as of course they will, we should expect continued volatility as risk is repriced.” U.S. Treasury Secretary Henry Paulson, following an early February meeting of G7 finance ministers and central bankers. The Investment Advisor is pleased to report that, after a challenging January, the Diamond Age Russia Fund very successfully surfed waves of volatility in February to close up +4.73% on a bid-to-bid basis and +2.75% on an offer-to-offer basis (the Fund’s spread has further tightened), outperforming the MSCI EME Index, which was up 1.32%; the MSCI Russia Index, which appreciated 1.44%; and the RTS Index, which rose 1.52% during same period. (Please note that performance is reported from 25 Jan 08 to 29 Feb 08, Friday-to-Friday at month-end).
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January 2008 was the most difficult for the Fund since its inception on 18 February 2005, as most equity markets globally plunged into bear market territory, with declines of more than 20% from recent peaks. Russia and other emerging markets were not immune during the global January collapse: intra-month, the RTS Index was down more than 20%, with several large capitalisation stocks falling as much as 25% (Appendix page 3). The Diamond Age Russia Fund was down 10.44%, outperforming comparable indices (the MSCI EME Index was down 12.42%; the MSCI Russia Index fell 11.22%; and the RTS Index declined 11.24%), but still registered its steepest monthly drawdown since launch. (Please note that performance is reported from 28 Dec 07 to 25 Jan 08, Friday-to-Friday at month-end).
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“I don't think Russia will follow the United States’ way. I don't think Russia will follow the French way. I'm sure Russia will find its own way.” CEO RAO Unified Energy Systems Anatoliy Chubais. “Individuals can make a difference to history, and Russia’s Vladimir Putin, our choice for 2007, proves the point.” Person of the Year, Time Magazine, December 31, 2007 / January 7, 2008. In December the Diamond Age Russia Fund was up +0.96% on a Bid-to-Bid basis, and +0.80% on an Offer-to-Offer basis. For full-year 2007, the Fund was up +21.40% on a Bidto- Bid basis, and +16.26% on an Offer-to-Offer basis. The Fund’s spread (which reflects the spread of the underlying portfolio, for the benefit of existing investors, in order for them not to be diluted by subscribing and redeeming investors) tightened from 5.9% at the end of 2006 to only 1.7% at the end of 2007. The tightening of the spread throughout the year is primarily attributable to increased liquidity and tighter spreads in those securities that previously were a part of the Fund’s 15% allocation to less liquid securities (defined as those for which it would take more than 10 days to build a position in or exit a position from; the remaining 85% of the Fund is liquid), but which now have “graduated” from this allocation to the liquid part of the portfolio.
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“Vladimir Putin is the most sinister figure in contemporary Russian history,” The New York Review. In advance of the December Russian Duma (Parliamentary) elections investors have witnessed a Western media celebration of the dark side of “Tsar Putin’s Reign.” Major European rights watchdogs, the OSCE and the Council of Europe, claim there may be a return to Soviet era vote rigging and pulled the bulk of their observers from the polling. The Warsaw-based Office for Democratic Institutions and Human Rights has withdrawn, citing to bureaucratic obstacles from Russian authorities. Former KGB operative Andrei Lugovoy has grabbed more than a few headlines while running for a Duma seat with the Populist-Nationalist LDPR party (wanted in the UK for the murder of Alexander Litvinenko by polonium-210 poisoning in London last year). Critics in America, Britain and the EU claim that because the media is biased in favour of United Russia party, the 7% minimum vote hurdle prevents fringe party participation, and harassment of “opposition parties”, resulting in overwhelming victory for Putin’s slate, make elections undemocratic and therefore invalid.
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The Chinese use two brush strokes to write the character “crisis”. One brush stroke means “danger”; the other “opportunity”. +5% in October and +10% since end of August (with 47% lower volatility than the salient indices) would represent a stellar result for most hedge fund investors, but this is “Russia” and 2007 has been characterised by not only the three powerful sell-offs but also a remarkable bull rally that only began in earnest just two months ago. While comfortably outperforming “the market”, (much more so on a risk-adjusted-basis, see Sharpe Ratio) it must be noted that it has been a challenge to keep up with the sudden and symmetrically V-shaped reversal.
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“The trouble with being poor is that it takes up all your time.” Willem De Kooning Dutch abstract expressionist. He could not afford artists' pigments, gained fame for using black and white household enamels
2007 has seen oil prices (Dated Brent) rise +55% from a low of $51.36 on Jan-16 to $79.40 at month end, Sep-28. Unfortunately, Russian hedge funds and the underlying equity markets have not produced the same result. The decorrelation between crude oil pricing and the index- heavy Russian oil majors (65% market capitalisation = oil and gas), began in May of 2006, and continues to the present (see chart above) leaving Russian investors in unfamiliar territory: 71st out of 89 global indices ranked by Bloomberg year to date. Latest Interfax data for September E&P reporting offered little encouragement to the bulls. Already disappointing upstream production (see June 07 Letter to Investors “Oil is like a wild animal”) slipped from an anaemic +1.8% to a negative -0.3% for the period. Annual growth projections were further downgraded from 2.2% to a dismal 1.7% with no potential for tax reform possible until well after the next election, if at all. The oil sector, driver of economic expansion in the post-financial crisis economy is no longer afforded the valuation premium, which once…
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“Alan White and I spent the last two or three years working together on this. We developed what is known a stochastic volatility model. This is a model where the volatility as well as the underlying asset price moves around in a completely unpredictable way.” Dr. John C. Hull, Professor of Finance, Director, Centre for Finance and Group Chair in Derivatives and Risk Management, University of Toronto. PhD, MA, BA, MS.
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18-June-03: “Russia is a disaster that's spiralling into a catastrophe. The whole thing is in the process of disintegrating.” Co-founder of the Quantum Fund Jim Rogers. Of note, Mr. Rogers said in interview on 02-July-07 that he has sold out of all emerging markets ex-China. “They are all ‘over-exploited’, so I have sold out.”
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“Oil is like a wild animal. Whoever captures it – has it.” John Paul Getty didn’t spend much time in Russia.. High oil prices are here to stay, but what is the effect of $70/bbl on the Russian oil producers’ bottom line? Not as much as one might think. There are country specific performance drivers associated with the oil sector which warrant close consideration – and appropriate discount. The Russian oil majors are trapped in the currency squeeze between rapidly appreciating Rouble and the continuing deterioration of the falling USD.
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Diamond Age continues to build on commanding absolute out performance against “the market” at less than half the standard deviation (risk). The Fund is up a stellar +60.89% per annum since inception and +11.43% bid-to-bid in 2007 while the RTS is down (6.62%) YTD.
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“Eternal Peace Lasts Only Until the Next War” (Russian Proverb). Just one short year ago emerging market investors were witness to the most significant market crash since the 1998 financial crisis. From peak-to-trough, the RTSI (Russian Trading System Index) and MSCI EME (MSCI Emerging Markets Europe) each fell more than 30% during six weeks, starting early May through the third week of June 2006.
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Beware the Ides of March. After an exceptional month of February (+5.7% vs. MSCI EM +4.6% and RTS +3.8%) the shareholders of Diamond Age watched while Russian equities lead the world down HARD: RTS -11.8% from 26 February to 5 March. The crash was exceptional in both the duration (just five trading days) and broad global reach: MSCI EME -11.6%, MSCI EM -10.6%, and from the NASDAQ on Times Square to the Hang Seng and Nikkei 225, down -7% to -10% in just over a week from peak to trough.
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“Regional Advantage: A Diamond Age Case Study” ~ Consultants sometimes ask “what is the Fund’s most important holding?”, likely expecting to hear Lukoil or Surgutneftegaz as with many “hedge fund” peers. But not only does Diamond Age own neither security (rather the Fund has been short the latter over the course of the last year), surprisingly the position comes not from the oil sector, nor even from Russia itself.
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“As January Goes, So Goes the Rest of the Year”, Yale Hirsch ~ Russia -3.05%, MSCI EM Europe -3.24%**. The oft-sited January Effect has served as an accurate precursor of bull markets with a remarkable 85.71% accuracy from 1962 to 2006***. The Diamond Age Russia Fund has allocated precious few resources to this statistical anomaly, rather crediting the more academic: Hemline indicator, Superbowl victor, and Santa Claus factors for stellar returns (and even taking the AFC on February 4th);… but nevertheless posted a solid +1.29% gain on an Offer-to-Offer basis, and +2.91% gain on a Bid-to-Bid basis, with 50% less RISK than the salient indices (measured by standard deviation and Beta)..
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2006 ~ Banner Year for All …but some animals are more equal than others.
The Diamond Age Russia Fund finished 2006 with a stellar performance +120% since inception, +53.7% YTD, and a powerful +9.49% for December (third best month ever). Of paramount importance, the Investment Advisor never varied from the six stated investment objectives, and the overall superior returns were achieved with approximately 50% LESS RISK (volatility) than the relevant indices (MSCI EME and RTS). Outstanding Sharpe Ratio of 2.81, ? Alpha (excess return) of near 30%, ? Beta of only 40%, and with only ? the standard deviation (annualised volatility of weekly returns) ~ aforementioned calculations were all registered at near peak levels.
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Of Russian spies, journalists, central bankers, and Mock Turtles – a heavy cross for the nation to bear…
Alexander Litvinenko, Anna Politkovskaya, Andrei Kozlov, Konstantin Meshcheryakov, Alexander Plokhin, et al…. A virtual YAHTZEE for the western press but most fortu-nately, of little significance to the economic dreadnaught that is Greater Russia (although tragic for the victims, their families and the country). Litvinenko: while it makes for good print media – assassin, secret agent, profiteer, criminal, traitor? ...the melancholy spy is clearly not the hap-less victim portrayed in the London tabloids, but rather an assemblage of characters and parts discarded.
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The End of Demand? It has been said that global demand for everything from base metals, to oil and gas, to other basic materials is waning. Economists warn that a global slowdown, expanding inventories, the U.S. housing crisis, and declining consumption from (of all places) China, is leading to an over-supply of commodities. The logic therefore is that the investment case for emerging market assets and currencies is deteriorating. Try as one may, it has proven challenging to construct a credible body of evidence to support these conclusions.
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RISK: Bloomberg reports 27-Sept-06: Russian market – highest risk profile of any major market in the world. Diamond Age validates calculating volatility both near-term (30 day average) and longterm (162 week average) of RTS vs. a) BRIC comps: Brasil IBX, Chinese Shenzhen A, Indian Bombay Sensex, b) EM peers: Hong Kong HSI, South Korean Kospi50, and MSCI EM Index, and c) developed market: FTSE, DAX, CAC, Nikkei225, and S&P500. Illustrated below, original thesis indeed correct by a wide margin. Perspective ~> the Russian market is 58% more risky than broad EM universe ranked by MSCI. Diamond Age portfolio construction = active participation (+84% since inception) in highest risk and potentially highest reward market at <50% of the risk.
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To capsulate, the Fund (unlike many broad capital markets) experienced a quiet but harmless August. While many substantial participants were taking in the “joie de vie” of Southern France and other snappie locales, the Investment Advisor has been anxiously awaiting a September rally to reflect and rebalance the significant mispricing in the FSU markets. While performance was hurt in the general EEMEA/GEM sell off – particularly in Kazakhstan – wide dispersion of asset classes, prudent diversification, and strong performance in some unique niches (notably Uzbekistan) negated serious damage with the Fund up +2.33% for the month of August on an offer-to-offer basis.
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Sleepless Days: It has often been quipped that “Money never sleeps.” In a Russian July however, it merely drives out to the oligarch picnic at the Prichal Restaurant and takes a long sunny nap.
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The Contrarian View and De-Coupling of Russian Fundamentals from Emerging Market Mayhem: As few would argue, the past two months have presented the most difficult of challenges for emerging market hedge funds since 2002, and few have been spared the apocalyptic spectre of doom coming from a new hawkish inflation fighter in Ben Bernanke driving the FOMC and surprising (to the overwhelming majority of economists) of future interest rate hikes. Inflationary fear looms large and the sinking dollar draws down profitability as it heightens borrowing costs. Diamond Age is very relaxed with a modest 1.67% decline for the month of June, and quite bullish on the future positioning of the portfolio.
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Abreast the Gale ~ Subsequent to the last month's April Letter to Investors, the seemingly unassailable advance of asset appreciation here in Russia and more broadly, in global emerging markets inevitably was met with a most powerful downdraft. One that not only pulled the wind from the wailing mast, but was enough to sheer -17.13% off the frothy RTS index ~ peak to trough. Most fortunately the risk adverse engineering of the Diamond Age model portfolio, while battered the Fund was unbeaten and bettered the RTS by 900 bps. As a direct result of the "world vision" related to the FSU by the Investment Advisor, The Diamond Age Russia Fund ended May down a modest 3.78%. In a complex and multilayered hedge fund such as yours, there stands a battery of able strategies and investments which the Fund has utilised to REDUCE RISK and consistently deliver against the Six Stated Investment Objectives: The Investment Advisor would like to share just few of them with you which last month produced exceptional results in an otherwise treacherous market.
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Diamond Age is most fortunate to be featured as the EUROMONEY Cover Story and the accompanying nine-page colour pictorial, detailing the pioneering investment process of the Fund’s unwavering mandate to search the FSU for value, in places and industries far from the oil-heavy RTS Index. Click on the link below to enter a mysterious and beautiful world with outstanding profit potential far from that of the usual portfolio investor. Diamond Age would like to extend heartfelt thanks to Kathryn Wells of Euromoney for her tireless dedication.
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Here is what has been said in the November 2005 Monthly Letter to Investors: “Having just returned to Moscow forging investment alliances all the way to the wrought iron gates of… Mayfair, the Investment Advisor has a new zeal for the game and a bright fire burning behind the Diamond Age… the Fund’s risk-adjusted performance made for pleasing intonations to many receptive and sophisticated ears”. Well, after the research trip to the Central Asia in early March, the Investment Advisor again travelled to London in late April, this time demonstrating to the UK investment community a +89.40% performance of the Fund since inception, compared to +33% during last trip in November. Current investors remain pleased (with some of them adding to their investments); previously prospective investors express their conviction by voting with their wallets in significant numbers; and even some sceptics and pessimists are scratching their heads. The Fund’s Sharpe Ratio of 3.72 with +89.40% performance net of fees since inception 14 months ago, +32.20% for 2006 to date, +8.80% in April – all of this at approximately half the broad market risk – are hard quantifiable statistics above reproach.
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The first month of spring was characterised by volatility and market weakness to the EEMEA universe in general, and to the Russian market in particular. During the week of 3 March to 10 March MSCI EME dropped nearly –10%, and the RTS Index surrendered –9.1%. Most of the Russia-dedicated long-only funds followed this pattern of indiscriminate selling of RTS Blue Chips. At the same time, The Diamond Age Russia Fund, after weeks of significant gains, coasted onto a “soft landing” for that same week, just barely moving by –1.4%.
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By all accounts the first 12 months, since the Fund’s inception on 18 February 2005, were very profitable for the investors of Diamond Age, but thinning air and fabulous views may invoke a natural temptation to seek refuge and build cash. When the RTS Index drilled a titanium path through 1,500 at the end of February, the ground shook. The Fund held on to its short positions in two fundamentally overvalued stocks, reducing its net long equity exposure from 81% to 75%, but even this small 6% short hedge proved to be a money-losing one, at least in the short-term, as all ships rose with the rising tide (this hedge, indeed, shaved off about 0.4% of the Fund’s February otherwise still positive performance of +3%, achieved on top of +13% in January).
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The Diamond Age Russia Fund produced an outstanding +13.67% for the month of January which represents the single largest monthly advance in the history of the Fund. Of additional consideration for institutional statistics, the Fund also achieved the highest Sharpe Ratio of 3.36. In keeping with the 5,000-year-old tradition that predates the wisdom of Confucianism, the “Year of the Rooster” lived up to its reputation (key characteristic is that rooster is the most proficient of all 12 animals in the handling of finances). “Guang Fa” to all (“time to get rich”), 2005 was a year to make wealth.
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Building on the strength of a powerful +7.49% November, Diamond Age ventured across the Atlantic with a story of fortunes and untold riches to “the home of the brave”. The Investment Advisor was very proud to serve as a featured speaker at the Global Capital Acquisition Conference at Time Warner Centre in New York.
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Having just returned to Moscow forging investment alliances all the way to the wrought iron gates of joyless Mayfair; the Investment Advisor has a new zeal for the game and a bright fire burning behind the Diamond Age. From the very heart of the European continent on mahogany desks from Lucerne to Geneva, the Fund’s risk-adjusted performance made for pleasing intonations to many receptive and sophisticated ears.
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Sir John Templeton’s 11th Mandate states: “If you buy the same securities as other people, you will have the same results as other people.” Since the Fund does not see Templeton as a competitor, Diamond Age has no reservation in disseminating his undeniable wisdom. In keeping with this theme, the Fund still maintains a modest 25.28% Long Position in RTS Blue Chips. Underweight Perhaps? With “Russian Titans of Industry” such as Surgutneftegaz falling -15.6% and Rostelecom -12.7% – the Fund does not own these names – the Investment Advisor has been fortunate.
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In Russia one says that “It is difficult to find a black cat in a dark room, especially if there is not one there.” “Трудно найти чёрную кошку в темной комнате, особенно если её там нет.” In this regard, the Investment Advisor feels a certain reward in once again presenting to his readers the following two analyses [Source: Diamond Age Monthly Letter to Investors, May and July 2005]:
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The “Salad Days” of August were rewarding to investors in Diamond Age as the Fund generated an inspiring +9% return on the back +8% appreciation for the month of July – on an offer to offer basis – net of all fees and expenses. While it is of paramount interest to the investors, as well as to the advisory company alike, that one of the six principal objectives – plainly stated as “Wealth Creation” via market out performance be met, the Investment Advisor will remain vigilant in the defence of the other five equally meaningful hallmarks of the investment philosophy.
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Patience, conviction, low turn-over and an unwavering mandate were rewarded as the Fund waited until July for the Investment Advisor’s core theses to be embraced by the market with any zeal. It was worth the wait.
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In May the Fund covered the last of its short equity positions, and in June, the only other transaction recommended by the Investment Advisor was to cover the last of the Fund’s short bond positions. As such, the Fund’s asset allocation is now positioned in its most bullish stance since launch.
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As foreshadowed in last month’s “Letter to Investors”, there were no substantial changes in the Diamond Age Russia Fund portfolio during the month of May. The Fund methodology requires a stage one detailed and quantitative top-down macro analysis to determine the asset allocation model, long/short exposure, currency weights, geographic dispersion, and industry/sector weighting. Stage two utilises a rigorous bottom-up fundamental analysis to determine each enterprise-specific position for all holdings including stocks, bonds, currencies and derivative investments.
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April proved to be a moderately challEnging month for The Diamond Age Russia Fund. As such investors can, for the first time since inception, buy shares in the Fund at or very near the original NAV of $100 (Offer is $99.37) or 0.63% lower than on launch date.
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The Investment Advisor maintains a long directional bias and holds strong conviction in A] the rapid integration of Russia and broadly speaking the Former Soviet Union, into the larger global capital markets, and B] the impressive velocity and scale of economic growth; it does not share the view that the future will be a one directional advance. The “once in a generation” buying opportunity that was witnessed from the ground in 1999, will not likely be replicated. Therefore the Investment Advisor intends to not only protect principal, but also to profit from volatility and periodic sell-offs or meaningful declines in asset valuations in the Fund’s respective theatre of operations.
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The Diamond Age Russia Fund Limited successfully initiates “live launch” with early stage investor capital on February 18th. The Fund is listed on Bloomberg Financial Services Ticker: <DIAMRUS> <KY> <Equity> <Go>

All three major ratings agencies including Moody’s and Fitch now assign Russian debt investment grade status. Pool of investment capital able to invest in Russia is perhaps 30x larger than potential funds available to invest is sub-investment grade (junk) credit. Foreign capital flows should increase in the form of Foreign Direct Investment (FDI). The equity risk premium will be lowered. Equities now more attractive (better valuation) relative basis vs. their global comps pre-upgrade. Cost of capital will decline for large Russian bond issuers like Vimplecom, municipalities, and the government.