Harvey Sawikin

Harvey Sawikin co-founded Firebird Management in 1994 and is lead manager of Firebird’s Eastern Europe and Russia funds. He also serves on the Management Boards of the Amber private equity funds. Before founding Firebird, he was a clerk on the U.S. Court of Appeals and an M&A specialist at the law firm of Wachtell, Lipton. Harvey is a graduate of Columbia University (magna cum laude) and Harvard Law School (laude), where he was an editor of the Harvard Law Review. He is a member of the New York State Bar. Harvey serves on the board of PR Foods (Estonia) and is a Trustee of Churchill School and a member of the Visiting Committee of the Department of Photographs of the Metropolitan Museum of Art.

Graham & Doddsville (G&D): Can you tell us a bit about your background and how you became interested in investing?

Harvey Sawikin (HS): I was an M&A lawyer at the firm Wachtell Lipton for five years. I always had an interest in investing. When I left Wachtell, one of the partners gave me a copy of The Intelligent Investor and said, “This is what you should read if you want to be a serious investor.” I read it and I thought, “This seems pretty easy. I could do this.”

I started doing research on stocks. In those days (1992), I had to go up to Columbia Business School; there was no Internet back then, so I sifted through these big Value Line books for stock ideas. I started buying value stocks according to Benjamin Graham’s principles. One of his main principles was that you could tell if the US stock market was a good buy or not if the earnings yield was double the bond yield. At that time, it wasn’t even close. But still, if you were American, you should have 25% of your net worth in US stocks even if the market valuation was not particularly attractive. So, I put 25% of my money in stocks, and said, “I’ll wait until the earnings yield is double the bond yield,” which actually took 16 years because it didn’t actually reach that relationship until 2008–2009.

I was at the library at Columbia and I ran into a guy named Dan Cloud, who’s now Geoffrey Batt’s partner at Euphrates Advisors, a hedge fund focused on investing in Iraq. Dan had just come back from Asia where he had been working for a brokerage. He said, “If you want to talk about value, you need to look at emerging markets. That’s where real deep value is found.” He convinced me to start a little friends-and-family partnership called Morningside Capital in October 1993, in which we invested in emerging markets.

In December 1993, Yeltsin disbanded the parliament and began a mass voucher privatization program in Russia. Dan, Ian Hague (our third partner), and I thought this would be a major investible opportunity. We looked at the program, and realized that they were going to be privatizing this vast economy of resources. Based on the low valuation the Russian people were attributing to the vouchers, companies could be selling for one cent on the dollar. So we put all of our money into the voucher auction program in Russia.

Our first voucher investment was into an oil and gas company called Surgutneftegas (“Surgut”) in January 1994. We knew very little about it. The only available information was on one sheet of paper. Surgut had the same amount of oil reserves as Mobil. At the time, we calculated that its implied market capitalization in the voucher auction would be about $40 million, versus $40 billion for Mobil. We said, “Look. It doesn’t have to be as good as Mobil. It only has to be a little less bad than Mobil, and we could make 2x or 3x our money.” In fact, at the peak, Surgut actually had a market cap above $40 billion.

People often ask me, “Weren’t you scared when you invested in Russia? You took a big risk.” At that moment, I was pretty sure we were going to make a fortune. How could it be any more obvious than when you’re buying something for one cent on the dollar? When we visited Russia in January 1994 I saw with my own eyes that it was a real country. It wasn’t nice, it didn’t smell good and there was no food, but it was a real country. In the course of my investing career, I’ve had three or four of these big revelations where I just was absolutely overwhelmed by something. Russia was the first one I ever had. So that’s how I got started.

There were four of us who got together and launched Firebird. We were all from different backgrounds. I was a lawyer. Ian was a political scientist. Dan Cloud had emerging markets experience. The fourth partner who joined, Brom Keifetz, had just finished an MBA.

The fact that none of us had much mainstream professional investing experience was a benefit at that time, because we didn’t have any preconceptions; if you required good financials to invest in a name, you would never have touched the stocks we looked at. In fact, you probably wouldn’t have touched it for ten years, because it really didn’t start looking like that until about 2004–2005, but by then, a lot of the money had been made. Because we were very green, but we had some big ideas, it was a benefit to us.

G&D: What were your other major revelations?

HS: We started investing in Kazakhstan in 1997 because it was a repeat of Russia, in a way.

We started a private equity fund for the Baltic States in 2002. I was very excited about that. With U.S. stocks in 2009, I was not as excited as I had been about Russia in 1994, but I felt that, finally, Benjamin Graham’s requirements were met — I had been waiting for it for 16 years. It was then that I finally added a decent weighting in U.S. equities.

There have been other times when I thought I had it, and it hasn’t worked out. We have a fund dedicated to Mongolia run by my partner James Passin. When he first showed that to me in 2010, I thought that was another amazing opportunity. So far, it hasn’t really broken out yet — it’s still struggling, but that’s typical with the frontier markets.

I have never invested in a frontier market that didn’t have those growing pains in the first few years. It’s always the same: they start out amazing and everybody gets very excited. Then, something goes wrong and you go into the wilderness. The first time we went to the wilderness in Russia was in late 1994 until about the third quarter of 1996, before it started to work again.

G&D: You’ve obviously expanded since investing in Russia. What statistics or data points do you look for to help you determine what country to invest in next?

HS: In the early stages, we’re looking for a few things. First, is the political environment: you want a country that has been through political change that has made things more stable. For example, Russia had come out of a period of chaos, and Yeltsin finally established more personal control and installed a prime minister who could make things happen. We’ve seen this many times, in Georgia in 2004, and Mongolia. Second is macroeconomic stabilization. If you have a government that is determined to stabilize the economy, it’s often after a period of high inflation or when they’ve lost a war and everything is in chaos. Someone comes in and manages to get control of the economy, and bring the inflation rate down. Third, we look for a functioning capital market that should have a few investible stocks. It doesn’t have to have a lot. You can make a lot of money on just one stock, which is what we did in Georgia where we made 10x our money on Bank of Georgia.

G&D: If you talk to a number of emerging market managers, they call Russia un-investible. They worry that the rule of law is murky, that there is corruption. That said, you’ve clearly managed quite well there. What would you say to those investors who consider it an un-investible country?

HS: People have been saying that for the last 20 years. I think it’s always required careful management, but the opportunities in Russia were, and are, huge. I think it’s actually gone through periods where it was more investible than it is now. Now, it’s more was akin to the early days where you really had to be a stock picker. I don’t think the ETFs are a good way to play Russia and they haven’t been since 2008.

In general, ETFs have proven to be a poor way to invest in emerging markets. Institutional investors who want low fees and that have played emerging markets through ETFs are starting to realize that it may not be suitable, and there’s a reason why: ETFs are market cap-weighted. Market caps tend to be the largest in state owned or state-influenced companies, which generally tend not to be managed for the benefit of minority shareholders. The top five stocks in the MSCI Russia constitute 60% of the index. You’re missing out on all these amazing companies that have smaller market caps.

So Russia is investible, but our required return is higher now than it has been at times in the past because the macro risks are so high, and because there is more government influence on private property.

Ukraine was different. Ukraine was a country where you couldn’t even find managements that were aligned with shareholders at all. In Russia, there are a lot of companies where the companies are controlled by majority shareholders who, a long time ago, determined that they were going to get value from the company through share ownership, not through theft.

At a lot of these Russian companies, the corporate governance is equivalent to an average company in Europe. In Ukraine, there have been almost no such companies. That’s what un-investible means to me: I consider any country “investible” where there are liquid listed companies run by managements that are aligned with shareholders.

G&D: Could you talk about your investment process when it comes to looking at these early stage macro and political catalysts? Can you also discuss the transition from these early stage opportunities to the later stages where you can start to look at the fundamentals and the reporting becomes better?

HS: In emerging markets investing, the dream is to buy an early stage frontier stock and hold it all the way until it becomes a NYSE-listed stock that’s highly regarded. That has occurred in a number of our investments. For example, the Bank of Georgia, which we first bought in 2004. Georgia had just changed its government. They had a new, very pro-Western government with a radical reform program. They called us, looking for somebody to buy shares from the old management. The EBRD (European Bank for Reconstruction and Development), which was involved with recapitalizing the bank, suggested Firebird, because they knew we had been interested in Georgia. We wound up buying 20% of the bank in two transactions. At that point, it didn’t have much earnings. We knew that the book value was overstated, and that much of the loan book was worthless. But we had acquired 20% of the bank for less than $10 million.

Over the next ten years, the bank cleaned itself up, cleaned up its balance sheet, and did capital raises at higher prices with good institutions, which diluted us down. Bank of Georgia eventually listed on the London Stock Exchange, which is where they are now. It now has an $800 million market cap with a blue chip investor base.

In 2003, we bought a stock in Russia called Uralkali, which was a potash producer. It was not a profitable company. Any the profits were being hidden, but we noticed one quarter when things started to change. So, we started buying stock at five cents a share; we also did a little bit of research and concluded that there was a potential structural supply deficit in potash, so we were bullish on the resource.

The management was trying to convince us not to buy it, because they were buying it themselves! This was something we called the “Scooby Doo” where they try to scare you to go away. You know that’s what they’re doing, because usually they end that by saying, “By the way, if you have any shares, we’ll buy them from you because we’re nice guys… but you shouldn’t buy them.”

We were also right about potash, and the stock went from five cents, which was our first purchase, eventually peaking above $12, so it was a huge win.

G&D: In the example that you just went through, with the Bank of Georgia shedding its non-performing loans, improving corporate governance, etc., what if something politically or economically adverse happens? How do you determine the risk-reward profile?

HS: Generally speaking, once companies become well-accepted and start to see the big mutual funds in the shareholder base, that’s usually a time to start taking profits. For example, with Uralkali, we were reducing exposure as it went up. Of course, the risk-reward starts to shift a little bit. Now, you start to have things priced for growth.

But there’s another element in what you said, which is what happens if something goes wrong. In my 20 years of doing this, I’ve seen a lot of things blow up that people thought were unassailable, such as Yukos. There is only one solution to that problem, which is diversification; because everybody thinks that they are going to know to get out before somebody says something about re-nationalization or something. These things happen all of a sudden. Also, the liquidity disappears very quickly. Investors get in trouble when they are over-concentrated. I believe that an emerging markets fund should not be over-concentrated; it’s a big mistake. When you’re over 10% in a single stock, alarm bells should start ringing. If you want to be over 10%, you should be aware that you’re taking a very aggressive view. Generally speaking, our position size for something that is a great value, is liquid, and has good management and a good macro situation, is somewhere between 4% and 6%. That’s pretty much it. If any of those elements is less, then it would be less. If it’s got all these great things, great value, great management, etc., but the liquidity isn’t so good, then maybe you’re talking about 2% to 3%.

I remember in 2003, Yukos was almost 30% of the Russian index. We were taking heat from investors because we were 2/3rds underweight in Yukos and underperforming as a result. I kept saying, “Well, we don’t think it’s as safe as everybody else seems to think.” Then the arrest of Khodorkovsky (then-CEO of Yukos) occurred and we heavily outperformed the index in 2004.

G&D: How do you think about geographical diversification?

HS: We have Russia funds and Eastern European regional funds. Even our Russia funds are fairly diversified. For example, our Firebird New Russia Fund is about 57% Russia. That’s on the lower end of what it’s been and that’s because of the geopolitical situation. Even at the peak, it was no more than 90% Russia. The rest consisted of our best ideas from Eastern Europe.

Studies have shown that even a small amount of diversification enhances expected return significantly. Our regional funds are about 25% Russia and very diversified.

On the other hand, personally, I’m not a big fan of global emerging markets equity funds. I think fixed income and currencies funds are different. But I know how hard it is to feel that we keep an edge in just the 12 markets that we’re currently active in, much less having to follow what’s going on in Indonesia and Egypt and everywhere else. At the same time, I think a single country fund is problematic because it’s very hard if the country is not doing well to just go to 100% cash. What if you’re wrong? Your investors would be very angry if you were wrong and the market continued rallying and you missed the whole thing if you’re calling yourself say a “Russia fund”.

Our regional funds are free to exit a country if it’s not working. Last year, after the events in the Crimea, we reduced Russia in our regional funds by a third very quickly. We felt no compunction about doing that; we reallocated the proceeds partly into Romania and Estonia, which we thought would have a better year, and they did.

G&D: A lot of funds categorize themselves as being bottoms-up, fundamental investors. Given your firm’s EM focus, does it necessitate a top-down approach? Does it require an assessment of what’s going on politically and any geopolitical risk?

HS: All of our investing is hybrid top-down and bottom-up because every company that we invest in has to operate within the context of a dynamic macro situation. Obviously, there is no way you could invest in Russia just running models on Sberbank and Lukoil without understanding what was going on in Ukraine, and what was going on in the oil industry.

We spent a lot of time on the macro over the last year. It comes and goes in waves. Between 2010 and 2013, we were really focused on the bottom-up. The macro was relatively stable in our region and geopolitics was relatively calm, so it was easier to just focus on stocks.

This is one of the pitfalls of being a value investor in emerging markets. The first thing you learn as a value investor is if your stock goes down you should be buying more. In an emerging market, very often, that first leg down is just the beginning of a total meltdown because of some major change that’s happened at the macro level. I’ve found that with all fund managers, both in EM and in the developed markets, people are always fighting the last war. For example, right now, everybody is a macro person thinking about the oil price and the Euro. All the things that blew up on people last year, everyone’s focusing on that when maybe now is the time they should just be picking their favorite stocks and buying value. That was why in 2009, most people failed to get back invested at the bottom, because they kept thinking about what they should have done in 2008. In emerging markets, certainly, it’s always a blend.

G&D: In our interview with Geoffrey Batt last year, he talked about the delta between perception and reality in emerging markets. In that context, when you think about Russia and Ukraine and some of these other countries, what do you see as the perception versus reality there?

HS: In the Ukraine, there is a perception that this new government is the same old thing. I think some of this is actually disinformation. In fact, the new government in Ukraine really is trying to do something new and different.

In Russia right now, I don’t see a huge gap between perception and reality. People perceive that Russia’s motives toward Ukraine are not particularly benign. We tend to see it the same way, which is why we reduced Russian exposure.

There are specific trends that people may not understand. For example, everybody thinks that because oil prices are down, they’ve taken down the prices of Russian oil stocks by 30%. But Russian oil companies are not that much less profitable with oil at $60 than they were at $80.

The reason is that the ruble is highly correlated to the oil price. When the ruble goes down, the companies’ costs do as well, since their costs are largely denominated in rubles. At the same time, the tax regime in Russia is set up in a way that as oil goes down, the tax burden gets lower, and as oil goes up, they tax away a lot of the profit. That’s something the market may not fully perceive.

The delta between perception and reality is greater in frontier markets than it is in more developed emerging markets. There are a lot of investors doing a lot of research on Russia. Maybe we have some insights they don’t have, but generally speaking, investors understand Russia more or less.

Some of our smaller markets may be different. Kazakhstan is a country where people who don’t specialize really have very little understanding about how things work there. The more “frontier” a country is, the greater the inefficiencies in terms of understanding the macro, and in stock-picking.

G&D: You said that Russian oil companies are not significantly less profitable at $60 a barrel partly because of the tax. How low can oil prices go such that these companies are only just breaking even?

HS: I think $40 is a level that I’ve seen Russian oil companies mention as a level where they would have to re-think a lot of their projects. By the way, here is something I noticed about oil. Everybody focuses on the fact that oil got down to $35 in 2008, and on why we might get back to those levels. We did get there, when you adjust for inflation. When oil hit $45 in January, it was like we were back to those levels — so we got there. I may be proven totally wrong, but the day I feel that oil bottomed was the day in early January when Goldman Sachs put out this piece of research that said that oil was going to be low forever. The piece of research got a lot of attention. They talked about it on CNBC. I and a few other people who think a lot about oil found it to be full of holes. My thought about it was that this was the kind of research that Goldman puts out is when they’re ready to cover their shorts.

I think we’ve seen the lows. Pricing is pretty solid at these levels in spite of production still rising. Maybe that has to do with the financial buyers of oil now pulling forward the better supply/demand picture that we’ll have in the second half of the year. Just as in the fourth quarter of last year, investors pulled forward the bad supply/demand picture into the fourth quarter and drove oil down in advance.

G&D: How does Firebird get comfortable investing in frontier markets given the limited information available and/or the opacity of the data?

HS: In frontier markets, you’re never going to get the kind of full information that you like. You don’t necessarily buy stocks on that basis. You’re buying franchises, large assets trading at 10% of replacement cost. You’re betting not on current profitability, but on what it could earn if it became a normal country and a normal company, and the management does the right thing. You’re looking for a management that’s competent and incentivized properly. You’re looking for a world-class franchise or a company that is a dominant player in its market. Also, you want to find the right sectors within a country. When we first came to Russia, we chose to buy oil stocks. Not everybody did that. In hindsight, it seems so obvious, but at that time, a lot of people were focusing on retailers, which were terrible retailers at the time, or consumer goods companies that could never survive.

Each country has a different sector that’s attractive. It’s a comparative advantage question. In Mongolia, it’s coal; they are the Saudi Arabia of coal. When we came to the Baltic States, it was about banking and retail, because they were a trading entrepôt between Russia and the West. If you’re requiring perfect financials, you’re not going to get the deep discounts.

G&D: Do you find yourself investing in certain sectors more than others?

HS: We invest in banks and resource companies much more than others. If you believe in the economy of a country, buying the bank is a leveraged play on the growth of that economy. That could work both ways; when things go wrong, it’s the banks that take the biggest hit. You have to be careful and take profits.

Also with banks, particularly if they’re systemic banks, they are generally going to be more regulated and less prone to theft. Take Sberbank for example — it’s too dominant. They hold half of Russia’s deposits. Of all the listed banks in Russia, here’s one that you feel is going to have to be under a microscope and it’s going to be pretty clean.

In Kazakhstan there are some resource companies that are huge and have unique assets. If you could find them in a developed market, you’d be paying 2x the multiple, at least. We’re always trying to achieve sector diversification, which is a challenge.

There aren’t a lot of listed consumer products companies. Over the years, there have been a few, but they keep getting taken over. Over the years, we had Wimm-Bill-Dann, which was a dairy that was acquired by PepsiCo. We had Baltika Beer, which was acquired by Carlsberg. It’s very difficult to find listed consumer companies because they are often logical takeover targets for the big international players.

G&D: We’ve talked about a number of names so far. Can you share any other ideas with us?

HS: I mentioned Bank of Georgia. When I look out five years and I look at the portfolio and I try to figure out which stocks I have a pretty high degree of confidence in, that’s one that I focus on just because Georgia is growing anywhere from 3% to 5% sustainably. Bank of Georgia has a 40% market share and the best management in the country. They not only have their bank business, they also now have the largest healthcare business and one of the best real estate developers. It’s sort of a play on the whole country now, not just the banking side. It’s not dirt cheap. It trades at about 1.4x book, but I feel like that’s something that I have confidence is going to go up over time. Among oil companies, we like Lukoil, which trades at about a 5% dividend yield. They have transitioned into a company that runs efficiently and pays big dividends.

In Russia, we also own Gazpromneft. It’s a subsidiary of Gazprom. I actually presented it in 2013 at two value investment conferences. It’s a company that has a portfolio of more mature and newer assets, generates a lot of cash flow and pays a large dividend. Because they are a subsidiary of Gazprom, they were allowed to acquire a lot of young oil fields from Gazprom. They were a preferred buyer. And they have a very good management team, which is unusual for a state-owned company. The quality of management is the main reason that they’re allowed to be independent and not fully absorbed into Gazprom, because they add so much value. If they had poor management and were inefficient, they would have no justification for staying independent.

Uralkali is an interesting case study. When potash prices came down over the least two years, this was actually an exercise in cartel behavior. They have to protect the cartel long-term by deterring a few major projects. They did so successfully. Now, gradually, they’re raising their prices again. This company took a double hit because of not only the potash prices and Russia problems, but they had an accident with one of their mines that knocked out 20% of their capacity. The stock is down 65% from where it was two years ago. The management is probably among the highest quality in Russia in terms of transparency and corporate governance. This is one of the stocks that was considered investible by the big institutions. I think it still is, although some of them got scared off because of the macro situation in Russia. I still like Uralkali, and we’ve been buying it back.

Long-term, I’m bullish on fertilizer, because I don’t see any major substitutes on the horizon. It’s not like oil with electric cars and alternatives. The population of the world keeps growing, so crop yields have got to be high.

G&D: Are both of Gazpromneft’s assets relatively well positioned on the cost curve such that they can still produce profit if the price of oil declines further?

HS: Yes. In Russia, even though costs have gone up, particularly at the older fields, the lifting costs are still much lower than a lot of other mature assets. Because of the tax regime I mentioned, they still generate a lot of free cash flow even with oil at $60. Even with oil at $50 they are still profitable.

G&D: Do you have any advice for people wanting to specifically invest in emerging, developing, and frontier markets?

HS: There are two paths. One path is to go to work at a company like ours. We’ve hired a lot of people out of Columbia’s Value Investing Program. Going to be an analyst at a buy side fund or emerging markets brokerage I think is a perfectly good way to get in the business.

The other way to get into the business, which is totally different, is to do it the way I did, which is just basically figure out something that other people haven’t noticed and just go and do it. If somebody noticed that some country in Africa was developing a great capital market, went there, made contacts, tested it out with their own money, and figured out what was good, and then came to New York, they would find lots of doors open to them. Everybody wants to hear about a new idea.

Even though the Firebird team all really came out of nowhere, because we had a great idea, doors were opened to us quickly. That’s the other way to get into the business, which is riskier, but ultimately can be more rewarding if you’re right.

G&D: This has been really fascinating. Thank you very much for your time.