Diamond Age Russia Fund: Monthly Letter to Investors – May 2013

In May, the all-Russia RTS Index sold off another -3.67%, on the back of the overall continued emerging market and commodity weakness, amplified by the Russia and CIS-related storm caused by the unlawful expropriation of investor assets in Cyprus. As the Investment Advisor reported in previous months, although the Fund never had any bank accounts in Cyprus, the entire Russian and CIS equity market, along with the countries in the MSCI EME Index, significantly de-rated in March, April and May, thus bringing the RTS Index to a -12.81% loss year-to-date, after a strong start in January.

But although the Fund was indirectly but significantly affected by Cyprus, in May it nevertheless outperformed the main Russian index by 132 basis points, losing only -2.35%, while the RTS fell by -3.67%…

Why has the whole EM space de-rated, and Russia even more so, since late summer of 2011? Well, one point of view, published by a respected Russia strategist, is that the commodity supercycle is over, after “conveniently” ending in autumn of 2011, with the benefit of hindsight. “The end of rapid investment-led growth in China and the typical supply and demand responses to high prices have led many to conclude that the commodity supercycle is over, implying a stronger dollar and weak performance from commodity markets.” The strategy piece then goes on to predict that oil will edge down 5% per annum, with the Russian market drifting further downwards. In an off-the-record conversation the argument goes something like this: “you see, the market has already de-rated within the last 18 months”, implying that this view is “correct”.

No, of course the last 18-month de-rating, no doubt, took Diamond Age by surprise…
namely, the velocity of the downward spiral combined with a whipsawing volatility, which makes trading the portfolio around extremely difficult. While being 8% over its pre-crisis high-watermark by April of 2011 (which virtually no other regional competitor managed to approach even remotely), the Fund has since lost a lot of its profits, but at these valuations looks into the future with a strong sense of further gains for its long-biased portfolio. Albeit having taken that pain, the Investment Advisor is confident that the afore-mentioned strategist (greatly respected by Diamond Age) is more likely to be wrong than correct.

As the Financial Times recently argued, this year is pivotal for the global economy.
Referring to research by the International Monetary Fund and the McKinsey Global Institute, the FT points out that in 2013, for the first time since mechanisation led Britain down the path of industrialization in the 19th century, emerging economies will produce the majority of the world’s goods and services:

The inhabitants of rich, advanced economies have long represented only a small but powerful proportion of the world’s population. Now, they are less economically important than the mass of people living in the world’s poor and middle-income countries.

The shift in the balance of global economic power is profound. It is also one that economists expect to continue. By 2018, the IMF reckons emerging markets’ share of world output will have risen to 55 per cent, making the term “emerging” increasingly irrelevant.

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