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The Hedgeweek Interview: Stephen Cohen, Troika Dialog Asset Management: "We are a Russian investment firm, rather than a firm that invests in Russia"

Stephen Cohen, chief executive for hedge funds at Troika Dialog Asset Management in London, believes the Troika Russia Fund, which has achieved an annualised return of 28 per cent since its launch in May 2006, is set to benefit this year from increased political stability across countries of the former Soviet Union, strong domestic consumption and a long-term infrastructure boom.

HW: What is the background to your company?

SC: Troika Dialog Asset Management was formed in 1996 with the aim of providing a comprehensive range of services, including mutual funds and individual accounts, for private investors, insurance firms, pension funds and major companies. We have consistently outperformed the market, and now stand as a leader in the Russian mutual fund market and in managed account and financial advisory services, with assets under management of USD4.7 billion on behalf of investors in equities, bonds, cash, private equity and real estate.

The Troika Russia Fund is a Russian equity long/short fund which was launched on May 3, 2006 with USD42m in assets, which had risen to more than USD162m at the end of last year and has delivered an annualised return of 28 per cent per annum since inception.

HW: Who are the senior investment professionals?

SC: Oleg Larichev is the chief investment officer of Troika Dialog Asset Management. He has over 11 years' experience in Russian securities with Troika. Previously he was an economic expert with the Russian European Centre for Economic Policy.

Vladimir Potapov, CFA, is the co-portfolio manager for the Troika Russia Fund together with Oleg Larichev. He joined the firm after graduating in economics from the State University and from the People's University of China in Beijing. In 2006 he was named in Finance Journal as one of Russia's top 10 fund managers.

Pavel Teplukhin is the chairman and executive director of TDAM (Cyprus) and also the chairman and a founder of Troika Dialog Asset Management in 1996. Previously he was involved in various government bodies during the transitional phase of the Russian economy, and he is widely known in the Russian investment community.

I am based in London with Troika Dialog (UK) and am responsible for risk oversight together with Pavel Teplukhin. I have worked in asset management since 1980 and invested in emerging markets for more than 25 years. Prior to joining Troika I was chief executive of Putnam in Europe and also worked with Mercury Asset Management for 19 years.

HW: Who are your service providers?

SC: The Troika Russia Fund is audited by PricewaterhouseCoopers and administered by JP Morgan Hedge Fund Services. The prime broker for the fund is Deutsche Bank, and we employ legal counsel from Dechert and Truman Bodden.

HW: What is the profile of your client base?

SC: The fund initially traditionally targeted high net worth individuals, but we have been witnessing growing interest from European institutional investors, including asset managers and funds of funds.

HW: What is the investment process of your fund?

SC: Our primary goal is to provide long-term returns through investment in Russia and other Commonwealth of Independent States countries, mainly through publicly-traded equity-related securities. Our main universe is around 150 listed companies operating in Russia, Ukraine and Kazakhstan, and we achieve our returns from capital appreciation, using leveraged long and short positions and OTC derivatives to manage the delta-adjusted exposures of our positions. In addition we look at other companies across the region on an ad hoc basis.

Our approach depends on market conditions, but we always strive to provide returns regardless. In bullish markets we aim to capture the majority of market returns, while we maintain positive absolute returns in bearish conditions by increasing our short positions and reducing our net long positions.

There is a wide spectrum of opportunity thrown up by the market that we look to capitalise on, which is when our research really comes into play. We study local market conditions such as under- or overvaluation of particular stocks, uneven research coverage, lack of rigorous valuation discipline, variable liquidity, rapid changes in corporate governance and variable foreign participation to discover where best to invest.

Under the terms of the prospectus, the fund's net long exposure may be between 0 and 150 per cent and a maximum of 30 per cent of the net exposure can be invested outside Russia, while only 20 per cent can be invested in any single issuer. In addition, we may invest no more than 20 per cent in less liquid issues, including pre-IPO private placements.

Almost all our investment decisions arise from our in-house research, and we maintain a detailed macro scenario for the region that leads to recommendations for sector, factor, country, currency, gross and net portfolio weightings and risk levels. Our internal company level research and valuation modelling leads to specific recommended long, short and pair trade positions.

The fund holds between 40 and 70 underlying positions over time and primarily uses American and global depository receipts and New York- or London-listed companies for short positions. Currently, Ukrainian and Kazakh companies are selected on a stock-by-stock basis. We also invest in certain OTC derivatives, including notably options as well as baskets, notes and traded futures.

HW: How do you generate ideas for the fund?

SC: We rely on the strength of our in-house teams to come up with ideas for our fund. We employ a top-down macro and sector research team, as well as a group of analysts providing stock research to identify opportunities within the market. We aim to meet the management of all companies we invest in, and this can be a good source of other ideas. We also discuss ideas with our Russian high net worth clients who can provide valuable insight as businessmen. In addition, we use research from our brokers.

HW: What is your approach to managing risk?

SC: We have a very thorough risk management approach, based on communication within the company. We hold regular team meetings where we review our investment activities, and assess performance, exposure and value at risk reports, as well as counterparty limits, market liquidity data, the macro scenario outlook, exposure limits for sector weightings, factor risks, foreign exchange, country weightings, net long and leverage.

We also have a series of checks and balances in place to ensure that major losses aren't incurred. A 10 per cent loss on any position will trigger a review within the team meeting, while I will personally review any position registering a 20 per cent loss. I also provide independent portfolio oversight, including positions, trades and risk measures. As a company, we employ OTC derivatives to help manage volatility and improve risk-adjusted returns, and beta is used as part of the strategy

HW: Has your performance been as per budget and expectations?

SC: Performance has been better than expected. We set an annual target of 20 to 25 per cent, and our annualised returns up to the end of 2007 were 27.8 per cent.

HW: What opportunities are you looking at right now?

SC: For example, at present we see the continued growth in the domestic banking sector and the revival of Russian agriculture as trends that will provide capital appreciation. Similarly, the reorganisation of hydropower, the consequences of natural gas price liberalisation and the overselling of various companies because of foreign investors' aversion to risk could all prove to be highly profitable opportunities.

HW: What events do you expect to see in your sector in the year ahead?

SC: I expect to see continued strong domestic consumption, with capital expenditure reinforced by the onset of a 25-year plus infrastructure spending boom. I think the region will continue to experience political stability, which will help to maintain the appreciation of the rouble through 2008.

In investment terms, I believe we will witness an increasing scope to short beyond the top 40 or 50 stocks, and a widening scope for the use of derivatives. I expect continued large IPO volume, and for other Commonwealth of Independent States markets to become more liquid and accessible, which in turn will trigger increased domestic investor participation across the region.

HW: How will these developments impact on your own portfolio?

SC: The impact on the portfolio will depend on individual sector and stock valuations, but we expect such changes to result in lower costs of hedging, which will allow us to increase the size of our short book. We will also look into increasing the overall capacity of the fund. I think we will also see increased scope for sector and stock diversification from new issues, and widening geographic exposure.

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

SC: The main difference is that we are a Russian investment firm, rather than a firm that invests in Russia. We are fully committed to Russia and the region and, with our research team based in the area, we have been part of the domestic financial scene since 1996.

The company has fully staffed back and middle offices with separate compliance and legal teams. Troika Group is a partnership 100 per cent owned by the management. On the investment side, we are set apart by our use of OTC derivatives to reduce volatility and increase returns, and by the fact that we have multiple independent alphas in the same fund.

HW: Do you have any plans for other product launches in the near future?

SC: While we have no immediate plans to launch a fund, we are always on the lookout for any opportunities that arise.

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