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The Hedgeweek Interview: George Nianias, Fund Manager, Denholm Hall Russia Arbitrage Fund; Founder, Denholm Hall Group: "In Russia, it's what you don't know that can hurt you"

George Nianias outlines the investment process and local market strength that drives the performance of the Denholm Hall Russia Arbitrage Fund.

HW: What is the background to your funds?

GN: Denholm Hall has been operating in Russia for more than a decade. We now have about 30 staff in Moscow and London. I set up Denholm Hall in 1992 in London and within a couple of years began consulting on government and municipal bond issuance and debt management strategies in Russia. This eventually spread to advising on other types of corporate finance, such as IPOs. That was back in the 1990s when the World Bank and other agencies were active in developing the Russian capital markets.

We later began to take advantage of arbitrage opportunities in Russian equities available because of the difference in the prices of shares for the same company throughout this vast country.

Denholm Hall now manages about USD 180 million, about double the amount we managed a year ago. The bulk of this is held in the Denholm Hall Russia Arbitrage Fund, a Bermuda-incorporated fund. The Fund was launched in June 2002 now consists of three classes of shares. The "A" shares invest in domestic short-term promissory notes (about two--thirds of the portfolio) and equities (one-third) while the "B" class is entirely a credit fund. The assets held by "C" shares are the same as the "B" shares but mitigate currency risk by hedging the rouble exposure.

I am the fund's manager and Denholm Hall's CEO. Mikhail Mikulin, my right hand man in Moscow for a decade, is responsible for managing the staff of OOO Denholm Hall, a licensed Russian broker. He also implements and oversees credit policy at the Fund.
HW: Who are your service providers?

GN: People are often surprised to learn that we don't have a prime broker. This is because we buy on the primary market so don't need to rely on a broker to obtain the securities. In any case, there aren't any prime brokers offering access to the promissory note market.

Our administrator is Argonaut Ltd in Bermuda and our auditor is KPMG.

HW: How and where do you distribute the funds? What is the profile of your current and targeted client base?

GN: We supply regular information on our Fund to about a dozen web-based hedge fund databases and news services. It is amazing how the internet is becoming a marketing source for us and nearly daily we are getting inquiries about the fund from all over the world, quite a few of which result in subscriptions. We also rely on a small number of agents to market our fund. Our investors are a mix of institutions, Fund of Funds and family money.

HW: What is the investment process of your funds? How do you manage risk?

GN: In many regards, we operate like a bank. For each investment we decide to proceed with, we've probably rejected dozens of requests for funds. We spend three to six months on due diligence. It's very labour intensive. In Russia, it's what you don't know that can hurt you.

Lending diversity is key to minimizing credit risk. We're invested in about 87 separate promissory notes, known as veksels. Of these, 45% are secured and 20% are held in liquid instruments. The portfolio spans 22 borrowers across 12 Russian regions and 12 industry classes.

HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?

September marked an unbroken run of 51 monthly positive returns. The 'A' class has returned 127.6% since inception, the 'B' class 77.02% and the 'C' class, launched just over a year ago, 12.57%. The annualised returns of the 'A' and 'B' shares are about 21%.

Our Sharpe ratios typically rank at the top of their asset class. The 'B' shares, for instance, are 4%, using a risk free rate of Fed Funds. This is partly because the default rate on the veksels is virtually nil. We've also benefited from the strong rouble, which has appreciated about 7% this year.

HW: What opportunities are you looking at right now?

GN: Going forward, we are increasingly looking at investing in structured debt that's asset-backed.

Yields on Russian debt might decline for the biggest and most liquid names, given the country's strong economic performance. In September, Standard & Poor's upgraded the country to BBB+. That said, many companies, particularly small and medium-sized ones, cannot get short-term loans from Russia's banks -- even though there are almost 1,200 of them. Domestic credit to the private sector and non-financial public enterprises is forecast at only 26% of GDP this year, compared with 59% for Kazakhstan and 45% for Ukraine, according to S&P. To put this in perspective, the figure for 2005 in the European Union was 114%.

HW: What differentiates you from other managers in your sector?

GN: We are probably the only institution with a team of so many staff on the ground in Moscow, not to mention agents working across Russia, to analyze, structure and originate deals.  

We recently won the Marhedge award for best European hedge fund in the Niche-Innovation category. We are the only western Fund investing in the asset class - domestic Russian short-term credit. Our competitors are mainly Russian high net worth individuals and funds.

It's taken us a decade of experience in sourcing and analyzing the deals in an environment that's constantly changing and extremely challenging. Our management team and partners have an excellent working relationship, which gives us the ability to move relatively quickly in and out of investment opportunities.

George Nianias was interviewed in October 2006

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