Ukraine: Overlooked, Yet a Promising Emerging Market

I am quite disappointed with the latest filings and listings of the new "Frontier Markets" ETFs. John Christy has made an excellent analysis of the recently launched Claymore Frontier Markets ETF (FRN) and I totally agree with him.

The upcoming Powershares MENA Frontier Portfolio (PMNA) isn't much better, as it is limited to the Middle East and Northern Africa.

What investors would really like to see on the shelves is a global frontier ETF, just like what iShares MSCI Emerg Mkts Index (EEM) and Vanguard Emerging Markets Stock VIPERs (VWO) had offered when everybody was paying attention to emerging markets, and I hope Van Eck will do a better job with its upcoming fund.

The optimal choice in my opinion would be to stick to the S&P/IFCG Extended Frontier 150 Index.

Among its holdings, I'd highlight Emaar Properties, a property investment and development company from the UAE, Nigeria's First Bank and Zenith Bank and Slovenia's pharmaceutical company KRKA.

Actually I would like to see more of Vietnam (1%) and Ukraine (0.5%) in the index, with the latter being my favorite frontier market, completely overlooked by the financial community.

I've been to Ukraine five times in the past six years and I am astonished at the improvements and the results the Ukrainian Government has achieved in such a short time. A smart move, for example, has been quickly abolishing the mandatory visa to enter the country for EU and Swiss citizens in may 2005. Since then, the number of tourists and interested investors from Europe has tripled and the Euro has replaced the US dollar as the currency of choice for everyday transactions.

It is the second largest country in Europe, after the European part of Russia, is home to almost 50 million citizens with a growing middle class, its GDP grew 6% in 2006 and more than 7% in 2007, and despite the global credit crunch, it is projected to grow slightly less than 6% in 2008; it is strategically placed between Europe, Russia and Asia and has access to the Black Sea through the seaport city of Odessa which represents a major transportation junction integrated with railways.

So I am really surprised that I haven't yet seen any CEF or ETF dedicated to this very promising country; we have a choice of funds for Cuba (CUBA) , Vietnam (VTOPF.PK) and Thailand (TTF), but to date Ukraine is being completely ignored in the US and Europe too. Yes, there are some private equity funds, but they are off limits to laymen.

I am not aware of any ADRs traded in the US, and here in Europe as well it's not easy to get hold of Ukrainian businesses through your everyday broker. There are I guess no more than five small- and mid-caps traded in Germany and in London (mostly mining). That's all.

Ukraine is not a major player in the energy sector, unlike its neighbour Russia, so my pick would be the financial sector there, and my favorite proxy is Italian banking group Unicredit, the leading international bank in Central and Eastern Europe, with 3,100 branches and 24 million customers in Azerbaijan, Bosnia and Herzegovina, Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Kazakhstan, Poland, Romania, Russia, Serbia, Slovakia, Slovenia, Turkey and Ukraine.

Other companies, more suitable to US investors, might be Russian Mobile Telesystems (MBT) and Vimpel Communications (VIP) as well as Turkish TurkCell (TKC). This is quite a poor selection in that they're all in the same industry and Ukraine represents just a fraction of their revenue.

Indeed, Ernst & Young associate director Oleksandra Dubovyk, as stated in this article, expects some 80 Ukrainian firms to raise funds via initial public offerings in the next two to three years, but for the time being I feel like I'm missing a big opportunity.

Disclosure: the author, as of today, has no position in any of the above mentioned securities except a long position in VWO.

Comments

[Trug]

www.foyil.com/manageme...
This fund is 80% Ukraine, 20% Russia if you're interested. 25K minimum though.

[netscorer]

Ukraine is heavily buried in corruption and partisan politics. It's business market is dominated by oligarchs with deep politic ties and though Ukraine is not a player in the energy sector, it's fate is tied very closely to the fortunes of the oil and gas trade as most of the money flowing into Ukraine come from the neighbor Russia and most of the exports coming out of Ukraine are metals, which production cost is directly depended on natural gas prices. It's heavy industry is outdated and is only able to survive so far due to the negotiated contracts on gas imports from Russia below market prices. The only positive in Ukraine market is it's rich soil and growing agriculture sector. But with ambitions to join EU these sectors may get heavily clipped as EU already has already well established agriculture trade with no place for newcomers.
So here it says - stay away from Ukraine until the country reforms it's corrupted system and until EU warms up to the idea of welcoming them into the alliance.

[Panskeptic]

Without a firm grip on Ukraine, Russia largely loses its access to the Black Sea and associated naval bases. Considering Russia's resurgent nationalism and superpower ambitions, this is unimaginable. You must consider political risk in exactly how far Russia will allow Ukraine to wander. NATO or the EU, for example, appear way beyond Russia's tolerance level. None of this bodes well for the future of transparent capitalism in Ukraine. There is much sound political analysis at Stratfor.com.

[itemirus]

Well netscorer, i know investing in Ukraine implies a lot of risk, but aren't we talking about Frontier Markets? Are Pakistan, Nigeria or Oman any better regarding corruption, political instability and the like? Yet they're all included in the Frontier 150 index - If i had to place a bet on a single state, for sure i'd choose Ukraine in place of the above mentioned countries.

[netscorer]

Diego,
I would not invest into these countries as well. The risks are just unacceptable for the average investor who does not fully appreciates local market flavors as well as geopolitical situation in the 'emerging' countries. I just though that you provided a one-sided picture of Ukrainian market without proper warnings to the regular folks who have difficulty locating country on the map, set aside understanding underwater current driving that countrie's markets. If you are going to invesdt anywhere from 'Eastern Europe Block', I would select Russia, followed by Baltic countries (Estonia, Latvia, Litva). With Russia you get the same upside potential as with Ukraine but without political instability and dependancy on outside energy resources.

[Kintu]

Panskeptik, I think you are overestimating Russia's power to influence Ukraine today. There is little what Russia can do if Ukraine manages to join NATO or the EU. The latest attempts (poisoning Yushchenko, raising gas prices, announcing visas for Ukrainians if they go with NATO) can only be seen as desperation.

I agree that Ukraine is a very corrupted place with little morals but comparing with Pakistan, Oman or Nigeria, Ukraine is undoubtedly above all of them. Aside from political chaos it is a very stable society, people are rather well educated and have much greed to have the western "boons".

[User 86945]

Ukraine has improved without a doubt. But my problem with it is the inflation rate which is running around 30%. If they would slow the printing presses, equities may do well in the future. Until that time, Ukraine will get cheaper as will many other emerging markets.

[milkchaser]

Last summer, I saw an ad in an Odessa bank window (in English!) offering 10% APR on savings deposits -- not CDs, just deposits. It was inviting, but there's nothing like FDIC over there. Likewise, Ukraine has a ways to go as far as protecting private property in the courts. Bribes are common and effective over there. The people have not come to trust or expect rule of law.

[TopForeignStocks]

I would agree Diego.Countries like Pakistan,Nigeria,Vietn... are not any better than Ukraine.In fact they are probably worse then Ukraine. I haven't heard of any Ukranian stocks or funds traded in US as ADRs.But if one goes as far as to invest in frontier markets like Indonesia, Vietname, Pakistan they might as well invest in Ukraine also.Just my 2 cents.

[netscorer]

Kintu,
I might side with panskeptik on the influence Russia has over Ukraine. In Ukraine politics money rule the ball and Russia is flush with oil money that it will not spare to restore its dominance over Ukraine. Yes, Russia made some costly mistakes in the past meddling with Ukraine but it learns very fast. With US in crisis both economically as well as politically, it can no longer play a containment role, so be prepared for Russia-backed party to win next presidential elections.

[michaelschn]

The big difference between Ukraine and countries like Indonesia, Vietnam, Pakistan etc. is climate there. You need energy to produce things in these countries. In Ukraine you need a lot of energy to just survive. The only reliable energy resource Ukraine has is coal. But coal production is in horrible state. There are constant fatal accidents there. Production is in decline. On top of all this the current government considers miners its worse enemy, because they overwhelmingly support pro-Russian opposition. Ukrainian coalition parties rely on the rural and small towns electorate of the west and north of the country as well as on government employees in Kiev.

On the other hand these villages and small towns can't produce anything valuable for the West. Their agriculture can't compete with much warmer countries like Bulgaria, Romania, Hungary etc.

Ironically, it makes Ukraine dependent on Russian natural gas and oil sold with huge discounts, (compared to international prices). This put Ukraine at complete mercy of Russian political games.

With Russian policy of raising natural gas prices inside Russia itself (with the goal of reaching the world prices level by 2012) Ukraine faces a huge energy crisis. Unlike small nations like Latvia and Estonia which rely on Western financial support and on tourism (including sex tourism from UK and alcoholic tourism from Scandinavia) Ukraine is to big to get this kind of help.

Considering all this and also the fact that much of the growth there is due to worldwide real estate bubble which is not sustainable I can't see how it may be a good place to invest in.

[itemirus]

Well, a lot of interesting points here - it looks like the main theme here is "Avoid Ukraine" because of this and that - BUT - imagine this thread was shifted ten years backwards and substitute Ukraine with Russia, Brazil, India, China...i know these are much bigger countries with lots of natural resources, but back then a lot of people was raising the same questions about politics, infrastructures, energy, inflation etc etc - the point is, once an economy is in its infancy it's easier to overweight the risks and overlook the opportunities.
To michaelschn: come on! Climate the big difference? What about the baltic states, scandinavian states or Canada then? they should all be living in the dark ages according to you. Besides, back in soviet times, Ukraine was providing most of the crops for all of the CCCP. Open Wikipedia and read about the climate in Crimea - you'll find out something interesting.
Once again, some of you are missing the point: we're dealing with Frontier Markets here, so avoiding risk shoud be taken out of the picture and thus risk shouldn't be made the case against investing in a frontier country. What i was stressing is that, compared to other frontier markets, Ukraine is overlooked; i am not complaining for the lack of a single country etf or fund, although i would like to see one, but for the lack of interest from the financial community in a country that has a lot of upside potential.
"A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty."
- Sir Winston Churchill -

[Kintu]

Netscorer, you can say the same about the Baltic countries where Russian money play very significant role. It creates problems and Ukrainian situation is even more complicated and some fallback is possible. But politically there is no way that Russia can stop Ukraine's affinity to the west.

Just think about that Wizzair, a budget airline, in July is about to start flights from the UK to Kiev and Ukrainian Black sea resorts while Russians are threatening to stop Russian tourists visiting the Crimea. I am afraid that Russia may lose this card if the void is filled by the European tourists (no visas, cheap flights, change of destination).

The high inflation makes me cautious to invest in Ukraine right now although CD deposits are actually insured up to $10,000 per bank.

[Jitomir]

I have been on short term teaching visits to Ukraine each year over a period of some 20 years and the economic changes in the last few years are astounding.

The economic sector functions reasonably well by ignoring the political turmoil. There are problems in the environment but the opportunities outweigh, lots of locals & foreign investors are very successful.

My problem is how to invest in Ukraine...........ther... is a shortage of investment opportunities for the foreign equity investor, even though there are dozens of new IPOs on Euro exchanges and many more are in planning. As in all investments, one must do due dilligence. There is a radical transformation process taking place in most major sectors. Example: Agriculture has been given up for dead, but in recent years mega agro-industrial enterprises, using the latest technology, have achieved very impressive results.

Last October, I found this kind of company, listed on the Warsaw stock exchange, up roughly 500% in 8 months. Too bad the float is only 20%. But there are numerous similar companies in this sector following a similar business model.

Agree with Diego, this is the time to invest in Ukraine, if you wait for a stable environment, your investment results are likely to be only average.

[netscorer]

Kintu,

you obviously have not been to Crimea if you think any respectable tourist from West would want to go there. There is zero, I repeat, zero tourism infrastructure and what is there are ruins left from Soviet times. And because of corruption level and criminalized goverment no small business can survive in that environment, meaning the situation will not change until the reforms are going to be implemented. The only reason so many Russians visited Crimea year after year is simple habits that are hard to die all the way back from Soviet times. But even without any threat from Russia, the number of Russians travelling to Crimea every summer is getting smaller and smaller.

michaelschn,

please think next time before hitting the Submit button. You are just embarassing yourself with posts like this. I am not even going to argue with you. Open Wikipedia as Diego suggested and educate yourself of what country Ukraine is before opening your mouth.

Diego,

you answered your own question on what separated Russia and Brazil on one hand and China and India on the other from countries like Ukraine. The first two won a lottery named Oil&Gas, the last two made some significant reforms, both political as well as economical before they started to boom. There are always indicators on when country is about to explode economically. I agree with you that Ukraine is very attractive both from geographical situation and from peoples resource but until they do some meaningful reforms your investment money might just as well be spent playing a roulette. In fact, with roulette the upside potential is always higher and one obviously disregards all risks as you pointed.

[netscorer]

Jitomir,

I don't agree with you very last statement. I think if one waits until the political powerplay in Ukraine stops and reforms are being implemented, there is still great upside potential. But at the same time the risks are being mitigated or, at least, minimized to a degree. This is what noone gets about smart investing. You don't have to search for the next best opportunity. Simply identifying an OK opportunity is enough as long as you know that you are covered on the downside. This is what made Buffet the greatest investor of all time. He never really tried to strike gold with each next acquisition or investment. He simply followed the very same rule that it's better to invest in great company with OK potential rather then invest in OK company with great potential.

[boyar]

Checked out the Foyil website. Interesting. Anyone here have any experience with it? I'm primarily concerned about any restrictions on cashing out after, say, 4-5 years.

[amatsak]

Ukraine is the everyday reality for me as I work for a Ukrainian investment bank in Kiev. There is a lot of truth – about the positives as well as the negatives – both in the article and the comments. However, now that the Ukrainian stock market has fallen around 70% from its all-time high in January, there are a lot of bargains. Some good companies are even selling below their book value.

Jumping in for short-term gains is dangerous, but investing for mid- and long-term makes a lot of sense. Drop me a line at matsak art-capital.com.ua if you want to learn more about Ukraine.