Bloomberg markets 2014 May by Steve Salomon Jaramillo Villamizar

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march volume 23

number 3

FeatuReS Special RepoRt: emeRging maRketS

30 The Gulf Speeds Ahead The standouts in our annual rankings are Qatar, the U.A.E. and Saudi Arabia, which are using their oil wealth to diversify their economies. by Weiyi lim

Remaking Russia’s Economy Vladimir Putin and Rosneft boss Igor Sechin are spearheading the drive to augment state capitalism—as growth flags and investors fret. by iRina Reznik, Stephen BieRman and henRy meyeR

50 Mexico and Nigeria: It’s Their Turn The economist who coined the BRIC acronym says investors should watch a new group of countries in Latin America, Africa and Asia. by Jim o’neill

Selling Korean Cool CJ Group’s Miky Lee is leading the $27 billion food-to-entertainment conglomerate as her brother fights tax-evasion charges. by yoolim lee

Panama Digs Deep The country is spending $5.25 billion to expand its 100-year-old canal, in a bid to retain its edge in international commerce.

A Heavier Touch Chief U.K. markets regulator Martin Wheatley is racing to clean up a banking culture tainted by Libor manipulation and insider trading. by lindSay FoRtado and Stephanie BakeR

on the cover Russian President Vladimir Putin in Paris Photograph by Stephane lavoue/ paScoandco

4 bloomberg markets March 2014

Ethanol Evangelist In an industry littered with bankruptcies, Todd Becker has built Green Plains into a $3.5 billion powerhouse. by John lippeRt and maRio paRkeR

80 The Fight Over Canada’s Riches First Nations peoples are asserting their right to be consulted before drillers and miners use their land. by JeRemy van loon

from top: Hong Jang Hyun; JoHn spinks; micHael friberg

by eRic SaBo

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March continued

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s t r at e g i e s

90 Equities

Why active fund managers are feeling optimistic

by douglas edler, cFa, and Jon asmundsson

92 Cheat Sheet

Emerging Markets

93 Equities Profiting From Deals

by eric roseman

14 16 18 20 22 24

Against the Stock Market Herd Bloomberg Global Poll: Confidence Reigns Stranded Sailors Abe’s Womenomics Green Racing Formula Tips From Billionaire Alexey Mordashov

94 Portfolios

Lowering Volatility

by nick Baturin

96 Influential News 98 Private Equity Exit Signs

by anita khalili and alicia looney

99 Riskless Return Best Defense

by nick taBorek

100 What’s New c o m m e n ta r y

Editor’s View Finding the Next BRICs

10 Letters 26 Bloomberg View

How Panama Can Seize Its Moment

6 blooMberg Markets March 2014

from top: Chris Buzelli; DaviD BeCker/Getty imaGes; sasha maslov

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Editor’s View

EdiTor-in-chiEF, BloomBErg nEWs

Matthew Winkler

Finding the Next BRICs ‘You can privatize enterprises, but they won’t be competitive,’ says Putin spokesman Dmitry Peskov.

It’s been a bumpy 12 months for some of the world’s biggest emerging markets, especially the BRICs—Brazil, Russia, India and China. Only one of those four, China, finished in the top 10 in BloomBerg markets’ rankings of the best emerging markets for investing. The standouts this year are smaller, so-called frontier, markets, including the Persian Gulf nations of Qatar, the United Arab Emirates and Saudi Arabia, which some investors see as ripe with potential, Weiyi Lim writes in the lead story of our special report (“ThE Gulf spEEds AhEAd,” page 30). In Russia, where growth likely slowed to 1.3 percent last year, President Vladimir Putin is reasserting the state’s role in the economy—to the chagrin of many investors. This shift is most notable at OAO Rosneft, the publicly traded, state-run oil giant led by longtime Putin ally Igor Sechin, write Irina Reznik, Stephen Bierman and Henry Meyer (“REMAkinG RussiA’s EconoMy,” page 38). “You can privatize enterprises, but they won’t be competitive,” Putin spokesman Dmitry Peskov says. In South Korea, the economy is dominated not by the state but by the chaebol. Yoolim Lee talks with the woman who’s now leading one of those familyrun conglomerates: CJ Group’s Miky Lee, who helped put Korean pop culture on the map (“sEllinG koREAn cool,” page 54). In Panama, No. 6 in our emerging-markets ranking, Eric Sabo reports on the country’s $5.25 billion canal renovation, a bid to retain its edge in international trade (“pAnAMA diGs dEEp,” page 62). And Jim O’Neill, the former Goldman Sachs Group Inc. economist who coined the term BRIC, has his eye on a new group of emerging and frontier markets (“MExico And niGERiA: iT’s ThEiR TuRn,” page 50)—including a quartet of countries he calls the MINTs.

ExEcutivE Editor

To write a letter to the editor, e-mail bloombergmag@bloomberg.net or type MAG <Go> on the Bloomberg Professional service. For subscription questions, e-mail bloombergmarkets@cdsfulﬁllment.com. Visit us at bloombergmarkets.com and follow us on Twitter at @BloombergMrkts. 8 BlooMBERG MARkETs March 2014

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FouNder, bloomberg lP

michael r. bloomberg chairmaN

Peter t. grauer

letters

chieF executive oFFicer

Daniel l. Doctoroff

Bloomberg Markets Publisher

michael Dukmejian 212-617-2653

“Fleeced by Fees” November 2013

I’ve never believed that managed futures should have any role whatsoever in the allocations of longterm investors. Shortterm speculators, as your story illustrates, shouldn’t bother either. When a security is bereft of any intrinsic value (interest, dividends, earnings growth), put your hand over your wallet pocket!

advertisiNg sales director, americas

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associate Publisher aNd global marketiNg director

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Management alumni based everywhere from Kabul to Bogota to Wichita. You made complex situations instantly easy to follow and grasp. I and other alumni are deeply indebted to you and everyone who helped you make this article possible. Margaret aMein Bad Soden, Germany

“A Gift to Billionaires” February 2014

I have always enjoyed Bloomberg articles, but this one struck home. The technique undermines the tax system as a whole and gives openings to the political few to play with as they desire. Dan goulDen Management representative Wellman Dynamics Machining & Assembly Inc. York, Pennsylvania

“Too Good to Be True” February 2014

tiago Castro 55-11-3048-4645 euroPeaN sales

Clare bowen 44-20-3216-4275 siqondile Ngubo 44-20-7073-3850 marketiNg executive

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Johnna ayres 212-617-1833 coNsumer marketiNg maNagers

Thank you for your focus on such scams, which are destroying the socioeconomic condition of West Bengal. We, the people of West Bengal, are helpless. We want a new leader of a new India as well as a new leader of West Bengal.

alexandria lopez 212-617-6019 Joelle Quinones 212-617-8777

ahasan MohaMMaD haBiB Kolkata

steven J. mcCarthy 212-617-4332

oPeratioNs director

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assistaNt to the Publisher

richette robillard 212-617-0838

“Education Empire” February 2014

I want to thank you for your brilliant, in-depth article on Laureate Education Inc., which is currently being read and reread by Thunderbird School of Global 10 bloomberg markets March 2014

a bPa international business Publication advertising inquiries: 212-617-3087

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Colombian Tungsten Mine Will Be Closed The Colombian government said in December it would seize and close a tungsten mine run by FARC guerrillas. In “Tungsten’s Tainted Trail” (September 2013), BLOOMBERG MaRkETS reported that the Colombian rebel group funneled the illegally mined metal to companies that exported it and major multinational corporations bought parts that originated from the tainted supply line. After the story was published, the European Union wrote tough laws to prevent companies from buying minerals that fund the conflict in Colombia. MichAel sMith And AndreW Willis

Global opportunities

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E Q U I T I E S . C O M M O D I T I E S. A LT E R N ATIV E S . BONDS.

Morningstar Rating™ as of 31 December 2013 for the institutional class shares; other classes may have different performance characteristics. Overall rating for the Multisector Bond category. Fund ratings are out of 5 Stars. For the PIMCO Income Fund: Overall 4 Stars (219 funds rated); 3 Yrs. 5 Stars (219 funds rated); 5 Yrs. 4 Stars (176 funds rated); 10 Yrs. N/A Stars (113 funds rated). For funds with at least a 3-yr history, Morningstar calculates a Morningstar Rating based on a risk-adjusted return measure that accounts for variation in a fund’s monthly performance (including the effects of sales charges, loads and redemption fees) with an emphasis on downward variations and consistent performance. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. The Overall Morningstar Rating is a weighted average of the performance fgures for its 3-, 5- and 10-yr (if applicable) Morningstar Rating metrics. Morningstar, Inc.® 2014. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/ or its affliates; (2) may not be copied or distributed; (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.

CFTC Investigating Managed Futures The Commodity Futures Trading Commission is investigating the effect that high fees in managed-futures funds have on customers. In “Fleeced by Fees,” BLOOMBERG MaRkETS reported that in the decade ended on Dec. 12, 2012, 89 percent of the $11.5 billion of profits in 63 funds was consumed by commissions, fees and expenses. The article spurred U.S. Senators Elizabeth Warren, a Democrat from Massachusetts, and Bill Nelson, a Florida Democrat, to urge the CFTC to work with the U.S. Securities and Exchange Commission to study ways to provide clearer disclosure of fees charged on retirement accounts invested in the funds. In announcing the inquiry in December, CFTC Commissioner Bart Chilton said the agency must protect investors. “That includes highlighting, and potentially banning, excessive fees that can dAVid eVAns gobble up profits,” he said.

correction In the “Activist Buys GM” item on the Influential News page (February 2014), we misstated the enterprise value of General Motors Co. It was $42.3 billion on Nov. 25.

I N F O R M AT I O N F O R R E A D E R S letters to the editor

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12 blooMbe rG MArkets March 2014

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p e op l e, c om pan ies a nd i de a s t h at mov e m a r k et s

As WAll street firms predict Another good yeAr for U.s. stocks, contrAriAns see risks from stretched vAlUAtions, inflAtion And the fed. 14 bloomberg markets March 2014

U.S. stocks are going up in 2014, at least a bit. At the beginning of January, after the Standard & Poorâ&#x20AC;&#x2122;s 500 Index closed out 2013 at 1,848, their end-of-year targets ranged from 1,850 to 2,100. The median among 20 sell-side prognosticators was 1,950, which would be a 5.5 percent gain if it pans out. In other words, after big advances for U.S. stocks in four of the past five years, including a robust 32 percent return for the S&P 500 last year, the forecast is for more.

IllustratIon by chrIs buzellI

Against the Herd

Bank strategists agree:

What could possibly go wrong? Fortunately, there are always a few money managers and strategists ready to address that question. Their present concerns encompass inflation, Federal Reserve tapering, stock valuations and technical chart breakdowns. David Rosenberg, chief economist at Gluskin Sheff & Associates Inc., says the biggest stock market risk right now is that the Fed will be forced to raise interest rates as the economy grows faster than expected. That flies in the face of current wisdom. While the Fed has begun to withdraw its monetary support for the economy by trimming its bond purchases, most economists say the central bank will keep its benchmark funds rate near zero at least into 2015. A market that shrugged off bad news for the past several years may quickly become one underwhelmed by good news, in Rosenberg’s thinking. “One thing that we learned in this cycle is that you can have very weak growth but a tremendous surge in the market when the Fed is providing a tremendous amount of liquidity,” he says. “I’d expect that when we actually get growth, and we get the Fed doing something different, we’re going to get different results in the market.” Jim Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, describes a scenario that has a lot in common with Rosenberg’s. Inflation, or inflation fears, is a possibility in 2014, Paulsen says. He sees nominal economic growth accelerating to as much as 6 percent—with gross domestic product expansion at 3.5 percent plus inflation, measured by the GDP price deflator, up to 2.5 percent. The threat of an overheating economy would then raise concern that the Fed will be unable to withdraw its extraordinary monetary support in an orderly fashion, Paulsen says. “The methodical and well-controlled monetary tapering which greets us here at the beginning of the year could turn to a ‘panic taper,’” Paulsen wrote in a Jan. 2 letter to clients. That would

expeNsive, or Not

Nobel laureate Robert Shiller’s cyclically adjusted price-earnings ratio shows that stocks are expensive versus the long-term average of 16.5, although not as overvalued as in 2000 and 2007.

2000 Technology Stock Bubble

40 1929 Stock Market Crash

30 Credit Crunch of 1966

Long-term average of 16.5

0 1880s 1890s 1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s 2010s Source: Yale University

wreak havoc in the bond market, and boost stock market volatility, he says. Paulsen forecasts that the S&P 500 will climb as high as 2,000 at some point in 2014, a gain of 9 percent from when he published his note, and then slide, finishing with no gain at all for the year. If that comes to pass, it likely would be a setback and not an end to the bull market, which he says has more years to go. Sam Stewart, chairman of Wasatch Advisors Inc. in Salt Lake City, predicts a rapid stock market sell-off at some point in 2014. He argues that stock valuations are stretched after the five-year bull market, especially when rising price-earnings ratios are compared with slowing growth rates—the socalled PEG ratio. Based on profits and profit growth for the most recent 12 months, the S&P 500’s PEG ratio was 3.1 at the beginning of the year, compared with a 20-year average of 1.1, according to Stewart. That’s higher than it was in 2007, when the market touched its pre-financial-crisis peak, he says. If stocks are expensive, they’re vulnerable to unpleasant surprises,

Stewart says. The nationwide steel strike in 1959 and the failure of LongTerm Capital Management in 1998 are examples of events that triggered selloffs in overvalued markets, according to Stewart, whose Wasatch World Innovators Fund beat 99 percent of its peers during the past five years. For Carter Worth of Oppenheimer & Co., the New York investment bank and wealth manager, the big risk may be simply that total returns for U.S. stocks have been positive for five years running. Worth is his firm’s chief market technician, meaning his forecasts are based on historical charts and patterns, not economic or company fundamentals. Since 1927, the S&P 500 has had five consecutive winning years on six previous occasions. The average return in the next year was negative 2.3 percent, according to Worth. And the peak-totrough decline in that sixth year, as opposed to the calendar year move, averaged 23 percent. “At a minimum, 2014 has high odds to be a below-average year,” Worth says, “with the possibility that it’s not only below average but has lU WaNg something quite ugly.” March 2014 bloomberg markets 15

Ag e n dA

Economics

“ Here is a guy who trained half of the central bankers in the world.” Donald Kohn on the nomination of Stanley Fischer to the post of Fed vice chairman, which Kohn once held

Conﬁdence Reigns

As growth strengthens in the U.s., investors Are more optimistic AboUt the world economy thAn At Any time since the greAt recession.

WHAT IS YOUR VIEW OF ...?

Positive sentiment is at an all-time high for the U.S., the euro zone and the global economy, while it’s negative on China.

THE GLOBAL ECONOMY No Idea

Stable 30%

Deteriorating

10%

Improving

59%

The recovery is

accelerating in the U.S., Europe is healing, and investors are feeling some animal spirits, according to the Bloomberg Global Poll. Fifty-nine percent of bankers, traders and money managers said the world economy is improving, the most bullish response since the poll of Bloomberg customers began in 2009. “Without doubt, confidence is the single most important determinant for growth,” says Wilhelm Schroeder, a poll participant and managing director of Schroeder Equities GmbH in Munich. “Developed countries are playing by far the most important part of the recovery in confidence.” sImoN keNNeDY

89% 6%

16 bloomberg markets March 2014

22%

72%

94% THE EURO-ZONE ECONOMY

14%

49%

35%

84% 2%

THE CHINESE ECONOMY

36%

49%

13%

62%

LOOKING AHEAd

Amid growing optimism about the strength of the recovery and a favorable view of incoming Federal reserve Chairman Janet yellen, a majority of poll respondents still say that U.S. growth in the coming decade will be subpar.

What Will the AVERAGE ANNUAL GROWTH RATE BE IN THE U.S. over the next decade? Less than 2% About 2%

The quarterly Bloomberg Global Poll was conducted Jan. 16 to 17 by Selzer & Co. of Des Moines, Iowa. Sample size: 477 investors, bankers and traders who are Bloomberg customers. Margin of error: plus or minus 4.5 percentage points.

THE U.S. ECONOMY

What is your vieW of incoming fed chair JANET YELLEN?

68%

44%

About 3% About 4%

40% 6%

Favorable

No idea

Unfavorable

No idea

16%

ToP: AnDrew HArrer/BlooMBerG; CHIP SoMoDevIllA/GeTTy IMAGeS

bloomberg global Poll

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Ag e n dA

Economics

sailors killed in the sinking of four ships carrying nickel ore, which can liquefy and destabilize a vessel when handled improperly, as tallied by GCaptain.com

Stranded Sailors

SeAFAReRS FAce the RiSk oF StoRmS And piRAteS—And getting Stuck in poRt without Food, pAy oR A ticket home.

onE crEw’s ordEal

$375 billion–a-year global shipping business that its workers are scattered across the planet. What’s not supposed to happen is for captains, engineers and sailors to end up stranded far from home. As early as 1926, international conventions established that shipowners must pay to repatriate crews. Nonetheless, hundreds of sailors get stuck each year when shipping companies go bust or when ships break down or land in legal limbo. Sailors may not have appropriate visas or, in the case of a vessel anchored offshore, any way to reach land. Some may be waiting for back wages or unable to afford a ticket home. The United Nations has documented 199 cases involving 2,379 stranded sailors in the past decade. 18 bloomberg markets March 2014

The actual numbers are likely higher, as many instances go unreported, according to The Mission to Seafarers, a London-based group that provides services for sailors in 260 ports around the world. The charity estimates that more crew members are held captive by the actions of shipowners than are kidnapped by Somali pirates. IsaaC arNsDorF

Kostas tsironis/BloomBerg (3)

It’s In the nature of the

The captain and nine crew members on the JSM were stranded in Kiato, Greece, in February 2013, after their ship became tangled in a legal dispute. The scheduled one-week stop dragged into months. The management company in Romania said it couldn’t reach the owner of the Moldovanﬂagged ship. Money for food and fuel ran out. By summer, the ship’s complement—from Syria, Egypt and Lebanon—was owed about $100,000 in back pay. Tempers rose until the chief engineer attacked the captain with a rock, sending him to the hospital. That clash alerted locals, who helped the crew with food and a place to wash and charge phones. The harbor master wouldn’t let the sailors leave the ship unmanned without Moldovan government permission, which came in October. The sailors ﬁnally got to go home.

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PA P uA N E W G u I N E A

AND

Ag e n dA

the

U.s.

Only countries that don’t provide or require paid maternity leave

Source: International Labour Organization data on 185 nations

Abe’s Womenomics

goldmAn SACHS StrAtegiSt KAtHy mAtSui’S propoSAlS for jApAn’S eConomy finAlly get tHeir due AS tHe prime miniSter SeeKS SuStAinAble growtH.

are working against Shinzo Abe’s efforts to foster growth in Japan after two decades of stagnation. By 2035, a third of the population will be 65 or older, up from 23 percent in 2010. The country will have an increasing number of retirees to care for as it tries to service a public debt that’s twice as big as annual gross domestic product. In a sign that Abe gets the problem, the prime minister has embraced something Kathy Matsui, Goldman Sachs Group Inc.’s chief Japan equity strategist, has been pushing for a decade and a half: the benefit of more women in the workforce. The proportion of Japanese women with jobs reached 60.7 percent in 2012, a record, up from 56.7

geNDer gaps iN sweDeN

Workforce ParticiPation rate, JaPanese Women aGes 15 to 64 80% 70 60

MATSUI’S TArgeT

50 40

1984

2012

Source: Japan’s statistics bureau

percent in 1999. It’s not high enough, says Matsui, who grew up in Salinas, California, working at her father’s flower nursery. Japan could expand its workforce by 8 million people and increase GDP by as much as 14 percent by raising female workforce participation to 80 percent, the same level as males. “We have to convince the Japanese people that running a marathon with

swed I s h s o C I et Y

In one of the world’s

most gender-equal countries, SEB AB chief executive Annika Falkengren says more work is needed: “It’s important not to glorify Sweden. We have so few women at the very top.” 20 bloomberg markets March 2014

Women

45 %

Goldman’s kathy matsui has pushed for womenomics since 1999.

one leg is going to take a very long time,” she says. Matsui coined the term womenomics in 1999, when she first wrote about the idea. Equalizing roles in the workforce was a more realistic and practical solution to Japan’s shrinking labor pool than

loosening immigration laws or raising the birth rate, she argued. Abe is convinced. His economic policy goals include the elimination of waiting lists for child care and support of training for mothers returning to work. YosHiaki NoHara

sw e d Is h B Us In es s

men

of elected ofcials are women

24 %

of corporate directors are women

22 %

of senior managers at top 25 companies are women

of Ceos at top 100 companies are female

TOmOhirO Ohsumi/BlOOmBerG

Demographic trends

Lipper. And Morningstar? And Barron’s? We’re going to need a bigger shelf.

Learn more about our breadth of award-winning mutual funds, available to your clients, at tiaa-cref.org/fundawards or call 800 719-1193. 1 In calculating the awards, Lipper considered funds registered for sale in the United States with at least 36 months of performance as of the end of the calendar year of the respective evaluation year. Fund groups with at least Àve equity, Àve bond or three mixed-asset portfolios were eligible for an overall group award. The award is given to the group with the lowest average decile ranking of three years’ Consistent Return measure of the eligible funds over the three-year period ended 11/30/12. TIAA-CREF was ranked against 35 fund companies. 2 As of September 30, 2013, 42.6% have 3 stars, 39.6% 4 stars and 15.4% 5 stars. Morningstar is an independent service that rates mutual funds and variable annuities. The top 10% of accounts in an investment category receive Àve stars, the next 22.5% receive four stars and the next 35% receive three stars. Morningstar proprietary ratings reÁect historical risk-adjusted performance and can change every month. They are calculated from the account’s three-, Àve- and ten-year average annual returns in excess of 90-day Treasury bill returns with appropriate fee adjustments, and a risk factor that reÁects mutual fund/subaccount performance below 90-day T-bill returns. The overall star ratings are Morningstar’s published ratings, which are weighted averages of its three-, Àve- and ten-year ratings for periods ended September 30, 2013. 3 The Barron’s/Lipper Fund Family survey uses an asset-weighted ranking system. Each fund’s return was measured against those in its Lipper category, and the resulting percentile ranking was then weighted by asset size relative to the fund family’s other assets in its general category. The family’s overall ranking was then determined by weighting the Àve fund categories in proportion to their overall importance within Lipper’s fund universe. In 2012, TIAA-CREF is ranked 10th of 62 for the one-year, 29th of 53 for the Àve-year and does not qualify for the 10-year ranking. Consider the investment objectives, risks, charges and expenses carefully before investing.

Visit tiaa-cref.org for product and fund prospectuses that contain this and other information. Read the prospectuses carefully before investing. TIAA-CREF Individual & Institutional Services, LLC and Teachers Personal Investors Services,

Inc., members FINRA, distribute securities products. Annuity contracts and certiÀcates are issued by Teachers Insurance and Annuity Association (TIAA) and College Retirement Equities Fund (CREF), New York, NY. ©2014 Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF), 730 Third Avenue, New York, NY 10017. C10238 TYPE TIAA <GO>

Ag e n dA

EnErgy

“The word ‘recall’ needs To be recalled.”

Elon musk on twitter during a spat with u.S. auto safety regulators over steps tesla took to reduce any ﬁre risk related to recharging its vehicles

A Greener Formula

A mogul humbled by SpAin’S reAl eStAte buSt SeekS A Second Act with An electric-cAr rAcing SerieS.

Banuelos lost most of his $5 billion fortune when his company imploded along with Spain’s real estate market. And yet, he hasn’t lost his taste for risk. Banuelos is using some of the money he has left to back a global, startup electric-car race series called Formula E. Banuelos aims to succeed in the creation of a new motor sport where others have failed—most recently, the A1 Grand Prix race series, meant to rival Formula One, which folded in 2009 after four seasons. Alejandro Agag, 43, the son-in-law of former

Spanish Prime Minister Jose Maria Aznar, is chief executive officer of Formula E Holdings and owns a stake. Actor Leonardo DiCaprio is helping fund one of the initial 10 racing teams. For now, all Formula E cars will be built to identical specifications, including 200 kilograms (441 pounds)

of lithium-ion batteries, by McLaren Group and other car companies. Spending is limited to 3.5 million euros ($4.7 million) per team per season, or about 2 percent of a Formula One team’s outlay. To ensure success beyond its first 10-race season, Formula E hopes to lure carmakers such as

BMW and Toyota to start their own teams and develop cars, according to Mark Gallagher, a former manager of an A1 team. He says it’s reasonable to think the companies will want to be associated with cuttingedge, superfast electric vehicles: “This is about making sustainability sexy, and that’s a powerful message for carmakers.” Which leaves the question of whether it will win fans. The first test of a motor sport that’s greener, slightly slower and lacks the ear-splitting roar of Formula One will be Sept. 13 in Beijing. ALEX DUFF

FormULA oNE

FormULA E

EnginE: 1.6-liter V-6 turbo (plus a 120-kilowatt hybrid electric boost)

EnginE: 200-kw electric motor

PowEr: 760 brake horsepower (peak/passing mode)

PowEr: 270 bhp (peak/passing mode)

AccElErAtion: 0 to 62 miles per hour in 2.5 seconds

AccElErAtion: 0 to 62 mph in 3 seconds

toP sPEEd: 200 mph

toP sPEEd: 140 mph

sound: 120 decibels (comparable to thunder)

sound: 80 dB (comparable to a city bus)

FormAt: 90 minutes on a 3.5-mile (5.6-kilometer) track; pit stops as needed for tires, repairs; no change of car allowed

FormAt: one hour on a 1.5-mile street circuit; two mandatory pit stops to change cars; no tire changes allowed

22 bLoombErg mArkEts March 2014

top: Simon DawSon/BloomBerg; courteSy formula e holDingS

Developer Enrique

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Ag e n dA

$ 6 3 1 , 8 5 0

InvestIng

record price for a bottle of single-malt whisky, a 6-liter lalique crystal “m” decanter of macallan auctioned by Sotheby’s in hong kong

Billionaire

Alexey Mordashov

THe MAJORITY OWneR OF STeeLMAKeR SeVeRSTAL HAS dIVeRSIFIed InTO TRAVeL And TeLeCOM—And SeeS nO ROOM In THe OIL And gAS BUSIneSS.

BLOOMBERG BILLIONAIRES INDEX NET WORTH: $11.1 BILLION

Where do you see opportunities? I have four criteria that potentially help make a successful investment: demographics—an increasing population in the region where you invest; developing technologies; a good entrepreneurial climate; and good potential for commodity businesses. Several regions meet these criteria. One of them is definitely Russia. We have a consumer boom and a rising population. Despite corruption and bureaucratic issues, it is still possible to start your own business in Russia.

How do you view gold? I don’t see the price of gold falling in the near future as it is already close to the production cost for the majority of producers. I also wouldn’t expect gold to rise by very much. In any case, I wouldn’t recommend putting everything in one

PRIMARY ASSETS: OAO SEVERSTAL

(Cherepovets, Russia) ;

SILOVIYE MASHINY (St. Petersburg) ; TUI AG

(Hanover, Germany)

INDUSTRIES: STEEL, INDUSTRIAL MACHINERY, TRAVEL

COMMODITIES, TELECOM

GOLD OIL AND GAS

basket. Any investor should diversify risks by adding different assets into the portfolio. How have you diversiﬁed? I have assets such as Utkonos, an online retailer. I recently bought the stake in Tele2 Russia, the mobile phone operator. I have a stake in travel company TUI. I also own Siloviye Mashiny, a heavy-machinery maker, and Sveza, a wood products company.

24 bloomberg markets March 2014

What about oil and gas? I don’t see any opportunities, as the sector is full of highly professional and effective players already. The sector is overheated. How long do you think the global steel glut will last? The industry is suffering from excess capacity. Even quite healthy 3 percent to 4 percent annual consumption growth can’t compensate for excessive and inefficient capacity. If the

situation remains like it is now, the utilization rate will only reach a more or less appropriate 83 percent to 85 percent in 2018. What’s safest: a global equities fund, Treasuries or a top-tier Picasso? Any investment is a risk, but I would say that art objects are less volatile. EXCERPTED FROM A DEC. 16 INTERVIEW BY aleX saZoNoV AND YUlIYa FeDorINoVa CONDUCTED AT MORDASHOV’S MOSCOW OFFICE.

PHOTOgRAPH BY TK

AlexAnder ZemliAnichenko Jr./BloomBerg

Do you invest in bonds, shares or hedge funds? I favor businesses that I manage rather than putting money into financial instruments, in which I am not an expert. All that I earn I reinvest into businesses that I consider strategic.

AGE: 48 CITIZENSHIP: RUSSIA

i travel for work. i see a lot of opportunity. i’m thinking about China. Brazil. i want to be a part of it.

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How Panama Can Seize Its Moment

With the world’s second-largest free-trade zone, four conAnd notwithstanding five successive elected civilian tainer-vessel seaports, the Pan-American Highway and numer- governments since the 1989 U.S. intervention that toppled ous free-trade agreements, Panama is on its way to becoming General Manuel Antonio Noriega, Panama’s civil institutions the Singapore of the Americas. And as Eric Sabo reports in and democratic culture remain weak. The judiciary is seen “Panama Digs Deep” (page as lacking independence. 62), the expansion of the PanThe press faces intimidaama Canal now under way “is tion. Martinelli’s leadership only part of the massive inhas been marked by scandals frastructure spending that is and efforts to amass execupropelling the Panamanian tive power. economy.” This May’s presidential Yet to reap the full beneelections offer Panamanians fits of such investment, and a chance to bring in a new adto address one of the hemiministration committed to sphere’s worst cases of ecoattacking corruption with nomic inequality, Panama greater urgency. It could needs to follow Singapore’s start with transparency—for lead in fighting corruption. example, by posting online Singapore placed fifth out of more details on corporate continued progress in panama isn’t 177 countries in last year’s ownership and taking other a given. it will require the successor to president ricardo martinelli Corruption Perceptions Insteps recommended by the to attack corruption with urgency. dex compiled by TransparOrganization for Economic ency International; Panama Cooperation and Developwas 102nd. (The higher the ranking, the less corruption.) ment. Panama also has yet to sign on to the World Trade OrExecutives surveyed by the World Economic Forum have ganization’s government procurement agreement. pegged corruption as Panama’s biggest problem for business. Strengthening the judiciary and building up anti-corruption Many of the qualities that have made Panama a hub for institutions will take time. In the interim, a few aggressive global trade and finance have also attracted malefactors. Drug prosecutions of cases involving corruption and abuses of aucartels from Mexico and Colombia take advantage of its loca- thority would be a down payment on reforms to follow. What tion, dollarized economy and free-trade zones to move their has made Singapore such a success, after all, isn’t just its freeproducts and launder their proceeds. Panama’s low tax rates dom of commerce but its commitment to following the rules. make it a haven for those seeking to shelter or hide assets. Revenue from the canal and huge investments in infrastructure BY THE EDITORS Of BlOOmBERg vIEw To read more editorials, type view <go> on the Bloomberg Professional service or feed temptations for misappropriation, bid rigging and bribery. go to bloomberg.com/view. 26 bloomberg markets March 2014

vatican pool/getty images

Ricardo Martinelli, the president of Panama, makes no secret of his admiration for Singapore, the island state that has turned itself into a thriving Asian financial and trading center. As he has put it, “We copy a lot from Singapore, and we need to copy more.”

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bloomberg markets 31

saudi arabia’s king abdullah economic City, far right, under construction in 2008. right, dubai hosted the 13th Dubai airshow in november. 32 bloomberg markets March 2014

—Qatar, the U.A.E. and Saudi Arabia— which jumped to the top of BLOOMBERG MARKETS’ third annual ranking of the most-promising frontier markets in which to invest. Three Asian nations led the separate emerging-markets ranking, with China No. 1 for the third consecutive year, followed by South Korea and Malaysia. Panama was No. 6; its economy took of as thousands of workers labored on an expanded canal that will be able to accommodate the world’s big ships. (For more on Panama, see “Panama Digs Deep,” page 62.) MSCI Inc., the publisher of equity indexes, designates countries as emerging or frontier based on a variety of criteria, including trading volumes, restrictions on foreign investors, corporate governance, and currency and political stability. The BLOOMBERG MARKETS ranking is based on 19 measures of the investing

Left to right: Jason aLden/BLoomBerg; susan BaaghiL/reuters/Landov

ﬁnancial capital of the United Arab Emirates. Tourists were once again jostling for a spot from which to watch the dancing fountains that adorn the downtown area. Recurring trafc jams, increasing retail sales and a rise in airport passengers were other signals for Khan, the senior executive ofcer at Dubai-based Shuaa Asset Management. “The signs in the economy were visible before the market took off,” says Khan, whose ﬁrm had 780 million dirhams ($212 million) under management at the end of September. “We waited for the pop and eventually it happened.” Dubai’s benchmark stock index, in the doldrums for two years, rose 117 percent in 2013, including reinvested dividends, leading the world. That helped Khan’s Arab Gateway Fund, which invests throughout the Middle East and North Africa, return 39 percent. Dubai’s performance was part of a surge by three Persian Gulf nations

climate, from forecasts of gross domestic product growth for the next two years to the ease of doing business. The gains for the Gulf nations came as Brent crude oil prices remained above $100 a barrel for the third year, and the petroleum producers used their huge revenues to diversify their economies. Qatar and the U.A.E. have progressed to a point that MSCI said on June 11 it would upgrade them from frontier to emerging status in May. “In these countries, you see a burst of construction, which is reminiscent of what you saw in China in the 2000s, when they came up with the high-speed bullet trains, the airports and all the new infrastructure—which opened up the interior of the country,’’ says Arjuna Mahendran, chief investment ofcer at the wealth management division of Dubaibased bank Emirates NBD PJSC. Saudi Arabia’s economy, the largest in the Middle East, expanded at a 5.9 percent average pace during the decade ended on Dec. 31, up from 2.3 percent in the previous 10 years and faster than the global average of 3.8 percent, according to the International Monetary Fund. Qatar will probably post the quickest growth in 2014 at 5 percent, while Saudi Arabia and the U.A.E. will both expand about 4 percent, according to the IMF. Overall, frontier markets were a more

profitable place to invest in 2013 than emerging markets—a trend that’s likely to continue into 2014, analysts say. The MSCI Frontier Markets Index rose 21 percent in 2013, outpacing the MSCI Emerging Markets Index by 26 percentage points, the widest annual gap since 2005. Corporate earnings in the 26 countries that make up the frontier index have risen to the highest level in five years. Profits in the MSCI emerging index, which is dominated by Brazil, Russia, India and China, are still 11 percent below their 2011 high. In late January, emerging-markets currencies saw their worst sell-of in ﬁve years as China’s economy showed new signs of weakness. As of Jan. 24, more than $940 billion in value had been erased from emerging-markets equities since the U.S. Federal Reserve signaled in May that it would start scaling back on bond purchases that boosted demand for high-yielding securities, including developing-nation stocks and bonds. Among the so-called BRICs, China is the only market in the top 10 of the 22 emerging-markets countries ranked by BLOOMBERG MARKETS. “China is going to continue to grow, although at a slower pace than in the past,” says Mark Mobius, who oversees $53 billion as chairman of Templeton Emerging Markets Group.

ToTal SCore

ProjeCTed annual GdP GrowTh, 2014 and 2015, %

PriCe-To-Book raTio of Primary equiTy index

Two-year CdS SPread, BaSiS PoinTS

eaSe of doinG BuSineSS, rank

C h in a

69.6

7.4

1.4

18.3

So u t h Ko r ea

68.4

3.5

1.1

19.5

Ma l aySi a

62.0

5.0

2.4

36.8

Chi l e

59.3

4.3

1.7

40.1

t ha i l a nd

59.0

4.5

1.9

57.9

Pa na Ma

58.8

6.7

0.04

57.2

P e ru

57.3

5.5

2.1

74.3

l at v i a

56.3

4.1

0.6

49.8

P o l a nd

53.2

3.2

1.3

25.7

1 0 Cz eCh re P u b l i C

52.6

2.1

1.0

25.3

1 1 Co lo Mbi a

48.9

4.6

1.6

63.6

12 t u rKe y

48.3

4.1

1.4

130.4

13 hu nga ry

46.2

1.9

0.9

186.2

14 ru SSi a

45.8

2.5

0.8

107.0

15 bra z i l

45.7

2.6

1.0

100.1

116

1 6 P hi l i P P i neS

45.3

6.1

2.6

39.5

108

17 Me x i Co

43.8

3.7

2.8

38.8

1 8 i nd o neSi a

39.6

5.7

2.4

103.7

120

1 9 So u t h a fri Ca

38.3

3.1

2.3

114.7

2 0 Mo ro CCo

37.9

4.4

2.1

157.8

2 1 i nd i a

28.6

5.2

2.6

173.3

134

2 2 egy Pt

20.0

3.3

1.3

642.1

128

for “how we CrunChed the nuMberS,” See Page 36.

“The reform process is going to result in more volatility.” China expanded in 2013 at a 7.7 percent rate, its weakest annual growth since 1999. The economy is forecast to grow 7.4 percent in 2014, according to a Bloomberg survey of economists. The Shanghai Stock Exchange Composite Index slumped 3.9 percent in 2013, including reinvested dividends, as slowing growth curbed corporate earnings. The Chinese government has pledged to stimulate the economy by allowing more private investment in statecontrolled industries. And for the ﬁrst time since the one-child policy was

Sources: Bloomberg, Economist Intelligence Unit, International Monetary Fund, Transparency International, World Bank, World Economic Forum

proclaimed in 1979, the Communist Party said on Nov. 15 it will permit couples to have two children if either parent is an only child. The move is intended to repopulate a rapidly aging workforce. The government, in a four-day Communist Party conclave in November, also said it will accelerate convertibility of the yuan, free up interest rates, improve Treasury yield curves and let qualified private investors set up small- to medium-sized banks. The other BRICs are ﬂoundering. As of September, India, which is No. 21 in the BLOOMBERG MARKETS ranking, had seen four straight quarters of economic March 2014 bloomberg markets 33

ToTal Score

ProjecTed annual GdP GrowTh, 2014 and 2015, %

Price-To-Book raTio of Primary equiTy index

Two-year cdS SPread, BaSiS PoinTS

eaSe of doinG BuSineSS, rank

Qata r

73.4

5.6

1.9

26.1

United arab emirates 72.5

3.8

1.4

116.6

saU d i a ra b i a

72.3

4.2

2.2

26.9

esto ni a

64.9

3.3

1.2

26.5

ba hra i n

61.0

3.6

0.9

147.8

slova ki a

58.8

2.4

0.8

25.7

l i t hUa ni a

58.7

4.0

0.8

49.4

bU lga ri a

55.6

2.2

0.7

62.6

–

ro ma ni a

55.6

2.8

0.2

86.0

1 0 ka z a khsta n

52.9

5.7

0.7

91.4

1 1 slov e ni a

52.6

0.4

0.8

245.8

12 v i e t na m

51.5

5.7

1.8

131.0

13 Croat i a

50.8

1.2

0.9

248.0

14 a rge nt i na

41.5

2.4

0.5

2,370.5

126

15 ni ge ri a

38.3

7.1

2.7

335.2

147

1 6 v e ne z U e l a

26.9

1.1

0.02

1,194.5

181

For “how we CrUnChed the nUmbers,” see page 36.

renderings of al-Wakrah stadium, planned for the 2022 World cup in Qatar. 34 bloomberg markets March 2014

Sources: Bloomberg, Economist Intelligence Unit, International Monetary Fund, Transparency International, World Bank, World Economic Forum

capita income, will host the 2022 soccer World Cup. “This is the largest sports event in the world,” says Rami Sidani, a money manager at Schroder Investment Management Ltd. in Dubai. “And Qatar is going to be spending more than $180 billion in infrastructure projects to be ready to hold this event.” The tiny Gulf country’s GDP last year was $200 billion, the IMF says. In Saudi Arabia, “strong oil prices have allowed the government to spend billions each year on infrastructure, housing, schools and hospitals,’’ says Brent Clayton, an LR Global emerging-markets money manager. “While Saudi Arabia is known for its oil, it is the nonoil sectors of the economy—companies tied to consumption growth and construction spending—that represent the real prize to investors.” Only investors within the Gulf Cooperation Council—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the

courtesy of zaha hadid architects

growth below 5 percent, while Standard & Poor’s said in November it may cut the country’s credit rating to junk. The GDP of Brazil, No. 15 on the emerging-markets list, fell 0.5 percent in the third quarter, the biggest drop since the ﬁrst quarter of 2009. Russia, No. 14, saw its GDP expand 1.3 percent in 2013, also the weakest rate since 2009. Russia’s growth has decelerated or remained unchanged every quarter since Vladimir Putin won a new term as president in March 2012. (For more on Russia, see “Remaking Russia’s Economy,” page 38.) To some extent, the emerging markets were at the mercy of the Fed decision to taper its bond purchases. Such macro forces had less impact on frontier markets, says Sean Wilson, chief investment officer at New York–based LR Global Partners, which oversees about $200 million in developing-nation investments. “It’s the local consumption growth, infrastructure spending and reforms, the broadening and deepening ﬁnancial services sectors that matter to these markets,” he says. “If you looked at each one of the countries, there’s some domestic infrastructure plays that are propelling the economy.” It was the construction and retail sectors—not the state-owned oil and gas industries—that led the big market gains in Qatar, the U.A.E. and Saudi Arabia. Qatar, which has the world’s thirdlargest reserves of gas and the highest per

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lenovo workers assemble smartphones in Wuhan. China is still the no. 1 emerging market.

“because of the young population, the consumer spending power, fast-growing GDP, low government debt. Prices are very attractive. I would rank them higher than Middle East countries.” Nigeria ranks No. 15 in the BloomBerg markets frontier list; Kenya is not ranked.

Morgan Stanley’s Drinkall likes Argentina (No. 14), Pakistan and Romania (No. 8), each of which, he says, has instituted policy changes that will trigger faster economic growth. Andy Brown, a London-based emerging-markets money manager at Aberdeen Asset Management Plc, which oversees about $322 billion, has a long list of what he calls “good quality” public frontier-market companies. He names Nairobi-based East African Breweries Ltd. and Safari.com. “In Nigeria, Zenith Bank is locally owned and managed and has a very strong deposit-gathering franchise,” Brown says. “Most importantly, it is well capitalized, so it has a bufer when the bad times come.” Bad times come more often to frontier markets than to their emerging counterparts, and investors have to be acutely aware of the risk, Brown says. One issue is the markets’ small size. About $6.2 billion of Dubai-based shares changed hands in December, versus $613 billion in China, according to data compiled by Bloomberg. “From a liquidity perspective, you have to be long term in your approach because it costs a lot to trade,” he says. “The markets are relatively thin. You don’t really want to be trading in and out on a regular basis. It can certainly be a bumpy ride.” Weiyi lim covers emerging markets at BloomBerg news in singapore. wlim26@BloomBerg.net with assistance from sarmad khan in DuBai anD alex m c intyre in new York.

ChinaFotoPress/Getty imaGes

U.A.E.—can invest directly in Saudi Arabia, where the benchmark stock index rose 26 percent in 2013. Outsiders access the market through mutual funds and derivatives sold by investment banks. The comeback story of the region is the emirate of Dubai, which at the height of the financial crisis was on the verge of default. It has been a key beneficiary of the unrest elsewhere in the Middle East, says Tim Drinkall, a New York–based money manager at Morgan Stanley Investment Management. “Your traditional tourist destinations have been places like Beirut, Lebanon, and all of Egypt,” he says. “All those destinations essentially have been closed down. You are finding a tourism pickup in Dubai.” The emirate also won the right to sponsor World Expo 2020, an event held every five years that is a stage for nations to show off their economic progress. “This confirms Dubai’s position as the financial gateway, the trading hub, the link between the East and the West,” Schroder’s Sidani says. The Dubai economy will grow an average of 6.4 percent a year over the next three years, Barclays Plc said in a Nov. 26 report. Sven Richter, who oversees about $260 million as managing director of frontier markets at Johannesburgbased Renaissance Asset Management Ltd., says the top frontier markets aren’t in the Middle East; they’re in Africa. “At the moment, the best opportunity is in Kenya and Nigeria,” Richter says,

36 bloomberg markets March 2014

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PowerShares DB Commodity Index Tracking Fund

Sechin, left, and Putin began working together in the 1990s.

March 2014 bloomberg markets 39

40 bloomberg markets March 2014

pharmaceuticals, Putin created Rostec, a state corporation that encompasses 663 companies employing 900,000 people, or 1.2 percent of the entire Russian workforce. He expanded state-run banks OAO Sberbank and VTB Group, whose dominance in retail banking has weakened foreign rivals such as HSBC Holdings Plc and Barclays Plc. Sechin declined requests to be interviewed or to answer written questions. In a telephone interview on Jan. 20, Putin spokesman Dmitry Peskov said: “Sechin is a believer in the role of the state in his economic philosophy while at the same time not excluding a free-market approach. And he is firm in pursuing his viewpoint.” Of Putin’s relationship with Rosneft, Peskov says,

oil from rosneft’s achinsk refinery flows through a state-controlled pipeline system.

Sechin is the leading exponent of Putin’s stated determination to restore the government’s role in the Russian economy. Putin used Rosneft, through its acquisitions, to return Russian oil to state control. The company, which is 69.5 percent government owned, controls about 40 percent of Russia’s crude output. In a similar vein, Putin re-established majority state control of natural gas– exporting behemoth OAO Gazprom. The company had been privatized in the mid-1990s under his predecessor, Boris Yeltsin, cutting the government’s stake to 41 percent. To develop high-technology industries such as armaments and

“The president can’t get involved in the affairs of a company.” Even as Putin, 61, stages the world’s most expensive Olympics, the $48 billion Winter Games in Sochi, to showcase the glories of present-day Russia, he has spent his time in office reshaping the economy to resemble the country’s Soviet past. Following Rosneft’s March 2013 acquisition of TNK-BP, state-owned enterprises accounted for more than 50 percent of Russia’s gross domestic product, up from 30 percent in 1999, according to data published by BNP Paribas SA’s Moscow unit and the European Bank for Reconstruction and Development, or the

opening spread: alexei nikolsky/itar-tass/landov; ilya naymushin/reuters/landov

visitors to his Kremlin office noticed an unusual collection on the bookshelves: row after row of bound volumes containing minutes of Communist Party congresses. The record stretched across the history of the party and its socialist predecessor—from the first meeting in March 1898 to the last one in July 1990, a year and a half before the Soviet Union collapsed. Sechin regularly perused the documents and took notes, says Dmitry Skarga, who at the time was chief executive officer of OAO Sovcomflot, Russia’s largest shipping company. “He was drinking from this fountain of sacred knowledge so that Russia could restore its superpower status and take its rightful place in the world,” Skarga says. Sechin’s back-to-the-future fascination with his country’s communist past is something he shares with Putin, who, soon after coming to power in 1999, restored the music (though not the lyrics) of the Soviet-era national anthem and later described the collapse of the USSR as the greatest geopolitical catastrophe of the 20th century. Sechin himself is an open admirer of socialist icons such as Cuba’s ailing Fidel Castro, the late antiU.S. Venezuelan leader Hugo Chavez and the executed Argentine Marxist Che Guevara, says Victor Mashendzhinov, who studied with Sechin at college. As a young man, Sechin served alongside Cuban fighters in the Cold War hot spots of Angola and Mozambique. Sechin, 53, has put his careful study of communist-era documents into practice at state-run OAO Rosneft, the

world’s largest publicly traded oil company by output and reserves. During a decade at Rosneft, Sechin has turned it into something resembling in size the gargantuan Soviet ministry that was once in charge of oil production, mainly by swallowing up rivals. Beginning in 2004, when Putin appointed him Rosneft’s chairman, Sechin arranged the company’s takeover of the main assets of Mikhail Khodorkovsky’s Yukos Oil Co., according to Khodorkovsky and former Yukos managers Bruce Misamore and Alexander Temerko. Yukos was Russia’s largest crude producer at the time. Last year, having become Rosneft’s CEO in May 2012, he orchestrated the company’s $55 billion purchase of TNKBP, a BP Plc oil joint venture in Russia.

putin: mikhail klimentyev/itar-tass/landov; clockwise from top right: sasha mordovets/getty images (2); eric piermont/afp/getty images; stanislav krasilnikov/itar-tass/landov; tomohiro ohsumi/bloomberg

EBRD. Russia’s economy probably grew 1.3 percent last year, Deputy Economy Minister Andrey Klepach told reporters on Jan. 15 in Moscow. That’s the slowest expansion since the 2009 recession. The ministry projects growth will average 2.5 percent a year through 2030 compared with 7 percent from 2000 to 2008. “Under Putin’s rule in Russia, the state is monopolizing key branches of the economy,” says Anders Aslund, a senior fellow at the Washington-based Peterson Institute for International Economics. Aslund was an economic adviser to Yeltsin in the 1990s, when the government prompted a wave of sell-offs of state assets that put 70 percent of the economy in private hands. “Incredibly, Putin

seems oblivious both to the collapse of the Soviet Union’s economic system and why it happened,” Aslund says. “Half of the economy is controlled by state companies, and that is why the Russian economy isn’t growing.” Such criticism ignores competitive realities, Peskov says. “For example, in shipbuilding, it’s absolutely pointless to carry out privatization,” he says. “You can privatize enterprises, but they won’t be competitive; they will be doomed to failure. So consolidating the assets under the state’s wing is the only way to preserve key sectors of the economy.” The slowdown in Russia coincides with widespread malaise in some of the

larger emerging markets—including Brazil and India, which along with Russia and China make up the BRIC countries, as they’re known. Russia is No. 14 in BLOOMBERG MARKETS’ annual ranking of emerging-markets countries. (See “The Gulf Speeds Ahead,” page 30.) Its growth has decelerated or remained unchanged every quarter since Putin won a new term as president in March 2012. Putin has said Russia stacks up favorably with many European countries on certain key economic indicators. For example, Russia’s unemployment rate for November was 5.4 percent compared with 11.1 percent in the euro zone. “The economy is in much better shape than in a number of European countries,”

Sberbank

Herman Gref

The russian presidenT mainTains a grip on The economy Thanks To The presence of loyal allies in The execuTive offices of big firms ThaT are owned wholly or mosTly by The sTaTe. gazprom, rosnefT and sberbank are The counTry’s Three largesT companies by markeT cap.

Russia’s largest lender

CEO

putin link:

worked with him at st. petersburg mayor’s office in the 1990s

50%

+ one shaRe

roSneft

Alexey Miller

Controls about 40 percent of Russia’s crude production

CEO

Igor Sechin

putin link:

CEO

worked with him at st. petersburg mayor’s office in the 1990s percentage of state control

Gazprom natural gas exporter that supplies a quarter of the european market putin link:

50.002%

69.5%

worked with him at st. petersburg mayor’s office in the 1990s

Vladimir Yakunin

Sergey Chemezov

CEO

roStec state industrial holding giant putin link:

a neighbor in east germany when putin was a kgb officer there in the 1980s

100%

100% Sources: Bloomberg, company data

oao ruSSian railwayS state monopoly railway operator putin link:

a neighbor of his in an elite dacha settlement outside st. petersburg March 2014 bloomberg markets 41

Peskov says. “That is why we don’t take this criticism seriously.” In furthering Putin’s mission, Sechin is more than just a loyal underling to the president, says Khodorkovsky, who accuses Sechin of orchestrating the destruction of Yukos. In December, Putin showed he’s confident enough in the economic change he’s wrought to free Khodorkovsky, once Russia’s richest man and Putin’s most powerful rival. Khodorkovsky, who was imprisoned in 2003 on tax evasion and fraud charges and spent 10 years in prison camps, says Sechin tried to block his release. “I don’t have any such information,” Peskov says. “I doubt it.” Khodorkovsky also says Sechin has helped to shape as well as execute Putin’s economic policies. “Sechin is a real oligarch, in the classic meaning of this word,” Khodorkovsky told Bloomberg News in an interview in Berlin on his fourth day of freedom. “He convinced Putin that state capitalism is right and is realizing this idea in practice.” Putin, a one-time KGB colonel, maintains his tight grip on the economy by drawing on Sechin and other members of his inner circle to ensure that loyal allies direct the country’s industrial strongholds and revenue flows. Sechin, like Putin, is a St. Petersburg native and worked for Putin in the 1990s, when the Russian leader was deputy mayor there. Like Sechin, Putin’s favored few are men who were associated with him before he became president. They include the CEOs of Gazprom, Sberbank, Rostec and monopoly rail operator OAO Russian Railways. Gazprom, Rosneft and Sberbank are now the country’s three largest companies by market value. Putin, Sechin and other senior figures want to ensure that big companies central to the economy are in state hands, says Chris Weafer, a senior partner at Moscow-based consulting firm Macro Advisory. “They hanker after what they recall as the stability of the Soviet system, and part of that is keeping control of socalled strategic industries,” he says. Despite his relatively low profile 42 bloomberg markets March 2014

internationally, Sechin looms large at home. “Sechin is easily the most influential person in the country after Putin,” says Sergei Markov, a political analyst at and vice rector of the Plekhanov Russian University of Economics in Moscow. “Putin trusts him more than anyone else.” Having Sechin in control at Rosneft reflects Putin’s commitment to large government-run corporations. “The experience of successful economic

from 2008 to the end of last year, according to the central bank—a trend the government has said it wants to reverse. Khodorkovsky’s release from prison won’t be enough to allay the concerns of foreign investors, Alexander Kliment and Yael Levine of Eurasia Group, a politicalrisk research firm, said in an e-mailed commentary on Dec. 19. His release, they said, was a public relations stunt ahead of the Sochi Olympics and doesn’t mean the business climate will improve.

Rosneft

oil and Gas output 1 (million barrels a day)

while Rosneft is the woRld’s laRgest publicly tRaded oil company by output and ReseRves, it lags behind exxon mobil in Revenue and maRket value. Data as of Jan. 13 unless otherwise noted. 1 Third quarter 2013. 2 As of Dec. 31, 2012. 3 As of April 25, 2013. 4Includes TNK-BP pro forma data. Sources: Bloomberg, company data

exxon Mobil

4.88 4.02

pRoven oil and Gas ReseRves 2 (billion barrels of oil equivalent)

29.6

liftinG costs peR baRRel 3

$3.70

$12.30

eMployees

235,827

76,900

2012 net pRofit peR eMployee

$70,815

$620,026

MaRket cap (in billions)

$76.6

2012 Revenue (in billions)

$159.2 4

pRice-eaRninGs Ratio

5.4

total debt 1 (in billions)

$71.5

modernization of countries such as South Korea and China shows that the state has a necessary role to play,” Putin said in a 2012 campaign manifesto. “Large private capital willingly doesn’t want to go into new areas because it doesn’t want to carry major risks.” Lately, that private capital has been flowing away from Russia. Concerns about Putin’s treatment of Khodorkovsky and what it said about doing business in Russia encouraged investors to pull $420.6 billion out of the country

25.0

$430.5 $420.7 13.2

$21.3

The key drag on the economy is corruption, much of it concentrated in the state sector, says Elena Panfilova, head of Berlin-based Transparency International’s Russia branch. Russia was ranked the most corrupt nation among the Group of 20 advanced economies in the organization’s 2013 Corruption Perceptions Index. Another hindrance is that state-run companies face no incentive to cut costs and eliminate waste because nonstate shareholders are in the minority, says Mattias Westman, CEO of London-based

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Prosperity Capital Management, the largest Russia-focused equity investor, which manages about $4 billion in Russia and other former Soviet countries. Jim O’Neill, the former Goldman Sachs Group Inc. economist who coined the term BRIC in 2001, says Putin’s stifling of private enterprise has led to Russia’s growth slowdown. “Unless they do undertake reform, that’s the future,” O’Neill says. (For more of O’Neill’s views, see “Mexico and Nigeria: It’s Their Turn,” page 50.) Kingsmill Bond, chief strategist at Sberbank CIB, an investment arm of Russia’s biggest lender, says some investors and commentators hold Russia and China to different standards on transparency and human rights issues. With Russia trailing behind China’s 7.7 percent growth in 2013, Bond says, “it would be fair to say that Russian capitalism is judged more assiduously than that in China.” Largely thanks to Rosneft and Gazprom, Russia (population: 143 million) is the world’s largest energy exporter by barrels of oil equivalent a day and the biggest crude producer after Saudi Arabia. The government receives about half of its budget revenue from oil and gas exports. The EBRD said in December 2012 that Russia was becoming perilously dependent on commodities and failing to prepare for falling oil output in 20 years. Lev Snykov, a partner at Greenwich Capital in Moscow, says the price of crude needs to be at $120 a barrel or higher for the government to be able to balance the budget. Brent crude fell to $106.75 on Jan. 13. When Sechin became CEO of Rosneft, he had already been deeply involved in the company. As chairman beginning in 2004, he had a decisive say in strategic decisions because of his unrivaled access to Putin, according to Vladimir Milov, who was deputy energy minister in 2002. As a boss, Sechin displayed a ruthless streak, Milov says. In 2010, he initiated the sacking of CEO Sergei Bogdanchikov, a lifelong oilman who had kept Rosneft afloat through the volatile economic 44 bloomberg markets March 2014

times of the late 1990s, Milov says. He says Bogdanchikov had his own relationship with Putin, though not as close as Sechin’s. The pair wrestled over operational control, and Sechin eventually forced Bogdanchikov’s exit, Milov says. While serving as Rosneft chairman, Sechin was also appointed deputy prime minister with responsibility for the energy sector in 2008. He held the Rosneft position until 2011, when government officials with a potential conflict of interest were required to quit board seats at state-run companies. He was the most

effective bureaucrat in the government, says former Central Bank First Deputy Chairman Sergei Aleksashenko. “From the point of view of bureaucratic management, he was simply amazing,” says Aleksashenko, now director of macroeconomic research at the Higher School of Economics in Moscow. “He worked like a machine.” Under Sechin, Rosneft has grown into a leviathan. From 2010 to 2013, its annual revenue increased 128 percent to an estimated $143.6 billion, according to a forecast by 13 analysts surveyed by Bloomberg. Its oil and gas output of 4.88 million barrels a day as of the end of the third quarter of 2013 was greater than Exxon Mobil Corp.’s 4.02 million and PetroChina Co.’s 3.8 million; its proven oil and gas reserves, including TNK-BP, rose to 29.6 billion barrels at the end of 2012, more than Exxon’s (25 billion) and PetroChina’s (23 billion). The company posted an eightfold

rise in third-quarter profit in 2013, after recording a 167 billion ruble ($4.98 billion) gain on the value of TNK-BP. Sechin clinched his latest deal on Dec. 20—the day of Khodorkovsky’s release— with the acquisition of Morgan Stanley’s global oil trading and transport business for an undisclosed sum. Sechin also presided over a $270 billion supply deal signed in June that will make China Russia’s largest crude customer during the coming decade. Compared with non-state-owned energy giants such as Exxon, Rosneft is inefficient. Even though Rosneft’s lifting costs—the costs of getting oil out of the ground—are less than a third of Exxon’s, the Russian company’s workforce is less productive. Net profit per employee at Rosneft was $70,815 in 2012 versus $620,026 for Exxon. Rosneft’s priceearnings ratio was 5.4, compared with Exxon’s 13.2, as of Jan. 13. Rosneft shares fell 6.87 percent in 2013, while Exxon shares rose 16.9 percent during the year. “The main reason to hold Rosneft is the reserves,” Snykov says. Sechin had no hands-on oil experience before joining Rosneft as a manager. Initially, operational control was left to Bogdanchikov. Still, Sechin’s resume as a state bureaucrat served him well, with his rise neatly trailing his boss’s. Born in what was then called Leningrad, he attended a school that specialized in French. His parents, who both worked at a metallurgical plant, were divorced when Igor and his sister, Irina, were young. After finishing secondary school in 1977, Sechin studied Portuguese at Leningrad State University. Unlike children of well-connected parents, Sechin was admitted on his own merits, says fellow student Mashendzhinov, who’s now CEO of First Media Co., a St. Petersburg– based advertising firm. Sechin pored over Marxist-Leninist texts and could cite from memory biographical details of Communist leaders through the decades, recalls Larisa Volodimerova, another fellow student. He wasn’t one to frequent underground rock concerts frowned upon

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46 bloomberg markets March 2014

In December, Putin freed former yukos oil Ceo khodorkovsky, once russia’s richest man.

as prime minister and installed Sechin as deputy prime minister while Dmitry Medvedev sat in as head of state. When Putin reclaimed the presidency in 2012, he appointed Sechin as CEO of Rosneft. Ex–Sovcomflot boss Skarga says that even after 2000, no one took Sechin seriously, seeing him merely as Putin’s loyal sidekick. Yet within a few years, according to Khodorkovsky, Sechin confounded his rivals by masterminding the attack on Yukos in 2003 to 2004. After Khodorkovsky was arrested by armed police at gunpoint in a corporate jet in Siberia in October 2003, Yukos was eventually driven to bankruptcy, owing the government $26.6 billion, according to Claire Davidson, a spokeswoman for the former management. With Khodorkovsky sidelined, Sechin personally launched takeover talks with Yukos Vice President Alexander Temerko in the summer of 2004, says Bruce Misamore, Yukos’s Ohio-born chief financial officer at the time. The Kremlin wanted to imprison Yukos executives so that they couldn’t prevent the

takeover, says Temerko, who now runs a London-based business selling North Sea oil platforms. “Sechin was the main ideologue and driver behind the Yukos case,” Temerko says. “He was intimately involved in the process from start to finish.” Putin spokesman Peskov says there’s no truth to these allegations. The government subsequently dismantled Yukos. Most of the company’s assets eventually ended up in Rosneft’s possession. That was always Putin’s endgame, says Misamore, who as a former director of Yukos helps run two Dutch foundations that hold Yukos’s overseas assets. “His philosophy was, private ownership of the commanding heights of the economy is not acceptable,” Misamore says. “He wanted to take it back to the Soviet Union.” In acquiring first Yukos and then TNKBP from BP and its billionaire partners in March 2013, Rosneft gained control of companies that had pioneered the use of Western technology and management in Russia. Yukos hired foreign executives such as Misamore, who made it the first Russian company to switch to quarterly financial reporting under U.S. accounting standards. Yukos also introduced new drilling techniques to bolster crude output, which had been in decline during most of the 1990s. BP set up TNK-BP in 2003 with Putin’s blessing. While the new company paid $19 billion in dividends to BP from its inception, according to BP’s 2012 annual report, infighting between the Russian and U.K. partners eventually led to last year’s takeover. Under that deal, BP has a 19.75 percent stake in Rosneft and BP CEO Bob Dudley occupies one of two seats BP will eventually be entitled to on Rosneft’s nine-person board of directors. Former Exxon Senior Vice President Donald Humphreys and former Morgan Stanley CEO John Mack are among the four independent board members. TNK-BP increased production by more than 40 percent during the nine years before Rosneft bought it. “The concern is, will Rosneft be able to achieve

Peter Foley/BloomBerg

by the authorities, says Volodimerova, now a human rights activist who lives in Amsterdam. After graduating in 1984 with a Ph.D. in economics and being fluent in Portuguese and French, Sechin joined the Soviet Army and served as a translator in Portuguese-speaking Mozambique and Angola, where Soviet- and U.S.-backed factions competed for dominance during the final decades of the Cold War. “A trip to a hot spot was seen as a good career move then,” Mashendzhinov says. In Angola, where Soviet officers served as advisers to Angolan insurgents and Cubans fighting at their side, Sechin’s friendships led to an affinity with Castro’s island bastion of communism. One day, Sechin witnessed at close hand the death of a Cuban pilot whose plane was shot down by Angolan rebels, according to Anatoly Kolomnin, deputy head of the Moscow-based Union of Veterans of Angola. In Cuba about three years ago, Sechin sought out the pilot’s widow and son, Kolomnin says. He brought the son to Russia for his university studies, Kolomnin says. What turned out to be Sechin’s best career move of all came in 1988, when he went to work at St. Petersburg’s city hall, where he became acquainted with Putin. In 1994, when filmmaker Igor Shadkhan came to interview Putin, then a newly appointed deputy mayor, he was surprised to see Sechin in the reception area of Putin’s office. Shadkhan says Sechin was the only male secretary in sight, recording the names and details of all visitors in a thick, black notebook. “Putin chose Sechin because he wasn’t talkative and can be trusted with any information,” Shadkhan says. When Putin went to Moscow in 1996 to work as a senior Kremlin official under Yeltsin, Sechin followed as a lowerranking bureaucrat in the presidential administration. When Putin became president in 2000, Sechin spent eight years as his deputy chief of staff. Constitutionally barred from serving more than two consecutive terms as president, Putin bided his time for four years

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died last March. Sechin, who sported a Chavez-emblazoned T-shirt during a trip to Venezuela in 2012 and headed the Russian delegation to the leader’s funeral, said last year that the country is “our No. 1 priority.” At a ceremony to mark the naming of a Moscow street

sechin, right, shares with putin a fascination with russia’s seven decades of Communist Party rule.

in Chavez’s memory, Sechin read from the patriotic poetry of Vladimir Mayakovsky, a Soviet revolutionary poet. “Chavez always told us that if you need to sort out an issue with Russia, you go to Sechin,” Diosdado Cabello, president of the National Assembly, told reporters before meeting Sechin in Moscow last October. “He’s the go-to man.” Sechin is the go-to man at home as well, former Sovcomflot head Skarga says. “The richer Rosneft becomes, the more his influence grows,” he says. Unlike those Russians who accumulated vast wealth during the privatization of state industries, Sechin isn’t preoccupied with money, Skarga says. “He doesn’t

bloomberg tıps

have any billions,” he says. What Sechin does have, Skarga says, is power. He will have it as long as Putin does, says Masha Lipman, an analyst at the Carnegie Moscow Center. Putin has been in power for 14 years. Under a 2008 amendment to the constitution that allows presidents to serve two consecutive six-year terms, Putin could remain as president until 2024, when he would be 72 years old. Though politically stricken by economic stagnation, Putin is likely to stand for re-election in 2018, says Andrew Monaghan, a senior research fellow at Chatham House, a London-based research center. “Putin’s leadership currently looks steady and sturdy enough to last until the next election,” he says. Sechin looks well set, too. He now has his eyes on a post-communist breakthrough: In a Jan. 9 research note, Sberbank said Russian oil output will probably approach the Soviet-era peak of 11.4 million barrels a day by 2016 or 2017. “It would be a very big psychological milestone for Russia to get back to the Sovietera peak production,” says Julian Lee, a senior analyst at the London-based Centre for Global Energy Studies. It would be a boost, too, for the former city hall secretary whose study of the Soviet communist past has positioned him to play a leading role in shaping Russia’s economic future. IrIna reznIk covers companies and politics at bloomberg news in moscow. ireznik@bloomberg.net stephen bIerman covers oil in moscow. sbierman1@bloomberg.net henry meyer covers politics in moscow. hmeyer4@bloomberg.net with assistance from Ilya arkhIpov in moscow and anatoly kurmanaev in caracas.

exploring rosneft

sasha mordovets/getty images

that same level of operating efficiency as TNK-BP did before it was acquired?” says Rob West, an oil analyst at Sanford C. Bernstein & Co. in London. “That really is the big question.” Rosneft managed to increase crude production by an annual average of more than 3.5 percent from 2009 to 2012. While that looks faster than TNK-BP’s annual 1.5 percent rise over the period, West says that’s largely because strong government ties have given it access to new resources such as the Vankor field in Siberia—the biggest oil find in Russia in 25 years—which started pumping oil in 2009 and now accounts for almost 10 percent of Rosneft’s production. Rosneft is also shouldering huge debts, says Tatiana Mitrova, head of the oil and gas department at the Energy Research Institute of the Russian Academy of Sciences. Following the TNK-BP deal, the company’s indebtedness more than doubled to $72 billion. To ease financial pressures, Rosneft has drawn down the first tranche of up to $70 billion in advance payments from China National Petroleum Corp. in exchange for supplies, according to a Jan. 15 Rosneft statement. In October, Rosneft separately signed a provisional $85 billion agreement to supply China Petrochemical Corp. with 100 million metric tons of crude over 10 years. While any advance payments from that deal could provide a cash lifeline, the agreement may also restrict Rosneft’s ability to supply other customers at potentially higher prices, West says. Rosneft, together with other Russian oil producers, is investing $13 billion in Venezuela in partnership with state-owned monopoly Petroleos de Venezuela SA. Rosneft wasn’t put off by PDVSA’s questionable performance. Even as proven reserves almost quadrupled from 1999, when Chavez became president, to 2012, the country’s crude output declined about 13 percent to 2.7 million barrels a day, according to the BP Statistical Review of World Energy 2013. Sechin has demonstrated a soft spot for Venezuela and for Chavez, who

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The pace of expansion in the MINT nations— Mexico, Indonesia, Nigeria and Turkey—will rival that of the better-known BRICs in coming years, according to economist forecasts. 2015 GDP GRowth

Mexico inDonesia niGeRia

tuRkey

BRazil

Russia

inDia

china

8% 7

7.1% 6.0%

3.9%

7.2%

6 5

4.4%

4 3 2 1 0

Median economist forecast. Source: Bloomberg

50 bloomberg markets March 2014

5.5%

2.7%

2.6%

emerging markets needs a rethink. Eight countries that today are grouped under this rubric rank in the world’s top 20 largest economies, each accounting for at least 1 percent of global output. They are Brazil, Russia, India and China, for which I coined the name BRICs more than a decade ago, plus South Korea, Mexico, Indonesia and Turkey. They’re systemically important enough to be part of the Group of 20, the core group of nations that meet annually to try to solve the world’s economic problems. Is South Korea really justified as being part of the emerging markets? Per capita wealth there isn’t far off

PIUS UTOMI EKPEI/AFP/GETTy IMAGES (2)

the level in Spain and is above that of euro-zone countries such as Greece and Portugal. (Index publisher MSCI Inc. in November moved Greece from the developed-economies group to its emerging-markets list, and it’s weighing whether to move South Korea in the other direction.) What about China? Its size, ambition and global economic reach give the country a unique role. Some among the big emerging economies are commodities producers, such as Brazil and Russia, while several are more raw-materials consumers—for example, South Korea, India and Turkey. The forces that these countries face are sufficiently diverse that grouping them together for any assessment of economic or investment outlook is probably an error. So what’s the right way to proceed? Give each country its due. There are a lot of opportunities out there. In recent months, I’ve focused on a new group beyond the BRICs, namely Mexico, Indonesia, Nigeria and Turkey, and I’m using a new acronym for them: MINTs. All four have not only large populations but also very favorable demographic dynamics. Each is set to see its working population rise relative to overall population, which is usually a good recipe for growth. I spent the fourth quarter of 2013 traveling through the MINT countries, working on a British Broadcasting Corp. radio documentary. I returned to London with a particular fondness for both Mexico and Nigeria, although Indonesia and Turkey have some positive stories, too. The reforms being undertaken in Mexico are broad and deep, spanning fiscal policy, energy, education and governance. If one were to compare them with the changes to the U.K. economy in the 1980s under Margaret Thatcher, one might conclude that the Iron Lady was a pussycat. And Mexico is regaining a competitive edge as China’s leaders orient their economy more toward domestic

The ingenuity and creativity of Nigerians is more akin to what one might expect in a developed economy.

consumption. Manufacturers such as Volkswagen AG, which operates North America’s biggest automobile plant in Puebla, are expanding in the country. The next decade in Mexico should be much better than the previous one.

Nigeria is remarkable not least because it has more than 15 percent of the entire African continent’s population. If the country stays together, it will likely have more people than the U.S. by 2050. The ingenuity and creativity of many Nigerians is more akin to what one might expect to find in the U.S. or another developed economy rather than in an emerging one. Their desire to harness modern technologies might allow Nigeria to leap through many stages of development more quickly than other countries. With a bit better governance, Nigeria could really go places. Sub-Saharan Africa generally seems on the cusp of significant progress. The story in this region at this time has more to do with improving leadership and the application of the best technologies than it does with commodities demand. I visited Turkey in October, after the protests in Istanbul’s Gezi Park but before December’s corruption arrests that have rocked Prime Minister Recep Tayyip Erdogan’s government. There were hints that all wasn’t well, not least of which was the reluctance of many officials to be interviewed by a foreign news organization. (In the other three MINT countries, senior policy makers were very willing to participate in our documentary.) March 2014 bloomberg markets 51

52 bloomberg markets March 2014

manufacturers such as Volkswagen, with its plant in Puebla, are expanding in mexico.

upon low-value-added exports and commodities, as well as the largest financial firms, because new entrants are both allowed and encouraged to bring more diversity to the sector. People lately say China has been a disappointing investment destination, but I’m not sure that’s true. Investing in the Shanghai stock market was a money loser in 2013, but that index is dominated by companies that represent the old China. The Shenzhen index, weighted more to smaller

companies and much less to the biggest state-owned enterprises, managed a rise of 20 percent. China doesn’t yet have anything like the wealth of a South Korea, but its rise is so important to the world that we probably shouldn’t consider China as being in any way a typical emerging market. Its nominal gross domestic product will have surpassed $9 trillion in 2013, and if it grows by 7.5 percent or thereabouts, China will be contributing more than $1 trillion a year to global GDP growth. That’s equivalent to what the U.S. would provide if it were growing by 4 percent annually—or Italy if it were growing 50 percent a year. Even comparisons with the other BRIC economies probably aren’t entirely fair, given that China’s growth is equivalent to the creation of another Brazil, Russia or India about every two years. It’s hard to overestimate the importance of China to global growth, even as the emerging-markets label begins to seem an odd fit. And yet investors may be rewarded most if they focus on the fundamentals of specific countries such as Mexico and Nigeria. They’re truly poised to emerge. Jim o’neill Is A ColumnIst For BloomBerg VIew In london, A VIsItIng reseArCh Fellow At Bruegel And A Former goldmAn sAChs eConomIst. the opInIons expressed Are hIs own. JoneIll62@BloomBerg.net

Thomas TruTschel/GeTTy ImaGes

Concerns about corruption and the government’s construction program cast considerable doubt over the near-term outlook for Turkey, especially as the country needs lots of foreign capital to fund its current-account deficit. All this said, however, Turkey has really big advantages that will persist. It has a youthful and expanding workforce and a unique geographic spot, connecting Europe, the Middle East and Central Asia. And, of course, it bridges the Muslim world and Western capitalism. No leader keeps power forever, and at some point, the issues roiling Turkish politics and economics will be history. Indonesia also faces a currentaccount deficit, and it has parliamentary elections in April and a presidential vote in July, in which incumbent Susilo Bambang Yudhoyono is barred from running because of term limits. If the country moves in a positive direction, growth will be quite strong, given its demographic trends and urbanization. Still, I finished my visit in Jakarta more uncertain about the outlook for Indonesia than the rest of the MINT group. Yes, the country has more than 240 million people, but as I kept asking during my visit, where is its edge? Where is its Samsung? Or, to contrast it with Turkey, where is its Turkish Airlines or its Beko, a fastgrowing brand of appliances? All of which is not to say that the BRIC nations should be forgotten. I continue to be quite bullish about China, especially what I would call the “new” China. Policy makers seem eager to boost the quality of the nation’s growth rate and less interested in the quantity of growth for its own sake. This suggests that there are good places to invest in China, such as alternative energy, creative and knowledge-based industries and businesses involved in the broad consumer development—not luxury goods but what might be called “luxury lite.” It will be best to avoid companies dependent

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miky lee stands before a portrait of lee byung Chull, her grandfather. She says she shares the Samsung Group founder’s desire to “create new industries, jobs and heroes.’’ 54 bloomberg markets March 2014

56 bloomberg markets March 2014

miky lee is shown above with lee byung Chull and at right with lee Jay Hyun, her younger brother.

fair-market environment is our most important objective,” she said. South Korea’s economy is picking up as Park begins her second year. After expanding 2 percent in 2012, the slowest pace in three years, gross domestic product growth will accelerate to 3.9 percent in 2014 from 2.8 percent in 2013, the finance ministry predicts. Korea is No. 2, behind China, in BloomBerg markets’ ranking of promising emerging markets for investors. Miky Lee helped fashion South Korea’s movies and music into a multibillion-dollar industry. Lee Mie Kyung, as she’s known in Korea, and Lee Jay Hyun, who turns 54 on March 19, turned a sugar and flour refiner their grandfather had

founded in 1953 called Cheil Jedang Corp. into the country’s 14th-biggest conglomerate. Lee Jay Hyun, known as Jay in international circles, changed the name to CJ Group in 2002. He established CJ Corp., the group’s holding company, in 2007. Revenue from CJ Group’s 76 units soared more than 16-fold from its start as Cheil Jedang in 1995 to about 28.5 trillion won ($26.9 billion) last year. Today, CJ’s 4-D theaters surprise moviegoers with motion, wind and scent, and the splashy Mnet Asian Music Awards, known as MAMA, honor the region’s musicians. Pop singer Psy says he was skeptical when Miky Lee began staging MAMA outside Korea in 2010. Psy came around

previous spread: Hong Jang Hyun; tHis page: courtesy of miky Lee (2)

South Korea’s biggest purveyor of food, home-shopping services, TV programs and movies. Wearing a black top, charcoal leggings and midcalf Michael Kors sneakers, the 55-year-old granddaughter of Samsung Group’s founder shows no sign it’s been a traumatic few months. Settling in for her first major interview, Lee opens up about how she’s leading the shaken Samsung offshoot after CJ Group Chairman Lee Jay Hyun, her younger brother, was arrested in July. “I’m now working longer, talking to more people, taking care of a lot more things, including the balance sheet,” she says in a room dominated by a portrait of Lee Byung Chull, her grandfather. “CJ will get back on track.” Lee is leading Seoul-based CJ Group during a pivotal time for South Korea. President Park Geun Hye, who took office in February 2013, has promised to crack down on chaebol, empower women and promote creative businesses to spark growth. Park told Bloomberg News in a Jan. 10 interview that her administration is determined to quash unfair business practices. She tempered those comments by saying she doesn’t want to saddle companies with excessive rules. “Having all economic participants grow to their potential, coexist and develop in harmony in a

after seeing MAMA’s popularity grow, drawing Stevie Wonder to jam with K-pop star Hyolyn and singer Aaron Kwok in Hong Kong in November. “MAMA is one of the flowers that came into bloom by Vice Chairman Lee’s insight, who always dreamed of music and culture making all of us one,” Psy says. David Geffen, who co-founded U.S. film studio DreamWorks SKG with Jeffrey Katzenberg and Steven Spielberg, says the Lees built their entertainment empire from scratch. “It’s remarkable that they have gone from absolutely nothing in entertainment to incredibly successful,” he says. At Miky’s urging, Cheil Jedang invested $300 million in DreamWorks in 1995 and won the right to distribute the then-neophyte studio’s movies in Asia outside Japan. The Lees parlayed the deal into their lucrative shift into entertainment. “Their intention was

ties to her brother, which is rare among Korea’s wealthiest families, and her success in media, little is known about her,” says Kim Sang Jo, director of Solidarity for Economic Reform, which promotes minority shareholders’ rights. Jay was the big-picture guy. “Lee Jay Hyun talked about businesses that didn’t yet exist in Korea,” Kim says. “He’s a strategist and a big shoe to fill.” Miky is raising her profile in Jay’s absence. As Park began her chaebol crackdown last year, prosecutors arrested him on charges of tax evasion, embezzlement and breach of trust. Imprisoned in July, he underwent a kidney transplant in August. His trial began in December. The charges relate to personal taxes, and Lee Jay Hyun didn’t cause losses at his companies, Kim Yong Sang, his attorney, says. “We are fighting to prove he’s not guilty,” he says.

BIotecHnology & pHarmaceutIcals 18% entertaInment & medIa 17% Home sHoppIng & logIstIcs 31%

Breakdown for CJ e&M 7%

cJ corp. 2012 revenue: 17.6 trillion won ($16.6 billion)

55% Broadcasting 16% Films

food & food servIce 34%

15% Games 14% Music,

Concerts, Internet

CJ Corp. is the holding company of CJ Group with 11 main subsidiaries at the end of 2012. The revenue breakdown is based on 2012 consolidated figures. Percentages are rounded. Source: CJ Corp.

to learn from this investment so they could build in Korea a great media company, which they did and quite a bit more,” he says. “It’s an indication of how good they are.” As CJ grew, Miky claimed less of the spotlight than Jay. “Other than her close

Infrastructure 1%

CJ Group appointed Miky to a new, four-person governing committee after Jay’s arrest in July. Maternal uncle Sohn Kyung Shik, 74, who was named cochairman with Jay then, and two outside managers complete the quartet. Miky Lee describes her role as CJ

Group’s de facto chief executive officer. She says that doesn’t mean she’ll get the chairman’s title in Jay’s absence: In practical terms, titles don’t change anything, she says. “It’s a familiar job,” she says. “We have been more like co-founders of a startup where he formed strategies and I carried them out.” Lee is poised to show that her instincts for what’s hot in K-pop can augment the revenue from CJ products such as nucleotides that enhance flavors and frozen dumplings. Businesses outside her entertainment bailiwick generated 83 percent of CJ’s revenue in 2012. At stake is how the conglomerate, with revenue that accounts for 2.4 percent of South Korea’s GDP, will emerge from its crisis. DreamWorks’ Katzenberg recalls Lee’s drive. When they met in 1995, she told him she wanted to create a multimedia giant from a Korean industry that barely existed. “I thought, ‘Well, this is going to be interesting,’” Katzenberg says. Today, Lee has exceeded his expectations. “I hold her in extraordinarily high esteem as a businesswoman, a manager and a leader,” Katzenberg says. Lee says she never expected to lead a large conglomerate, thinking she’d become a professor. During her 20s and 30s, a neurological disorder she inherited called Charcot-Marie-Tooth flared up. The condition affects motor and sensory nerves, and left her with a limp. “When you have such a condition, you feel a lot of anger at first,” she says. “You don’t know why this is happening.” Lee, a Buddhist, says she has come to terms, aided by meditation. “Now I know God has given this to me for a reason,” she says, explaining that her mission is to fulfill her duty as a business leader, as her grandfather once did. Lee says her goal is to keep CJ profitable and efficient as it expands overseas. “The world I am dreaming of is one where people all over the world eat Korean food once a week, listen to Korean music sometimes and watch a Korean film twice a year,” she says. As for her management style, Lee says the era of South Korea’s authoritarian March 2014 bloomberg markets 57

Sources: Bloomberg, CJ Group

58 bloomberg markets March 2014

DreamWorks co-founders katzenberg, geffen and spielberg, left to right, pose with miky lee and Jay lee in this 1995 photo.

Inc., gained 14 percent as of Jan. 13 following Lee’s arrest on July 1. It hit an alltime high of 426,100 won on Jan. 2. Lee is exploiting links between CJ’s businesses to multiply sales. CJ O Shopping broke a South Korean record on Dec. 1, selling $2.3 million of Siberian goose-down jackets in 49 minutes. In a marriage of shopping and entertainment, CJ’s outdoor clothing unit designed the jacket and a celebrity wore it on a popular reality show on CJ E&M Corp.’s tvN cable channel, sparking a buying stampede. Star pitchwomen promote upscale products, texting on air and gossiping about their husbands to hook customers. CJ is taking this business formula to China, Vietnam, Indonesia, Japan, the Philippines, Thailand, Turkey and even Latin America. CJ O Shopping predicts overseas sales from TV-based shopping will top domestic revenue for the first time in 2015. The company aims to sur-

pass QVC by 2020. Restaurant unit CJ Foodville Corp. has big plans, too. It runs more than 160 eateries overseas, from New York to Cambodia. Lee wants the Bibigo chain to grow to 740 outlets outside Korea by 2020, up from just 14 today—with Psy promoting the brand. China, where CJ gets $4 billion of annual sales, is its biggest market. CJ has made inroads with animal-feed factories, home shopping, VIPS steakhouses and the multisensory 4DX theaters. Lee plans new restaurant brands and additional theaters and shopping channels. Lee’s passion remains entertainment. She and Jay built South Korea’s first multiplex at the height of the 1998 Asian financial crisis. The inaugural movie, The Prince of Egypt, sold out on all 11 screens for all showings. Other venues have screens on three walls and fine dining. CJ CGV Co., Korea’s biggest multiplex chain operator, runs 87 4DX theaters in 22 countries, including 19 in Mexico. Lee

1953: Samsung Group founder lee byung Chull, shown at left, starts sugar refiner Cheil Sugar Co., later renamed Cheil Jedang.

lifestyle-related businesses.

1993: Cheil Jedang separates from Samsung Group.

1998: Company opens CGV, South Korea’s first multiplex theater.

1995: Cheil Jedang invests in DreamWorks. 1996: Company begins focus on

1997: Cheil Jedang acquires cable music channel Mnet.

2000: Company acquires 39 Shopping, later renamed CJ O Shopping.

2002: Name changes to CJ Group; Lee Jay Hyun becomes chairman. 2011: CJ E&M Corp. set up to house entertainment units. 2011: CJ acquires Korea Express Co. logistics company. July 2013: Lee Jay Hyun arrested on charges of tax evasion.

TOP: cOurTesy Of miky lee; cOurTesy Of cj cOrP.; OPPOsiTe Page: HOng jang Hyun

leaders is over. “I see myself as a connector linking people and businesses,” she says. In December, she hosted Korean films at New York’s Museum of Modern Art, where Korean directors and actors met executives from U.S. companies including Viacom Inc. and Imax Corp. Such leadership can infuse CJ Group with a welcome openness, says Kang Sung Boo, head of fixed-income research at Seoul-based Shinhan Investment Corp. who specializes in corporate governance of chaebol. “The fact that she’s communicating for the first time through a media interview is a very encouraging sign,” he says. Lee is doing her part to promote her country’s culture. She started the KCON annual convention devoted to K-pop, Korean film and food in Los Angeles. In January, she traveled to Davos Switzerland, to showcase South Korean cuisine at a party President Park hosted. Lee has Asia’s youth on her side. Some 750 million people aged 15 to 24 live in the Asia-Pacific region, according to the United Nations. They’re prime targets for CJ’s online games, shopping, concerts and bibimbap, the signature rice-bowl dish at its Bibigo restaurants. With most sales still at home, some CJ units are rare beneficiaries of the won’s rise. The currency gained 6.5 percent against the dollar and 10.6 percent against the yen in the six months ended on Jan. 13. Shares of CJ O Shopping Co., the world’s No. 2 home-shopping service in gross merchandising sales, behind West Chester, Pennsylvania–based QVC

herself has produced several movies. In the latest, a $40 million sci-fi thriller called Snowpiercer, people jam a massive train fleeing a new ice age. “Today, it seems like jumping into entertainment is a no-brainer,” says Choi Chunghwan, an entertainment partner at Lee & Ko in Seoul, who says he spoke with Lee about the industry over lunch back in 1998. “Then, it was an audacious business decision.” South Koreans on average saw 1.17 films at cinemas a year in 1999, according to the Korea Film Council. That rose to 4.12 in 2013, more than the 3.88 for the U.S., market researcher Screen Digest says. “People wonder how Korean films became so cool overnight,” Choi says. “It’s really her vision and capital that made it all possible.” CJ’s next step is movies and music that appeal to cultures worldwide. A Wedding Invitation, the Chinese-language film CJ

lee shows off a CJ exhibit where a sample of the company’s best-selling cooked rice grows under artificial sunlight.

E&M and Chinese companies coproduced and South Korea’s Oh Ki Hwan directed, features lovers who reunite after a falling-out. It became China’s top romantic box-office hit when it opened in April. “I see no reason why we can’t do in the content business what Korean companies have done in mobile phones and cars,” Lee says. Still, she says, it’s easier for traditional, manufacturing-centric chaebol to go global than a company that promotes lifestyles and was founded on the principles of convenience, health and joy. “The production line will churn out the same product rain or shine,” Lee says. “We interact with our customers directly, and that requires soft skills, care and sophistication. It’s more challenging.” For all her Korean boosterism, Lee was born in Tennessee, where her father attended the University of Tennessee. The

March 2014 bloomberg markets 59

cj’s 4DX theaters, shown at right, enhance on-screen action with mist, wind and other effects. screenX technology, shown below, projects images onto three walls.

major for women at that time. After studying the Chinese language at National Taiwan University and the Japanese language at Keio University in Tokyo, she enrolled at Harvard University. She earned a master’s degree in East Asian studies there in 1986 and then studied Chinese literature and history at Fudan University in Shanghai. She married financier Kim Seok Ki; the couple later divorced. Lee says her years at Harvard showed her South Korea’s dismal international standing. Harvard’s Korean-language classes attracted few students because Korea was little known, so she volunteered as a teaching assistant. Future World Bank President Jim Yong Kim, one of her students, became a close friend. “My lifetime obsession to promote the Korean culture started then,” she says. 60 bloomberg markets March 2014

In 1993, Samsung Chairman Lee Kun Hee, Miky’s uncle, unexpectedly offered the deal that sparked CJ’s empire. Chairman Lee proposed to Miky’s mother, Sohn Bok Nam, that she swap her stake in what is today Samsung Life Insurance Co. for his stake in Cheil Jedang. She agreed. Miky joined Cheil

bloomberg tıps

Jedang in 1994 and plunged into the DreamWorks investment. She never forgot Geffen’s advice: “You can have the greatest idea in the world, but at the end of the day, the key is, who’s going to execute it?” he said. The headquarters of CJ’s food-related businesses hold a reminder of the challenges ahead. A hologram of Lee Byung Chull seems to move as if surveying passersby. His corporate philosophy is written nearby: Contribute to the national economy, value talent and promote rational management. Miky Lee, recalling carefree days at her grandfather’s home half a century ago, says his motto remains relevant. Lee Byung Chull never stopped thinking about the next big trend. He fashioned computer chips during his time and would be building lifestyle companies now, she says. “For him, it was never about, ‘Let’s make lots of money so I can live comfortably,’” she says. “Rather, it was about creating new industries, jobs and heroes, thereby contributing to the nation. My brother and I live in his legacy. We have that DNA.” Without her grandfather, or her brother Jay, Miky Lee will have to muster the determination that helped her turn a sugar refiner into an entertainment behemoth as she steers CJ through crisis. Some longtime enthusiasts say she’s up to the task. “All I’ll say is, don’t bet against Miky Lee,” DreamWorks’ Katzenberg says. Yoolim lee is a senior writer at BloomBerg markets in singapore. Yoolim@BloomBerg.net with assistance from sam kim in seoul.

CheCking CJ’s ConneCtions

top: cj corp.; bottom: EpA/YoNHAp SoUtH KorEA/AlAmY

family moved back to Seoul when she was 3. Lee and Jay were joined by brother Lee Jae Whan, now 51, who runs an advertising agency called JS Communications Co. The Lees lived with Samsung founder Lee Byung Chull, who was building one of South Korea’s biggest business dynasties, before they moved down the block. Every morning, grown-ups and cousins gathered at the grandparents’ house for breakfast before work or school. Miky Lee graduated from the elite Seoul National University in 1981 with a degree in home economics, a popular

TYPE SIAI <GO>

Construction on the new locks on the Pacific side of the 51-milelong Panama Canal bloomberg markets 63

64 bloomberg markets March 2014

emphasized this last point. “This is a very important thing for the United States,” Biden said as workers pounded away on the 10-story-tall concrete blocks that will hold the gates for the new locks. “And as the energy production throughout the Americas grows, Panama is going to play a critical role in bridging energy supplies in the Atlantic with a growing demand in the Pacific.” The Panamanian economy has been on a tear: Gross domestic product has risen an average of 8 percent annually

the latest trouble for Jorge Quijano, head of the canal authority: massive cost overruns.

arnulfo franco/ap photo

The ship is part of a dwindling fleet that still uses the waterway to transport stacks of freight containers from Asia. Just west of the canal, a new shipping lane is taking shape—one that’s designed to bring Asian vessels back. Cranes rise above the jungle, while Caterpillar trucks the size of two-story houses carry away some of the 50 million tons of dirt and rock being excavated. The work goes on seven days a week, 24 hours a day, with about 31,000 workers suffering through tropical humidity and an eight-month rainy season. “Lightning and thunder, you can’t do anything about,” says Ilya de Marotta, the canal’s executive vice president for engineering and program management. “Other than that, you have to work.” A century after U.S. President Theodore Roosevelt’s gunboat diplomacy made the Panama Canal a reality, the Panama Canal Authority is rushing to finish a $5.25 billion effort to keep the canal relevant. New locks and a deeper channel will accommodate ships 1,200 feet (366 meters) long and 160 feet wide—25 percent longer and more than a third wider than the biggest ships that can use the canal today. These bigger vessels will be loaded with as many as 12,600 20-foot containers, 2½ times what a ship like the Zim Shanghai can handle. The canal expansion will also make room for ships that carry commodities such as liquefied natural gas. Touring the project in November, U.S. Vice President Joe Biden

for the past five years, to $36 billion in 2013. The canal project is both a big reason for this growth and the linchpin of Panama’s plan for sustaining it. The country ranks sixth among emerging markets in investment outlook, according to BLOOMBERG MARKETS’ annual ranking. (See “The Gulf Speeds Ahead,” page 30.) In projected GDP growth, Panama ranks second, behind only China, at 6.7 percent for 2014 through 2015. The Panama Canal Authority, the agency that operates the canal, began the expansion project in 2007, with the goal of completing it in 2014, the waterway’s centennial year. That won’t happen, for reasons including an early foul-up with the concrete mix for the locks, a number of strikes and a still-raging fight between the canal authority and contractors over cost overruns. The expected opening has been pushed back to late 2015. When the new locks do become operational, the canal will once again shake up shipping and ports worldwide. Among the winners will be manufacturers that move goods from Asia to the U.S. Copenhagen-based A.P. Moeller-Maersk A/S, the world’s

biggest container-shipping company; Beijing-based China Ocean Shipping Group Co.; and other firms may be able to cut transport costs as much as 30 percent by sending bigger ships through Panama to move Asian cargo to Boston, New York and other East Coast ports. These shippers now unload goods onto trains and trucks on the West Coast of the U.S. to finish the journey east or make the trip to East Coast destinations from Asia via Egypt’s Suez Canal. The losers are likely to be the West Coast ports—Long Beach, California; Los Angeles; Oakland, California; Seattle—and the Suez Canal. “A cheaper Panama Canal route may also divert current U.S. imports from the Suez Canal, with a significant time savings on the shorter routing,” Barclays Plc analysts said in a report issued in April. The canal project is only part of the massive infrastructure spending that’s propelling the Panamanian economy. Panama is nearing the end of a fouryear, $13.6 billion campaign intended to, in the terms of a 2012 report from Standard & Poor’s, remake the country as a shipping and logistics hub on a par with Singapore. (The Singapore analogy is also a favorite of Ricardo Martinelli, Panama’s president.) The spending is mostly on new hospitals and roads and a subway in the capital of Panama City. Singapore status, however, isn’t imminent. The most significant barrier to achieving it is, in the words of the S&P report, a “duality” in the economy: “a split between a modern, prosperous and externally oriented sector strongly connected with the global economy and a backward, poorer sector employing less-educated people and generating less per capita income.” In other words, inequality. Add to that a legacy of corruption and a reputation as a regional center for money laundering. It was only in August that Panama outlawed the bearer share corporation—a favorite corporate structure

A great majority of container-ship traffic will be able to use the new Panama Canal. The biggest ships, though, will keep to the other side of the world. early container ship 17 meters wide 137 m long 9 m draft 800 containers

maximum ship size, existing locks 32.3 m wide 294.1 m long 12 m draft 4,500 containers

existing locks

33.5 m wide / 12.8 m deep / 304.8 m long

maximum ship size, new locks 49 m wide 366 m long 15.2 m draft 12,500 containers

the largest container ship, maersk’s triple e 59 m wide 400 m long 14.5 m draft 18,000 containers

new locks

55 m wide / 18.3 m deep / 427 m long

Sources: A.P. Moeller-Maersk, Hofstra University, Panama Canal Authority

The Panamanian economy has expanded every year in the past 25 and is expected to keep going. GDP Growth 12 % 10 8 6 4 2 0 2000

2010

2018

Figure for 2013 is an estimate; 2014 to 2018 are projections. Source: International Monetary Fund

for drug traffickers looking to launder cash, says Angel Gurria, secretary-general of the Organization for Economic Cooperation and Development. The country remains behind

even Switzerland in sharing tax information with foreign governments searching for citizens who are hiding income. “There is less and less tolerance, less and less patience” for that, Gurria says. “Now, 120 nations around the world are [sharing tax information]. Sixty of them have already signed, including Switzerland, to migrate towards automatic exchange of information, which is the standard we are going to have in the world in the near future. Panama should be part of the collective.” That the Panama Canal would one day become obsolete was clear not long after it opened in 1914: Even then, U.S. Navy ships narrowly fit through the waterway. The maximum size of a ship that could pass through the locks came to be called Panamax. By 1996, three years before the U.S. handed control of the canal to Panama, the first post-Panamax ships were in use. Since then, two more March 2014 bloomberg markets 65

66 bloomberg markets March 2014

u.S. Vice president Joe biden, in foreground, tours the canal project with panamanian president ricardo martinelli.

current 5 million metric tons, according to Sanford C. Bernstein & Co. Jurisdictions threatened by the canal are fighting to keep their share of the shipping market. U.S. West Coast ports now account for about 70 percent of container trade between the

bloomberg tıps

U.S. and Asia. Cheaper transport by water could shift 10 to 15 percent of the action over to Eastern ports, according to Barclays. Los Angeles, the busiest U.S. port, is spending more than $1 million a day to improve infrastructure during the next five years and defend its market share, says Phillip Sanfield, a spokesman for the port. Panama’s neighbors also see gold in opening avenues across the Central American isthmus. Guatemalan President Otto Perez Molina said in July that his government was seeking investors to build a rail line that would shuttle cargo between ships on the Atlantic and Pacific sides of the country, following a similar proposal announced by Honduras. The most ambitious proposal is from Nicaragua, which narrowly lost out when Panama was chosen as the site of the U.S.-built canal a century ago. In June, President Daniel Ortega’s government granted rights to Hong Kong–based HKND Group to construct an interoceanic canal at an estimated cost of $40 billion. Rodolfo Sabonge, a former vice president for the Panama Canal Authority, says all competitors are taken seriously. Yet he doubts that any other Central American country has what it takes. “It’s not that easy,” Sabonge says. “You need human resources, the processes and the culture to be efficient. We have all that.” eric sabo covers central america for bloomberg news in panama city. esabo1@bloomberg.net

tracking canal traffic

arnulfo franco/ap photo

generations of new, larger ships have been placed in service. Even the expanded locks won’t fit the largest of them, but those are specialty ships intended for shorter routes between Asia and Europe. The New Panamax ships, as those designed around the dimensions of the expanded canal are called, will be more than sufficient to alter the face of Asia-to-America shipping. The delay in the project is a problem. Last year, Maersk and Singapore’s Neptune Orient Lines Ltd. began using the Suez Canal for bigger ships from Asia. The rerouting cost the Panama Canal, which produces about $2 billion in annual revenue, about $40 million in business, says Jorge Quijano, the waterway’s chief administrator. “It was going to happen sooner or later,” he says. “We’ll accommodate for it, and we will survive.” The widening of the canal has triggered preparations at ports up and down the East Coast of the U.S. and throughout Latin America. The Port Authority of New York and New Jersey is raising the Bayonne Bridge; Savannah, Georgia, plans to deepen its river by 6 feet; and Miami has budgeted $2 billion to modernize its port. In the Bahamas, Hong Kong billionaire Li Ka-shing’s Hutchison Whampoa Ltd. has built a deep-water port at Freeport, vying to become a transshipment hub, a place where cargo is unloaded to smaller boats that can navigate cramped waterways across the Caribbean. And in Louisiana, Lake Charles Exports LLC got permission in August from the U.S. Department of Energy to ship liquefied natural gas from its terminal in Lake Charles. It’s the fourth company awarded such a license, and 21 more applications are pending. This activity is largely about Asian markets, which will be made accessible when the expanded canal opens. U.S. exports of natural gas liquids could jump to 20 million metric tons in 2020 from the

Oppenheimer International Growth Fund Overall Morningstar Rating™ (Among 230 Foreign Large Growth Funds). Overall rating of Class Y shares for the 3- and 5-year periods ended 9/30/13 based on risk-adjusted performance.1

Today, investors must be willing to pursue growth opportunities globally or risk missing them altogether. Three out of four billion-dollar companies are now outside the U.S. and 80% of global GDP growth comes from emerging markets.2 This fund is designed to help take advantage of long-term global macro-trends by investing in many of the best and fastest-growing companies around the world. Let’s take a fresh look at portfolios and start a new conversation about growth, income and protection* against certain risks in a changing world.

*Protection is positioned as an investment goal. Investing in certain securities may help to hedge against certain risks, but does not imply any guarantee from loss. Mutual funds are subject to market risk and volatility. Shares may gain or lose value. Different share classes may have different expenses, performance characteristics and Morningstar Ratings. Class Y shares are not subject to a sales charge and are available to certain institutional investors such as insurance companies, registered investment companies, employee benefit plans and 529 plans. Please consult your financial advisor and/or see the prospectus for additional information about investor eligibility requirements. Foreign investments may be volatile and involve additional expenses and special risks including currency fluctuations, foreign taxes and political and economic uncertainties. Emerging and developing market investments may be especially volatile. Investments in securities of small-cap and growth companies may be especially volatile. Diversification does not guarantee profit or protect against loss. 1. For each fund with at least a three-year history, Morningstar calculates ratings based on a proprietary risk-adjusted return score that accounts for variation in a fund’s monthly performance (including the effects of sales charges, loads and redemption fees), placing more emphasis on downward variations and rewarding consistency. The top 10% of funds in each category receive 5 stars, the next 22.5% 4 stars, the next 35% 3 stars, the next 22.5% 2 stars and the bottom 10% 1 star with some adjustments for multiple share class portfolios. The Overall Morningstar Rating is derived from a weighted average of the 3-, 5- and 10-year ratings (where applicable). For the 3- and 5-year periods, respectively, the International Growth Fund was rated 5 and 5 stars among 230 and 190 funds in the Foreign Large Growth category for the time period ended 9/30/13. Rating is for Class Y shares and rating may include more than one share class of funds in the category, including other share classes of this fund. Ratings are relative peer group ratings and do not necessarily mean that the fund had high total returns. Past performance does not guarantee future results. 2. Source: IMF World Economic Outlook, 10/9/12 (latest data available).

Before investing in any of the Oppenheimer funds, investors should carefully consider a fund’s investment objectives, risks, charges and expenses. Fund prospectuses and summary prospectuses contain this and other information about the funds, and may be obtained by asking your ﬁnancial advisor, visiting oppenheimerfunds.com or calling 1.800.CALL.OPP (225.5677). Read prospectuses and summary prospectuses carefully before investing. ©2014 OppenheimerFunds Distributor, Inc. TYPE OPPFUN <GO>

70 bloomberg markets March 2014

benchmark, used by companies and money managers in the $379 trillion market for interest-rate swaps. Wheatley faces a daunting cleanup. In 1997, then–U.K. Chancellor of the Exchequer Gordon Brown stripped oversight responsibilities from the Bank of England and created the Financial Services Authority. The upshot was what U.K. Treasury Select Committee Chairman Andrew Tyrie later called a “failed culture of box ticking” at the FSA. Under a light-touch regime, regulators allowed banks to build up subprime holdings and other risky debt without enough capital to back them up. When the financial crisis came, the U.K. government

on interest rates, currencies and the gold market. Wheatley has initiated a probe into alleged rigging of the $5.3 trillion–a-day foreign-exchange market and is examining the ISDAfix

paid an unprecedented price—£1.16 trillion in loan guarantees and cash to bail out Royal Bank of Scotland Plc, Lloyds Banking Group Plc, Northern Rock Plc and two smaller banks. When George Osborne took office as chancellor of the Exchequer in 2010, he called for a “resetting” of regulation. He announced plans to disband Brown’s FSA over time and split regulation into “twin peaks”: the FCA, to oversee banking behavior and protect consumers, and the Prudential Regulation Authority, an arm of the Bank of England designed to supervise capital and liquidity requirements at banks, insurers and investment firms. In 2011, Osborne gave Wheatley

U.K. Chancellor george osborne said the regulatory system in place before Wheatley’s tenure was ‘discredited.’

tim goode/pa photos/landov

who leads London’s top markets watchdog, says he wishes he could bike to and from his home in Greenwich, a borough along the Thames. He can’t because he’s lugging too much paperwork around. That doesn’t stop him from applying a cycling analogy to his job. He compares cleaning up banking to eradicating doping in the Tour de France, which was rocked by Lance Armstrong’s admission that he cheated to win his record seven titles. “The Tour de France is in many ways similar to banking,” Wheatley says, wearing an army-green camouflage Nike wristband that counts the miles he covers and the calories he burns. “I want to believe they’re all clean,” he says of bankers. “We hope beyond hope that actually the bad stuff is behind us. We’ve got a testing system that really goes in and validates, which is what we do with the banks.” It took the U.S. Anti-Doping Agency 12 years to ban Armstrong from competitive cycling. Wheatley, 55, has had barely a year to uncover the Armstrongs of the banking world. He says any “cultural shift” will take time. As head of the Financial Conduct Authority, created in April 2013, Wheatley meted out a record 474 million pounds ($778 million) in fines to financial firms last year, more than seven times higher than had been issued in 2011. Among the top penalties: The FCA fined three firms £206 million for manipulating the London interbank offered rate, or Libor, and charged JPMorgan Chase & Co. £137.6 million as part of the probe into a $6.2 billion loss by Bruno Iksil, the trader known as the London Whale. When it comes to punishing bankers, Wheatley made his mark as head

of the consumer and markets business unit at the FCA’s predecessor, the Financial Services Authority, where he was posted in September 2011 while waiting for the new regulator to be created. Wheatley has brought charges against nine people for insider trading, including Martyn Dodgson, a former Deutsche Bank AG managing director, and Julian Rifat, a former trader at Moore Capital Management LLC. Dodgson and Rifat deny wrongdoing. Their cases were ongoing as of Jan. 24. More penalties may be on the way. The FCA is widening its investigation into price manipulation of financial benchmarks that have a direct impact

Peter Foley/BloomBerg

a transitional role at the FSA as it was being phased out. In a speech last year when the FCA came into force and Wheatley took over, Osborne said the regulatory changes would strengthen London as a financial center. “They do away with the discredited system that failed to sound the alarm as the financial system went wrong,” Osborne said. Sitting in his FCA office, Wheatley says he’s working toward the cultural transformation that Osborne espoused. “We came through a period in 2007 and 2008 when everybody’s moral compass got slightly out of kilter,” he says. “The biggest concern is whether the business model of financial institutions can adequately adapt to the new world order, where you can’t just rip off your clients.” U.K. fines pale in comparison with those levied on banks by U.S. authorities. Last year alone, JPMorgan, the biggest U.S. bank by assets, said it paid out more than $23 billion to settle government and private disputes. By contrast, the largest-ever fine by U.K. regulators was £160 million in 2012 against UBS AG for attempting to manipulate Libor. The same year, Barclays Plc also became ensnared in the Libor probe. It paid out £59.5 million and lost its Massachusetts-born chief executive officer, Robert Diamond, in a barrage of scathing publicity. U.K. penalties haven’t been steep enough, says Tom Kirchmaier, a fellow in the Financial Markets Group Research Center at the London School of Economics and Political Science. “Bankers are shell-shocked and more frightened than they were in 2007, so that will put a lid on some bad habits,” he says. “But the fines should have been bigger for Libor, in my opinion, given the damage done to society.” Bolstered by an annual budget of £445.7 million and a staff of about 3,000, Wheatley has the power to initiate criminal prosecutions for insider trading and market manipulation, issue subpoena-like requests for records and shut down businesses. On April 1,

the FCA will begin supervising consumer credit, cracking down on payday lenders that offer short-term loans at interest rates sometimes exceeding 4,000 percent a year. “He’s setting a new tone,” says Peter Allen, managing director at London-based Lombard Street Research Ltd. “He’s taking on the role of headmaster and making clear to prefects and bullies what will be tolerated. He’s trying to bring back ethics rather than just rules.” Wheatley says he’s trying to position the FCA as a global leader on regulation. Under the auspices of the International Organization of Securities Commissions, he worked with Gary Gensler, then-chairman of the U.S. Commodity Futures Trading Commission, to promulgate the first global recommendations on how benchmarks should be set and regulated. With U.S. Federal Reserve Governor Jeremy Stein, he’s co-chairing a Basel, Switzerland–based Financial Stability Board panel looking at whether the lack of benchmark oversight led to manipulation. “The U.K. response has been to position itself as

Wheatley worked with ex-U.S. CFtC Chairman gary gensler on benchmark setting and regulation.

a reformer-in-chief,” he told a group of investors in London in November. That’s a change. During the aftermath of the financial crisis, the old U.K. regulatory setup played catch-up. In the U.S., the CFTC began its Libor investigation in 2008. It took the U.K. a year

The penalties handed down by Wheatley’s FCA last year were more than seven times greater than those meted out by its predecessor, the FSA, in 2011. fsa and fCa fines (in millions of pounds)

£474.1

£500

under review The U.K. regulator is widening its investigations into the manipulation of key financial benchmarks.

Libor Rates affect $360 triLLion of securities worldwide.

400

CurrenCy rates FX deals amount to $5.3 triLLion a day.

300

isdafix Interest-rate swaps are a $379 triLLion market.

200

GoLd priCinG This is a $20 triLLion market .

100

0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Sources: Bloomberg, FCA, FSA

March 2014 bloomberg markets 71

£0 million

Under a light-touch regime that began in the mid-1990s, banks and other firms lost their bearings. as regulators got tougher, so did the penalties.

Sources: Bloomberg, FCA, FSA

200

300

400

500

600

649.8

Libor

London whaLe

CLient moneY

UbS rogUe trading

£425.5 million

£137.6 million

About £57 million

£29.7 million

against five firms for rigging interbank offered rates to profit from their own trades

for failings at JPmorgan that allowed former london-based trader bruno iksil to rack up trading losses

against more than a dozen firms, including aberdeen asset management and JPmorgan, for failing to protect client money

for not preventing unauthorized trades that cost the bank $2.3 billion

and a half to follow suit, even though Libor is set in London. In July, Wheatley announced plans to remove control of Libor from the British Bankers’ Association, an industry group. ICE Benchmark Administration, a unit of IntercontinentalExchange Group Inc., which acquired NYSE Euronext last year, was set to take over Libor in February. This time around Wheatley has gotten out in front, spearheading the foreign-exchange investigation that began in October. The FCA has 60 people exploring benchmark manipulation, including whether a small group of senior traders at a dozen major banks colluded to manipulate currency rates. The banks have said they’re cooperating with the investigation. At least 17 traders have been suspended by their institutions in the probe. “There is huge political impetus behind change,” says David Green, a former regulator who worked at the Bank of England and the FSA. “The FCA is bound to push out the boundaries. Having found abuse in one market, it was inevitable they would start looking at other markets,” he says. With a degree in English and philosophy from the University of York in northern England, Wheatley is the thinking man’s regulator. He gained experience as a financial cop in Hong Kong after 17 years at London Stock Exchange Group Plc, where he rose to the post of deputy chief executive. He

72 bloomberg markets March 2014

100

moved to the former colony in 2005, eventually becoming head of the Securities and Futures Commission. When Lehman Brothers Holdings Inc. collapsed in September 2008, a creditlinked product structured by Lehman blew up and wiped out the savings of as many as 40,000 people in Hong Kong. For months, protesters gathered outside Wheatley’s office, brandishing placards, including one that said “Wheatley Go Home,” and burning images of him. Within a year, Wheatley forced the 16 Hong Kong banks that sold $1.8 billion of the products, known as Lehman minibonds, to return more than 90 percent of the money to investors. “Martin saw firsthand what’s involved in dealing with large institutions wielding more political power than regulators,” says Mark Steward, who worked with Wheatley as his head of enforcement. Wheatley says he wants to end what

bloomberg tıps

he calls regulation through the “rearview mirror.” He says he’ll intervene when he sees trouble brewing as banks peddle their wares. “Any product that’s growing very, very quickly in terms of scale is usually a good place to start to look,” he says. “We’re saying to major organizations, ‘Actually, your customers matter.’” Julian Franks, a finance professor at London Business School, says it’s too early to judge Wheatley’s performance. “We don’t know if regulation has gone far enough to prevent another crisis.” Given the pent-up public anger about bankers’ wayward ways, Wheatley’s success or failure depends as much on heading off the next crisis as on cleaning up the mess left by the last one.

lindsay fortado covers legal matters at bloomberg news in london. lfortado@bloomberg.net stephanie baker is a senior writer at bloomberg markets in london. stebaker@bloomberg.net with assistance from douglas Wong in hong kong.

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In an Industry lIttered wIth bankruptcIes, Todd Becker has buIlt Green plaIns Into a $3.5 bIllIon powerhouse.

By John LipperT and Mario parker 74

Becker says the fundamentals of ethanol are as good as he has ever seen.

photographs By Jenn ackerMan and tiM gruBer

e t H a N o l e Va N g e l I st

odd becker couldn’t stop checking prices on his iPhone as he prepared to speak at a Nov. 21 investor conference in Manhattan. Ethanol was rising, and corn was falling, he says, driving potential profits on the gasoline additive to one of their highest levels in six years. Becker, chief executive officer of Green Plains Renewable Energy Inc., says he didn’t want to wait for a bank loan. Instead, he ordered deputies to wire a third of the company’s cash— $108 million—and buy two ethanol plants, in Nebraska and Minnesota, from creditors of Denver-based BioFuel Energy Corp. He says he worried that if he didn’t jump, rival Valero Energy Corp. in San Antonio would snatch the properties, robbing him of a chance to expand annual production by almost a third to 1 billion gallons. Such is Becker’s confidence in a U.S. industry rocked by at least a dozen bankruptcies since 2008. Some investors are still spooked after BioFuel defaulted on its debt amid a 2012 drought, leaving David Einhorn’s Greenlight Capital Inc., its largest shareholder, a victim of ethanol’s volatility. Political challenges are piling up, too. Big Oil lists minimum ethanol requirements as its top policy concern for 2014 and wants to completely eliminate them. Government ofcials are already backtracking. A week before Becker bought the BioFuel plants, the Environmental Protection Agency proposed lowering its 2014 requirement for corn-based ethanol in U.S. gasoline to about 13 billion gallons from 14.4 billion. Senators Dianne Feinstein, a California Democrat, and Tom Coburn, an Oklahoma Republican, want to scrap mandates for corn-derived ethanol entirely. Ethanol consumes 44 percent of U.S. corn only to inflate food prices, harm the environment and potentially damage engines, Feinstein says. Rising U.S. crude output diminishes the need for ethanol, says Scott Faber, vice president of government afairs for the Washington-based

76 bloomberg markets March 2014

Environmental Working Group. “Ethanol is bad news for anyone who eats, drives a car or cares about the environment,” Faber says. Becker isn’t deterred. “It’s a contrarian play,” he says, driving along I-29 east of the company’s Omaha, Nebraska, headquarters. “But the fundamentals of ethanol are as good today as we’ve ever seen them.” He says ethanol, a form of alcohol made by fermenting starch from corn and other crops, will thrive because it contains the octane that modern, highcompression engines need. Ford Motor Co. and others are designing cars to run on ethanol mixtures greater than today’s 10 percent. And at $1.94 a gallon,

Becker, wearing a tie, meets with his staff for their daily strategy session at Green Plains’ Omaha headquarters.

ethanol costs reﬁners 26 percent less than petroleum products used to make gasoline. “We’re the cheapest molecule in the fuel tank,” Becker says. As for the environment, growing corn for ethanol is less harmful than drilling, reﬁning and using oil for gasoline, Becker says. The technology isn’t yet commercially viable to make ethanol from switch grass and other cellulosic sources, which would require less energy to produce and release fewer greenhouse gases during manufacturing, use and disposal, Becker says. “I’m not a dreamer,” he says. “I want to make money.”

In the six years ended in 2013, Becker built Green Plains into a company with $3.5 billion in revenue and 700 employees with two strategies: He buys plants on the cheap and converts them for low-cost manufacturing, says Matthew Farwell, an analyst at Imperial Capital LLC in New York. Green Plains also deploys sophisticated futures, options and swaps to make fewer wrong-way commodities bets than such rivals as now-liquidated VeraSun Energy Corp. As corn soared 66 percent during the ﬁrst half of 2008, VeraSun, the industry leader at the time, stumbled. It bet prices would continue to rise with futures contracts that would require VeraSun to pay

more for the commodity than rivals if prices fell, the company said in a statement. Instead of rising, corn tumbled 61 percent and ethanol fell 51 percent. VeraSun lost $476 million on revenue of $1.1 billion in the third quarter of 2008 and ﬁled for bankruptcy. Becker keeps his grain purchases and ethanol sales in lock step. He rarely has more than a day’s worth of corn that hasn’t been sold and assigned a slot in his ethanol production. That helped him charge premium prices for ethanol when corn was expensive and protected him as values of both tanked. Green Plains lost a comparatively small $880,000 on revenue of $105.9 million during 2008’s third

quarter and had enough cash to buy two VeraSun plants. Companies that trade the commodities separately can wind up with big inventories and wide price swings, says Michael Cox, a Piper Jafray Cos. researcher in Minneapolis. The survivors use Becker’s strategy now, he says. Becker’s tactics made Green Plains, with its 12 plants, the fourth-largest U.S. ethanol producer by production capacity in 2013, behind Archer-DanielsMidland Co., a consortium called Poet LLC and Valero—and ahead of Flint Hills Resources, a subsidiary of Koch Industries Inc. The top ﬁve now control 45.2 percent of the industry, up from 39 percent in 2008, the Washingtonbased trade group Renewable Fuels Association says. Unlike the others, Becker relies exclusively on corn-based ethanol. ADM is 25 times bigger than Green

How Becker Makes Money

This ethanol plant in Shenandoah, Iowa, is one of 12 the company runs across the U.S. The output is shown at right.

Plains, and its unit that includes ethanol accounts for 15 percent of the company’s revenue. Green Plains shares more than doubled to $19.38 in 2013, outpacing the 30 percent rise for the Standard & Poor’s 500 Index. “Todd has a disciplined approach to maintaining margins and growing through acquisitions,” says Sam Halpert, manager of a Van Eck Associates Corp. fund that owned 407,600 shares in September. “He’s got a fair amount of stock, which we like.” In January, Becker had options on 250,000 shares he can buy at any time for $12 or less apiece on top of the 509,584 he already owns. Green Plains’ headquarters is humming on a 14-degrees-Fahrenheit

Green Plains’ use of futures contracts at the end of 2011 helped it lock in profits for the following year. The strategy saved the company money when the worst U.S. drought since the 1930s drove up corn prices and the company didn’t need to buy any.

Q4 2011 price of corn price of ethanol

(minus-10-degrees-Celsius) Tuesday in December. Becker, who’s 6 feet 3 inches (1.9 meters) tall, thrusts his hands as if throwing a basketball to emphasize a point during his 30-minute strategy session. He grills his two dozen traders on corn hoarding in Nebraska and animal-feed demand in China. Back at their desks, they pore over potential plant-by-plant proﬁt breakdowns using futures contracts covering a matrix of commodities and time frames. Becker doesn’t waste time when deals pop up. After his subordinates wired cash to buy the BioFuel plants on Nov. 22, Becker took control of the Wood River, Nebraska, facility at 5 p.m. that day. By lunchtime the next working day, his traders had sold most of the ethanol and animal feed Wood River would produce in December and purchased most of the corn it would need,

Because Green Plains bought futures contracts to secure prices for corn and ethanol to be delivered in Q4 2012 ...

$6.73 a bushel $2.19 a gallon

30%

... it produced an operating profit of 15.3 cents a gallon of ethanol.

Q4 2012 If Green Plains had waited and paid spot prices ...

$7.39 a bushel $2.36 a gallon

... it would have produced a loss of 7.4 cents a gallon.

Drought, June to July 2012

20 10 0 –10 –20 Q3 2011

Q4 2011

Q1 2012

Q2 2012

Q3 2012

Q4 2012 Source: Green Plains

e T h a n o l e Va n g e l i sT

the Big five Green Plains, which focuses exclusively on corn-based ethanol, competes in a U.S. market dominated by diversified companies.

proDuCTion CapaCiTY

1 Archer-Daniels-Midland

1,720

2 *Poet

1,649

3 Valero

1,130

4 green plains

1,020

5 Flint Hills Resources (Koch Industries)

660

ToTal producTion, u.s. indusTry: 13.7 billion gallons

(millions of gallons a year)

ToTal producTion by Top 5: 6.2 billion gallons 45% market share

*A consortium of independent plants. As of Dec. 20. Sources: Green Plains, Renewable Fuels Association

plus natural gas to heat it. In half a day, they generated an operating profit of as much as $10.2 million, a 10th of the plants’ purchase price, says Jason Ward, a Northstar Commodity Investment Co. analyst in Minneapolis. Becker bet big in 2011, when he sold ethanol and bought corn futures for most of the following year. Corn had dropped as Europe’s debt crisis cut demand and Ukraine tripled exports. Becker ﬁgured he could earn 20 cents per gallon of ethanol, a third more than usual. He got lucky when a drought pushed corn from $5.50 a bushel to $8.24 in July 2012 and he didn’t need any. Green Plains earned $11.8 million in 2012; Becker got a $4.3 million paycheck. Valero had an operating loss of $47 million on ethanol that year. Becker started a separate Green Plains hedge fund that had $55 million in assets as of mid-January. He hopes to reach $1 billion in assets, declining to say when. “There’s always another bottom coming in the commodity markets,” Becker says. “We prepare for that, and when margins turn, we can generate signiﬁcant amounts of cash.” Jim Barry, chief investment officer of renewable power at BlackRock Inc., the world’s biggest money manager, recruited Becker for a forerunner to Green Plains in 2007. Becker took charge at the BlackRock-funded startup in Chicago that later bought out Green Plains, gaining its name and stock listing. “Since what we 78 BloomBerg markeTs March 2014

were really doing was playing in commodities, we needed a guy who could do that,” says Barry, a Green Plains director whose various BlackRock funds own 1.3 million shares. Becker learned to temper risk with caution after watching his grandfather, a Russian immigrant who ran a scrap yard and grew soybeans before opening a Los Angeles delicatessen. “Millions of dollars passed through his hands, but he died with nothing,” Becker says. The ﬁrst of his family to attend college, Becker chose the University of Kansas for its scholarships. He interned at what’s now CBOE Holdings Inc. in Chicago. Becker experienced what he calls a perfect trade in 1993. He was working at Kansas City, Missouri–based Farmland Industries, then the biggest U.S. farm cooperative. Farmland sold so much wheat, it convinced competitors the company had huge reserves. In fact, Farmland’s traders were also shorting wheat, or selling borrowed grain with hopes of proﬁting when prices later fell.

Bloomberg Tıps

Becker says the sheer volume of wheat they were selling threw rivals of. When competitors started dumping their reserves amid what appeared to be Farmland’s massive holdings, Farmland was the only buyer. It resumed wheat sales and made huge proﬁts, Becker says. “It was like a trifecta,” he says. Becker modeled Green Plains after Farmland. Rail cars, storage elevators and shipping terminals complement his trading desk and ethanol plants. Fifty miles (80 kilometers) southeast of Omaha, in Shenandoah, Iowa, Green Plains produces 65 million gallons of ethanol a year in towers that emit a sweet beerlike scent. The company wrings 175,000 tons of animal feed from leftover parts of the corn. It converts some feed to corn oil, adding a nickel to its typical 15 cents–agallon ethanol proﬁt. It saves three cents a gallon by grinding corn thoroughly. Becker promises to pressure presidential candidates to support ethanol when they pass through Iowa in 2016— even though he’s sure lawmakers will scrap minimum requirements. “It’s just a matter of when,” he says. Becker says Green Plains is ready for that day—and for the once-in-a-lifetime trading opportunity that will multiply revenue. “Green Plains hasn’t had an event like that, but we will,” he says. “We could grow quickly into a $10 billion or $20 billion company.” john lipperT is a senior writer at bloomberg markets in chicago. jlippert@bloomberg.net mario parker covers alternative energy at bloomberg news in chicago. mparker22@bloomberg.net with assistance from jeff Wilson and elizaBeTh CampBell in chicago and aniTa kumar in princeton.

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The Fight Over Canadaâ&#x20AC;&#x2122;s

PhotograPhs by

Michael Friberg

First NatioNs peoples are assertiNg their right to be coNsulted beFore drillers aNd miNers use their laNd—complicatiNg stepheN harper’s plaNs to turN the couNtry iNto aN ‘eNergy superpower.’

Riches by

Jeremy VaN looN 1 2 3

5 6 9

Scenes from the Aroland community in northern Ontario: 1. The Church of the Immaculate Heart of St. Mary 2. Village elder Julia Mendowegan 3. The railroad that would carry minerals south 4. Trapper Mark Bell with marten pelts 5. Darcy Gagnon runs the O’Sullivan Lake Gas Bar. 6. His cousin Sonny Gagnon is Aroland’s chief. 7. Route 684 is the only road in town. The Cliffs mining company wants to build a new artery to carry ore to the railhead. 8. Jack Shabogamik, an elder 9. Children gather at an educational tepee for a lesson on traditional practices.

The Fight Over Canada’s Riches

Back in the spring of 2012, while walking in

the deep woods of northern Ontario, Sonny Gagnon stumbled across a collection of surveying equipment among the towering spruce trees. Gagnon is chief of the Aroland aboriginal tribe, a band of 450 people living in a village of ramshackle houses surrounded by swampy muskeg. He tracks everything that goes on in his community. And the surveying tools weren’t supposed to be there, he says. “I was ticked off,” he says, after learning that the equipment belonged to a subcontractor of Cleveland-based mining company Cliffs Natural Resources Inc. It turned out Cliffs had plans to mine for chromite to the north of the Aroland reserve and to build a road through the territory to transport truckloads of the mineral to a railhead. “They weren’t consulting us on what they were doing on the land,” Gagnon says. “I told them to leave and that we didn’t want them back.” Gagnon and his native band then set up a roadblock to monitor traffic. Cliffs suspended plans for the mine in November, in a statement citing “risks” associated with its ability to transport the ore for processing. Cliffs officials didn’t respond to repeated requests for comment. Aboriginal Canadians from Quebec to British Columbia are asserting their rights. Energized by a 2004 Supreme Court decision that requires governments to “consult and accommodate” aboriginal groups before miners and oil and gas drillers encroach on their lands, the natives have blocked half a dozen major projects since the court ruling, including a proposed C$6.5 billion ($6 billion) oil pipeline from Alberta to the Pacific Ocean and a shale gas project in the eastern province of New Brunswick. The natives’ activism complicates Prime Minister Stephen Harper’s grand plan to boost the Canadian economy 82 bloomberg markets March 2014

Former Liberal Party leader bob rae is negotiating on behalf of Ontario’s Matawa First Nations.

with C$650 billion worth of natural resource projects over the next decade in a quest to make the nation an “energy superpower.” Among the government’s priorities are mining projects in the so-called Ring of Fire region of northern Ontario, stepped-up oil extraction from Alberta’s tar sands and natural gas exploration in British Columbia. Native Canadians are demanding a say in how these projects proceed, and the 2004 court decision forces the government to give them one. “These are huge issues, which have enormous implications for the economy of the country,” says Bob Rae, a former Ontario premier who, until April 2013, led Canada’s federal Liberal Party. “They’re right at the center of Canada’s economic life.”

The natives have a powerful political ally in Rae, who has agreed to negotiate with mining companies and the provincial and federal governments on behalf of the nine chiefs of the Matawa First Nations, including Gagnon. The council holds sway over northern Ontario lands where major mineral discoveries were made as recently as 2008. Mining companies, including Cliffs and Toronto-based Noront Resources Ltd., estimate the region contains C$50 billion worth of copper, zinc and chromite. The aboriginals’ latest show of power came in New Brunswick in October and November, when demonstrators gathered in opposition to Houston-based Southwestern Energy Co.’s plans to drill for natural gas on native lands. The protesters clashed violently with police, at one point throwing Molotov cocktails that incinerated six police vehicles. The company says the disruption in its operations cost it $60,000 a day. It got a court injunction that stopped the protests and proceeded with exploratory drilling in December. Confrontations such as the one in New Brunswick are proof that the Canadian federal government has mishandled its mandate to consult with the First Nations over such projects,

Coastal First Nations director art sterritt says the Northern Gateway project threatens fragile shellfish beds.

Canada’s 600 First Nations reserves are scattered across six time zones, many of them within or near proposed resource projects. says Paul Martin, an aboriginal rights advocate who led Canada as prime minister from December 2003 to February 2006. “If you want to have a relationship, begin by listening,” Martin says. “And the federal government seems incapable of doing so.” Prime Minister Harper has pledged to “reset the relationship” between government and Canada’s indigenous people. “Certainly, in the past, lack of trust on both sides has held us back,” he said in 2012.

Canada is facing more challenges to resource-extraction projects from aboriginals than any other nation in the world, according to an October report by Fredericksburg, Virginia–based First Peoples Worldwide, which provides grants and services to native tribes. The activists are divided into two groups. The so-called traditionalists want to shut out development and preserve native lands for hunting and fishing. “Progressives” want to share in

the enormous wealth being produced by the country’s resource companies. Often both points of view are represented in the same native band, creating conflict. Both can be found in a national movement called Idle No More, which has staged protests around the world—including in Stockholm and London—demanding jobs, education and economic development for Canada’s indigenous communities. Idle No More made headlines in January 2013, when it staged protests that blocked train traffic between Montreal and Toronto. Canada is home to 1.4 million natives, who make up 4.3 percent of the population, compared with the U.S.’s 2 percent, according to the most-current census data. More than half of Canada’s March 2014 bloomberg markets 83

The Fight Over CanadaÕs Riches

pipeline builder Enbridge Inc. has reached an angry impasse with the natives. The company wants to lay a 1,178-kilometer line called Northern Gateway to connect Alberta’s oil sands with the Pacific port of Kitimat, where the oil would be loaded onto tankers and shipped to petroleum-thirsty Asian markets. The pipeline would traverse British Columbia’s mountains and salmon streams. The pipeline is opposed by native groups along much of its proposed route because they say oil spills and leaks would destroy their hunting and fishing grounds. The Yinka Dene Alliance, a group of six tribes whose lands span the pipeline’s proposed route to the sea, have banned any Northern

Heavy equipment at work at an oil sands site in Alberta. The Fort Mckay native reserve is nearby.

of the Fort McKay First Nation, whose traditional hunting grounds are adjacent to the proposed site. The Fort McKay group wants a 20-kilometer (12-mile) buffer around the bitumen drilling operation. Athabasca rejected the idea, but on Dec. 17, Sveinung Svarte, its chief executive officer, said, “It is our view that a mutually acceptable solution is achievable.” Athabasca’s shares sank 38 percent in 2013 amid uncertainty about the project, which could produce 250,000 barrels of oil a day at full capacity. On the Pacific coast, Calgary-based 84 bloomberg markets March 2014

opposition to the pipeline during 2012 regulatory hearings by Canada’s National Energy Board. The board gave the project a green light in a December ruling, placing 209 conditions on the pipeline, many of them designed to protect the environment—and, by implication, native lands. Enbridge says it will spend an extra C$500 million to boost the thickness of its pipes, will install dual leak detection systems and will post permanent staff at remote pumping stations to minimize the risk of a spill. “I’ve been in a number of locations in B.C. trying to talk to people about the project, but, more importantly, listening to what they are saying,” Enbridge CEO Al Monaco says. “I don’t say a heck of a lot. I basically listen to what the concerns are.” The natives aren’t persuaded. Art Sterritt, executive director of Coastal First Nations, stands aboard a 20meter (70-foot) boat plying the waters near Prince Rupert and points across the Hecate Strait at a string of buoys, marking the spots where the seabed was seeded with juvenile scallops in 2012. The fragile shellfish beds are part of an effort to rebuild a traditional aboriginal economy based on aquaculture. “The real foundation of who we are is shellfish,” Sterritt says, as a pod of whales surfaces within view of the boat. He adds that he doesn’t want to take a chance that an oil spill will destroy the

Prime Minister Harper says his goal is to Ôreset the relationshipÕ between government and the aboriginals. ÔLack of trust has held us back.Õ Gateway contractors from setting foot on their lands. The Coastal First Nations, an alliance of nine aboriginal groups on the British Columbia seashore, is equally determined to block Enbridge’s pipeline, and joined dozens of First Nations that voiced their

pristine bay. “We are still hopeful that they will see the merit of stopping this project,” says Arnold Clifton, chief councilor of the Gitga’at First Nation. “The recommendation is by no means the final say. All options are on the table.” Harper, who also faces opposition

kevin cooley/redux

First Nations peoples, as they are known, live and work in cities; the rest are scattered across six time zones on more than 600 reserves. Unemployment is as high as 90 percent in native communities such as Aroland, and the median per capita income was C$14,000 in 2005, the latest year for which figures are available. The per capita income of all Canadians today is C$40,650, according to Statistics Canada. Canadian resource companies say they’re eager to accommodate the First Nations—so long as they don’t make unreasonable demands. In August, Calgary-based Athabasca Oil Corp. won approval from Alberta’s energy regulator to start up an oil sands project in northeastern Alberta over the protests

clash of cultures

IndIgenous people are protestIng and suIng to block a host of resource projects the canadIan government Is countIng on to bolster the country’s economIc future.

pRoposed ResouRce pRoject

noRtheRn gateway pipeline

apaChe-ChevRon paCifiC tRail pipeline

kindeR moRgan tRans mountain expansion

athabasCa, doveR/ bRion eneRgy oil sands pRojeCt

Ring of fiRe mines

southwesteRn eneRgy Co. shale gas pRojeCt

FiRst NatioN(s) aFFected

Coastal (including gitga’at, haisla and others), yinka dene allianCe (six tribes)

wet’suwet’en

squamish, tsleil-waututh

foRt m c kay

matawa (nine tribes)

elsipogtog, mi’kmaq

ecoNomic poteNtial

Asian oil sales. Producers command global prices, now 30% higher than Canadian crude.

Increased gas production, sales at global prices

Asian oil sales; increased oil production at global prices

Potential oil production of 250,000 barrels a day

Metals and minerals worth as much as C$50 billion

Exploitation of the 80 trillion cubic feet of natural gas thought to lie under New Brunswick

Risks

Oil spills in B.C. rivers and bays where salmon and shellfish spawn; more tanker traffic in Hecate Strait

Fish and animal habitat destruction; local pollution

Oil spills in rivers and ocean; increased tanker traffic in Salish Sea

Moose and caribou habitat destruction; encroachment on native hunting grounds

Clearing of north Ontario forests, including moose and caribou habitat destruction

Encroachment on native lands; contamination of the water supply; earthquakes Source: Bloomberg

to the pipeline from nonnative British Columbians, has until June to decide the project’s fate. Their recent victories in holding up projects have emboldened the aboriginals. “We have the authority to enter

into any agreement that we want to,” says Gary Allen, chief of the Nigigoonsiminikaaning First Nation, which is negotiating logging rights on its land in northern Ontario with Montrealbased Resolute Forest Products Inc.

and other companies. “Whether with the mining sector, whether it’s in forestry, whether it’s water—we own it all,” he says. In reality, what the natives own or control is a matter of dispute—and has March 2014 bloomberg markets 85

The Fight Over Canada’s Riches

been since Canada was founded. Although the 2004 Supreme Court decision forced the government to negotiate with First Nations when a company encroaches on land they occupy, the court did not give aboriginals veto power over government-backed resource projects. Canada has signed 11 major treaties with natives since 1867, when the country gained independence from Great Britain. The treaties guarantee that the natives can practice their traditional way of life without giving them ownership of any land, says Thomas Isaac, a

‘Whether with the mining sector, whether it’s in forestry, whether it’s water—we own it all,’ says chief Gary Allen. “First Nations communities can and will bring important understanding to the environmental assessment processes.” Former Prime Minister Martin says “Canada’s indigenous peoples are not anti-development. What they want is

Natives take part in a ceremony in the educational tepee on the Aroland reserve.

partner and head of aboriginal law at Toronto-based law firm Osler, Hoskin & Harcourt LLP. The Supreme Court decision clarified Ottawa’s responsibilities, Isaac says. “Government is the centerpiece of the wheel,” he says. “The courts are going back and relying on ancient principles around fairness and equity. This is about government treating its subjects fairly.” In the Ring of Fire in northern Ontario, the federal government is serving as an intermediary to make sure the new mines include training and jobs for the aboriginals and do no permanent harm to the environment. “We want to do this right. It has to be inclusive,’’ says Greg Rickford, the federal minister responsible for the development. 86 bloomberg markets March 2014

for it to be done in a sustainable way. That means doing it in full consultation with the people who live near these projects.” Native claims are mostly addressed in the courts and other government forums. Since 2011, aboriginals have filed 165 complaints against the federal government with the Canadian Human Rights Commission, claiming they receive insufficient funding for education and child welfare. In disputes over resource projects, the mining and drilling companies are caught in the middle. “The expectations placed on companies in this area over the past 10 years have evolved incredibly quickly,” says Robert Walker, vice president at Vancouver-based NEI Investments, which

oversees C$5.5 billion in assets. “First Nations’ power is growing.” Aroland’s Sonny Gagnon intends to take full advantage of that fact. Conditions in Aroland are typical of rural native communities. Houses stand unfinished or in a state of decay. Clutches of mothers stroll up and down the dirt roads pushing baby carriages. The only business is a corner store selling gasoline and canned food. The biggest of the few employers is the tribal government, which provides paychecks to about 30 people. Most of the rest live on government welfare of about C$400 a month. “Every day is a challenge,” says Robinson Meshake, in charge of social work on the reserve. “We take each day one at a time.” Gagnon says alleviating his community’s deep poverty is his only goal. Even as he blocks construction of Cliffs’ proposed road through his settlement, he says he has no objection to the mining project. “I’m pro-development,” he says. Cliffs would use the road to transport ore from a mine 340 kilometers to the north to a railhead in Aroland. As many as 100 ore-laden trucks a day would pass through the community. “I want those jobs for my people,” Gagnon says. “I want them to be making $400 a day.” With the stakes in the tens of billions of dollars for Harper’s government and the resource companies he supports, Gagnon and other native Canadians have never been in a better position to right some of the historic wrongs they believe their people have suffered. Jeremy van loon is chief of the calgary bureau of bloomberg News. jvaNlooN@bloomberg.Net with assistaNce from Paul badertscher aNd greg Quinn iN ottawa.

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strategies equities

Risk Returns As the Fed tapers its asset purchases, correlations among shares may ratchet down from historic highs and provide opportunities for active managers. By douglas edler, Cfa, and jon asmundsson PhOTOGRAPh By SAShA MASLOv

In the aftermath of the global fInan-

benchmark as of Oct. 31, according to a BLOOMcial crisis, correlations among U.S. stocks rose to BERG MARKETS ranking. (See “Larry Robbins: Off levels higher than during the Great Depression. to the Races,” February 2014.) More broadly, less To show how equities move together over time, than 20 percent of actively managed mutual funds New York–based Empirical Research Partners in the U.S. outperformed their benchmarks in LLC calculated the correlations of returns among 2013, according to Morgan Stanley research. the 750 largest U.S. stocks by market value, averaging daily data during each quarter from 1926 through Since 2007, correlations of returns among U.S. stocks have remained the end of 2013. In all but one quarmostly higher than their 87-year average. ter since the start of the crisis in Average correlation of capitalization-weighted returns among the 750 largest U.S. stocks* 2007, correlations have been higher Average for entire period than the historical average, the calRecessions 2011 culations show. The average corre1929 The downgrade of the 70% lation peaked at 67 percent from The Great Depression sent U.S. pushed readings to correlations to a record high June to September 2011, when an even higher level. 60 that held until 2011. Standard & Poor’s downgraded the U.S. credit rating and stock markets 50 tumbled. Stocks were more in lock 40 step than they had been in 87 years.

stocks in lock step

CorrelatIons typICally

spike when stocks plunge. However, in 2013’s rising market, the share tango persisted, to the frustration of stock pickers. As the S&P 500 Index racked up its biggest gain since 1997, only 16 of the best-performing large hedge funds beat the

90 bloomberg markets March 2014

30 20 10 0 1926

1930s

1940s

1950s

1960s

*Computed using daily data, averaged over each quarter. Source: Empirical Research Partners

1970s

1980s

1990s

2000s

2013

SkyView’s steven turi, andrew melnick and larry Chiarello, left to right, say the flood of money from the Fed had reduced stocks’ riskiness.

“When correlations of stocks are very high, it’s more difficult for active management to perform—in that the market isn’t really separating the wheat from the chaff,” says John Linehan, head of U.S. equities at Baltimore-based fund giant T. Rowe Price Group Inc. That doesn’t mean that active managers are throwing in the towel. Far from it, Linehan says. “We fervently believe that we can outperform the market over the long term,” he says. In 2013, in fact, the firm’s largest mutual fund, the $42 billion T. Rowe Price

Growth Stock Fund, returned 39.2 percent, beating the S&P 500’s 29.6 percent. Teasing ouT whaT’s caused The higher

correlations is difficult. One culprit may be investors’ moves into passive index-based investments, such as exchange-traded funds that track a benchmark by proportionally buying all of the stocks it includes. For example, the Vanguard Total Stock Market Index Fund—which surpassed the Pimco Total Return Fund as the largest U.S.

March 2014 bloomberg markets 91

strategies

from $85 billion, portends a drop in stock correlations, which as of early 2014 had already started to ebb from their 2011 peak. type FsRC <go> to Linehan says he doesn’t anticipate a screen for sea change just yet. “You tend to see more actively mutual fund in October—seeks to track dispersion and less correlation around an managed funds. the performance of the CRSP U.S. Total inflection point,” he says. Active managers Market Index by passively sampling the should be able to do well in a lot of differbenchmark’s holdings. ent environments, though the best conditions are Another potential cause has been the Federal characterized by extremes in valuation and low Reserve’s purchase of Treasuries and agency correlation, he says. mortgage-backed securities, which has held SkyView focuses on investing in long-short down bond yields and pushed investors into hedge funds, which pursue strategies of buying other markets in search of higher returns. An- some stocks and selling others short with an eye drew Melnick, a managing partner at SkyView toward profiting from a decline in their prices. Investment Advisors LLC Turi says that the broad market rise of late has in Shrewsbury, New Jersey, made it tough for managers to profit from their says that the Fed’s unconven- short bets. One factor is that many companies tional monetary policy has had with large debt loads have been able to refinance a spillover effect from bonds at low rates, he says. to stocks. “It’s the enormous amount of money that’s coming Turi poinTs To The 1990s, when sTock out of the Fed,” Melnick says. correlations were the lowest since the 1960s, as “There is inflation; it’s in assets, not in the a prime time for long-short managers. “It was alreal economy. In the asset world, we’re getting most nirvana,” Turi says. Melnick says the stock market is probably a an enormous amount of inflation.” Steven Turi, SkyView’s chief investment offi- couple years away from another sharp downturn. cer, agrees. “We’ve been using monetary policy to Yet as we move closer to that turning of the cycle, solve all of our ills,” he says. “That’s a very blunt he says, parsing the quality of companies will tool.” One byproduct of Fed policy, Turi says, is a become more important. “Stock selection will bereduction in the riskiness of risky assets. In ef- come more and more critical because risky assets fect, the flood of liquidity into the markets has will become riskier again,” he says. floated all boats, says Larry Chiarello, a managing Douglas EDlEr, CFa, is an equities application director at SkyView. specialist at BloomBerg in new York. The Fed’s Dec. 18 announcement that it would dedler@BloomBerg.net Jon asmunDsson is strategies editor of BloomBerg markets. trim its bond purchases, to $75 billion per month jasmundsson@BloomBerg.net

equities

tiP boX

‘stoCk seleCtion will beCome moRe and moRe CRitiCal,’ melniCk says.

tRaCking CoRRelations You can use the Volatility and correlation analysis (Vca) function to examine changes in correlations. type VCa <go>, click on the arrow in the upper-left corner of the screen and select index. click on north/latin america to expand the list if it isn’t already displayed. click on the impl/realized corr tab to compare correlations implied by trading in index and single-stock options and historical correlations. options are contracts that grant the right to buy or sell an asset at a set strike price by a certain date. as of jan. 13, the one-month implied correlation on the standard & poor’s 500 index was lower than the onemonth realized correlation. to track correlations for the 50 largest stocks in the s&p 500, click on the index’s name. Jon asmundsson

92 bloombErg markEts March 2014

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Before investing, carefully consider the funds’ investment objectives, risks, charges and expenses. To obtain a prospectus or summary prospectus, which contains this and other information, call 1.866.787.2257 or visit www.spdrs.com. Read it carefully. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns. The SPDR® S&P 500® ETF Trust is an exchange traded fund designed to generally correspond to the price and yield performance of the S&P 500 Index.TM “SPDR,” S&P and S&P 500 are registered trademarks of Standard & Poor’s Financial Services, LLC (“S&P”) and have been licensed for use by State Street Corporation. No financial product offered by State Street or its affiliates is sponsored, endorsed, sold or promoted by S&P. ALPS Distributors, Inc., a registered broker-dealer, is distributor for SPDR S&P 500 ETF Trust, a unit investment trust. IBG-9400 TYPE SPDR <GO>

strategies EquitiEs

Proﬁting From Deals You can use Bloomberg’s M&A-monitoring tool to track arbitrage opportunities. By ERic RosEMAn

Mergers and acquisitions delivered

an average premium of more than 30 percent to shareholders of target firms last year. While holders of the companies profited by owning the shares before the deals were announced, investors using risk arbitrage strategies can also win by betting on whether such transactions will eventually succeed or fail.

related companies, to see details of the offer or to chart the prices and premiums over time. The Current Premium in % column shows how a takeover bid relates to a target’s stock price and is a key metric in M&A analysis. A negative value, which occurs when the shares are trading above the offer price, is a sign that the bid may eventually be raised. If the current premium crosses over to positive territory, it may indicate skepticism that the offer will succeed. To show first those deals that the market has priced furthest from completion, use MARB to sort the premiums from highest to lowest. Targets of M&A offers typically appreciate after the deal is announced, while the buyer’s shares usually decline. An investor could wager against the success of a deal by buying the stock of the acquirer and selling short the target. the dueling bids between Men’s wear-

Type MARB <Go> for a dashboard of pending deals.

Wagers on deal completion can provide a cushion for investors in bearish markets and generate returns that don’t depend on broader market movements. The M&A Arbitrage (MARB) function on the Bloomberg Professional service can help you pursue this strategy by showing pending offers and terms, as well as breaking news about the companies involved. Type MARB <Go>. The function lets you create templates for M&A monitors and customize their metrics. Click on a deal to view news on the

house Inc. and Jos. A. Bank Clothiers Inc. show how to use the current premium as a barometer for a deal’s expected success. After rebuffing a buyout offer from its smaller rival, Men’s Wearhouse offered to purchase Jos. A. Bank on Nov. 26 for $55 a share, an 8.7 percent premium over the previous day’s closing price of $50.60. Jos. A. Bank rejected the offer, and Men’s Wearhouse raised its bid to $57.50 on Jan. 6. That was still a 1.64 percent premium to Jos. A. Bank’s stock as of Jan. 13, signaling remaining doubt among some investors that the offer would bring the two retailers together. Eric rosEman is on the stAff of the AnAlYtics depArtMent At BlooMBerg in new York. eroseMAn5@BlooMBerg.net

March 2014 bloombErg markEts 93

strategies PORTfOliOS

Lowering Volatility You can use the optimizer in PORT to build and backtest a reduced-risk equity strategy based on an index or other list of stocks. By Nick BaTURiN

Low-voLatiLity equity strategies —

investment approaches that focus on stocks whose prices swing less than others—have attracted interest from many investors during the past few years. The oldest exchange-traded fund based on such a strategy—the PowerShares S&P 500 Low Volatility Portfolio, which was started in 2011—had $4 billion in assets as of Jan. 13. The attraction of such strategies lies in their

Let’s create a strategy, for example, based on an ETF that tracks an emerging-markets index. Type VWO US <Equity> PORT <Go> to load the Vanguard FTSE Emerging Markets ETF in PORT. Click on the Tracking Error tab and then on the Summary subtab. Click on the arrow to the right of Model, select Bloomberg Risk Model (Global) and press <Go>. The annualized one-year volatility forecast by the PORT risk model was 14.9 percent as of Jan. 13. Let’s see how much we can reduce that risk using optimization. Click on the Trade Simulation button on the red tool bar and select Launch Optimizer. If you’re using the optimizer for the first time, PORT will display a window that offers a menu of tasks and a link to a user guide. Click on Close. Let’s start with a ready-made task.

Type PORT <Go> and click on the Tracking Error tab to display model-predicted, one-year volatility for a selected portfolio.

lower realized volatility combined with a return that matches or beats traditional market-capitalization-weighted indexes. Such strategies aren’t entirely new. Part of Warren Buffett’s success may be explained by his bets on low-volatility, “boring” stocks, according to a recent academic paper. The Portfolio & Risk Analytics (PORT) function lets you build low-risk portfolios. You can base such a strategy on a capitalization-weighted index that you have access to on the Bloomberg Professional service or on your own list of stocks.

9 4 bloomberg markets March 2014 94

Click on Tasks, select Predefined Tasks and click on Reduce Risk: Minimize Risk With 20% Turnover. To specify an optimization, you need to define four components of the process: your goals, the universe of securities you can trade, constraints and security properties. Let’s change the goal to minimizing portfolio total risk. In the Goals section of the screen, click on the pencil icon. Click on the plus sign to the left of Risk to expand the list. Click on the plus sign to the left of Risk (Ex Ante). Scroll down and click on Portfolio Total Risk. A description of the data item—which calculates the predicted volatility of the portfolio’s returns—is displayed to the right. Click on Select. We want the optimizer to re-weight the securities in the portfolio to achieve the goal. So in the Trade Universes section, under Security List, we can use the setting of Current Portfolio. The next step is to define portfolio- and

TiP BOX Type DOcS #2066156 <Go> 1 <Go> for a user guide to the PORT optimizer.

reduced risk

The optimization here cut the predicted volatility by almost half.

After you load the backtested portfolio into PORT, the Performance tab lets you track the results.

security-level constraints. We don’t need the turnover constraint. Click on Turnover under Constraint Field and then on the gray Delete button. Let’s allow both long and short positions in the optimized portfolio. In the Security Properties section, click on the arrow to the right of Long Positions Only and select Long/Short Positions. Let’s allow up to 100 percent short exposure and up to 200 percent long. Enter 200 in the MAX field to the right of Long. The ETF may hold some bonds that we In the optimizer, set the goal to minimize portfolio total risk, add don’t want to use in the optimization. To your constraints and click on the Run button on the red tool bar. avoid them, click on the Add Constraint button. Click on the plus sign to the left of Weight reduced forecast risk to 8.5 percent from 14.9 perand then on Weight to select it. On the right side cent. The portfolio was somewhat levered, with a 163 of the screen, click on the plus sign to the left of percent long weight and 63 percent short weight. Now that we’ve seen that we can reduce the Bucket and then on the plus sign to the left of Asset Class. Click on the plus sign to the left of Asset risk of the current portfolio, let’s run a backtest Type and then on Fixed Income to select it. Enter in which we rebalance the portfolio over time, 0 in the MIN field and 0 in the MAX field. Click on minimizing risk at each rebalance date. Click on the arrow to the right of Aggregation, select Gross the box to the left of Backtest so that a check mark appears. In the Backtest Settings window, Value and press <Go>. Click on Add Constraint. click on the arrow to the right of Rebalance Frenow, let’s set the cash position to quency and select Monthly. To test five years of zero. Enter 0 in the MAX field to the right of data, set the date range to 60 Months from Last Cash (USD Curncy). In addition, let’s limit the Month End. In the field to the right of Create minimum weight for any given security to minus New Portfolio, enter a name. Click on Save and 30 percent and the maximum to 30 percent. then on the Run Backtest button. Click on the arrow to the right of Init. Portfolio The PORT system will start your backtest and and select None. Enter –30 in the MIN WGT(%) alert you with a Bloomberg message. You’ll get anfield and 30 in the MAX WGT(%) field. Click on other message when it’s complete. Click on the atthe Run button on the red tool bar. tachment to load the backtested portfolio into As of Jan. 13, the optimizer created a portfolio that PORT. Click on the Performance tab and on the Total Return subtab if it isn’t already selected. Click on the arrow to the right of Time, select Maximum Range and press <Go>. During the five years ended on Jan. 13, the optimized portfolio returned a total of 175 percent, while the ETF returned 95 percent. Importantly, the ride was a lot smoother, too. In addition, the risk statistics all look much better. To display them, click on the Statistical Summary subtab. The realized volatility during the past five years was lower: 14 percent versus 23 percent. That gave the optimized portfolio a Sharpe ratio of 2.36. By comparison, the ETF’s ratio of excess return to volatility was 0.98. Nick BaturiN is the head of Portfolio & risk analytics research at BloomBerg in new york. nick.Baturin@BloomBerg.net

March 2014 BloomBerg markets 95

strategies INFLUENTIAL NEwS

Taper Trouble

TIP BOX type NI INFLUENTIAL <Go> for daily roundups of exclusive market-moving stories.

pacific investment management Co. had record redemptions in 2013 in its $237 billion total return fund, which trailed 65 percent of peers and fell 1.9 percent for its biggest annual loss since 1994. the barclays U.s. Aggregate index, a benchmark for bond funds, declined 2 percent as the U.s. federal reserve signaled a tapering of its stimulus, while the standard & poor’s 500 index of stocks surged 30 percent, prompting investors to flee traditional bond funds. investors in 2013 pulled $41.1 billion from the total return fund, causing it to surrender its position as the world’s largest mutual fund to the Vanguard total stock market index fund. pimco was hurt by wrongway bets on U.s. treasuries, inflation-linked bonds and brazil’s currency. the firm concluded at its annual investment forum in may that the U.s. had not reached “escape velocity” and that growth over the next three to five years would average not much more than 2 percent a year. what it didn’t anticipate was that fed Chairman ben s. bernanke would raise the possibility that the central bank might scale back its bond-buying program if the economy picked up. douglas Hodge, pimco’s chief operating officer, in a december interview called the taper a “five-letter word” and said the firm’s holdings in longer-dated bonds ahead of the central bank move “cost us.”

taper timing

Pimco’s Total Return Fund underperformed from May through December.

Lira Rally Seen After Scandal A corruption scandal pushed turkey’s currency to its most oversold level in a decade. the lira’s relative strength index climbed to a 10-year high of 74 in early January, measured on a quarterly basis, signaling a turnaround might be imminent, according to data compiled by bloomberg. the slide worsened as the sons of three ministers and the head of a state-run lender were arrested in december amid a corruption probe. the central bank pledged to buy at least $6 billion of the liras to prop it up, while the currency slid to 2.1948 per U.s. dollar on Jan. 6, its weakest to that point since at least 1981. most of the move in the lira has run its course, and it’s now attractive, according to benoit Anne, the head of emergingmarkets strategy at societe generale sA in london. “the central bank cannot afford a currency crisis on top of a political crisis,” he says. for the original story, type NSN MYU67N6KLVRB <Go>.

FORECASTING CURRENCIES type FXFC <Go> to ﬁnd analyst forecasts for the turkish lira and other currencies. right click on a forecast and select gp – Historical graph to see how it has changed over time. Compiled by rocky swift rswift5@bloomberg.net

96 bloomberg markets March 2014

ENRICHING THE LIVES OF CHILDREN

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©2013 Samsung Electronics America, Inc. Samsung and Samsung Hope for Children are trademarks/service marks of Samsung Electronics Co., Ltd. All other logos/marks are property of their respective owners. Screen image simulated.

strategies Private equity

Exit Signs

You can use IPO to analyze trends in offerings by private-equity-backed companies, and new functionality lets you dig into details of buyout funds’ holdings. By anita Khalili and alicia lOOney

InItIal publIc offerIngs were the

most popular method for private-equity firms in Europe and North America to cash out of their investments in 2013. By contrast, exits via secondary buyouts and sales to strategic buyers last year were 30 percent below 2011 levels. Because selling a stake in a public offering typically exposes the private-equity firm to market fluctuations for a period after the listing, the spike in the use of this exit strategy suggests firms are increasingly bullish.

on the red tool bar. To set a period you want to track, click on Date Range on the left side of the screen. Click on the arrow to the right of Date Range and select Last 12 Months, for example. Click on the box to the left of Effective Date so that a check mark appears and then click on Update. Next, click on Offer Type. To track all privateequity and venture-capital exits, click on the box to the left of Private Equity Exit to select it and then do the same for Venture Capital Exit. Click on Update and then on Result to display an overview of the past year’s private-equity and venture-capital exits. to chart trends, clIck on the tIme

A search in IPO shows private-equity exits climbed last year.

You can use the Equity Offerings (IPO) function to track private-equity exits and keep tabs on market sentiment. In addition, new private-equity functionality lets you dig deeper to identify the specific funds that back a particular company and find other holdings that may be ripe for exits. To create a search that lets you track privateequity exits via IPOs or additional offerings, type iPO <Go> and click on the Custom Search button

9 8 b l o o m b e r g m a r k e t s March 2014 98

Series tab. To add a line plotting the number of deals, click on the box to the left of Deal Count. Click on the Deal List tab. In 2013, one of the largest private-equity-backed IPOs was Merlin Entertainments Plc’s. Click on the Merlin deal to display details. The London-based owner of Madame Tussauds wax museums sold 303.8 million shares, valued at 957 million pounds ($1.6 billion). Click on the Shareholders tab and you can see that Blackstone Group LP, the world’s largest manager of alternative assets, sold 76 million shares in the offering. To dig deeper and see which specific Blackstone fund sold shares and the history of the investment, first type BX uS <equity> Phd <Go> to display New York–based Blackstone’s portfolio holdings. Tab in to the field under Portfolio Company, enter MERLIN, press <Go> and click on Merlin Entertainments. The All Related Transactions section of the window shows that the fund—Blackstone Capital Partners IV LP—first acquired its stake in the

tiP BOX Type Pe <Go> 1 <Go> for a menu of privateequity-related functions, news and data.

Click on Merlin in Blackstone’s list of holdings for details.

company in 2005. Click on that acquisition to display details of the fund’s takeover of the company for £102.5 million from Hermes Private Equity Ltd. For a description of the Blackstone fund, type PeF1163 US <equity> DeS <Go>. The Financials section of the screen shows that the 2003-vintage private-equity fund is in Harvesting status. The $6.5 billion fund made 24 investments, seven of

which are still active. In the Performance section of the screen, you can see that the fund had a 30.6 percent net internal rate of return. Move your mouse over the figure and you can see the source of the information: Fresno County Employees’ Retirement Association. The return ranked the Blackstone vehicle in the first quartile among all other 2003 buyout funds based on Bloomberg’s quartile benchmarking. Type 3 <Go> to view details of the fund’s remaining investments. anita khalili is on the staff of the data management department at BloomBerg in london. akhalili2@BloomBerg.net alicia looney is on the staff of the data management department in new York. alooneY1@BloomBerg.net

riSkleSS reTUrN

Best Defense By Nick TaBorek

A rAlly in weApons mAkers such As

Northrop Grumman Corp. and Lockheed Martin Corp. made aerospace companies the bestperforming sector among U.S. stocks last year, even under the cloud of cutbacks in government spending. The industry returned 3.8 percent in 2013 after adjusting for volatility, the Bloomberg Riskless Return ranking shows, the most among 68 groups in the Standard & Poor’s 500 Index. Northrop led gains in the sector, with a risk-adjusted gain of 4.6 percent and volatility that was lower than the average for producers of military

aeroSPace SoarS aBove S&P PeerS

riskaDjusteD total return volatility return

1 aerosPace & Defense 2 life sciences 3 meDia – automobiles 5 airlines

3.8% 3.6 3.4 3.4 3.3

14.3 14.8 14.8 19.5 21.9

54.9% 52.9 50.4 65.4 72.7

Figures are for 2013. The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A lower volatility means the price of an asset doesn’t swing dramatically during a specified period, reducing the potential for unexpected losses. Source: Bloomberg

and commercial aircraft. While U.S. lawmakers reduced spending amid troop withdrawals from Afghanistan and Iraq, defense companies responded by cutting staff and using cash stockpiles to boost shareholder payouts. The top five U.S. weapons makers, a group that also includes Boeing Co., General Dynamics Corp. and Raytheon Co., raised their earnings forecasts in October as cost savings helped boost profit margins. Investors took advantage of cheap valuations to put money into the sector. Northrop, Lockheed and Raytheon saw their shares surge at least 57 percent last year and traded at an average priceearnings ratio of 14.3 at the end of December, still lower than the 17.4 level for the S&P 500, according to data compiled by Bloomberg. As the outlook for government defense spending dims, contractors are focusing on streamlining and buying back shares, says Brian Ruttenbur, an analyst at CRT Capital Group LLC in Stamford, Connecticut. “Cash flows are at record levels, and the companies are deploying those cash flows back to shareholders,” he says. nick taborek CoVers stoCks at BloomBerg news in new York. ntaBorek@BloomBerg.net

March 2014 bloomberg markets 99

strategies WHAt’s neW

Normalizing Bars and Candles

You can normalize data in bar and candle charts to compare the performance of securities. Type XAU <Crncy> GPC <Go>, for example, to graph gold with the Historical Candle Chart function. Click on Compare. To compare with silver, enter XAG <Crncy> in the TO ﬁeld and click on the Silver Spot item in the list of matches. Click on the box to the left of Normalize All Series in First Panel so that a check mark appears. Then click on the Update button.

GenerAtinG trAde ideAs

The optimizer in the Portfolio Risk & Analytics function has been enhanced to let you generate trading ideas based on goals such as minimizing your portfolio’s value-at-risk and maximizing its Sharpe ratio. To minimize VaR of the Standard & Poor’s 500 Index, for example, type sPX <index> POrt/i <Go>. Click on the Trade Simulation button on the red tool bar and select Launch Optimizer. If a Welcome to the Optimizer window appears, click on the Close button.

Click on the Tasks button on the red tool bar, select Predeﬁned Tasks and click on Reduce Risk: Minimize Active VaR. Click on the Run button to run the optimization. VaR is an estimate of the maximum plausible loss on a portfolio over a speciﬁed time horizon.

MAnAGinG COntACts in dAsH

The Equity Sales Dashboard has been enhanced to make it easier to import and edit your client contact information. Type dAsH <Go>, click on the Manage

Contacts button on the red tool bar and select Add Contacts for a menu of features you can use to import contacts. For more information on the new enhancements, type dAsH WeLCOMe LAndinG <Go>. synCinG events

The Events Calendar function has been enhanced to automatically update your Microsoft Outlook calendar with upcoming company events. To add an event to your Outlook calendar, ﬁrst type evts <Go> and click on the AutoSync button on the red tool bar. Click

on Add AutoSync and in the pop-up window, click on the arrow to the right of Source and select a category, such as a portfolio, a list of securities or a single stock. You can then pick the types of events to track. Click on the box to the left of I Conﬁrm That I Am Logged In With My Primary Windows Login and then on the Add button. PriCinG WAterfALLs

The Portfolio & Risk Analytics function has been enhanced to let you specify a hierarchy of price sources for ﬁxed-

income assets and currencies. Type POrt <Go>, click on the View button on the red tool bar and select Edit Current View. Click on Pricing Source under Calculation Settings. You can then specify price sources in the Fixed Income Intraday Data section of the screen. For more information on setting up price waterfalls, type nsn MZ1vyv6vdKHv <Go> 97 <Go>. COMPILED bY Jon Asmundsson jASMUNDSSON@ bLOOMbERG.NET

tiP BOX For more recent enhancements, type neW <Go>.

The bLOOMbERG PROFESSIONAL service (“bPS”) is owned and distributed by bloomberg Finance L.P. (“bFLP”), except that bloomberg L.P. and its subsidiaries distribute the bPS in Argentina, bermuda, China, japan, Korea and India. bloomberg Tradebook is provided by bloomberg Tradebook LLC and its afliates and is available on the bPS. bLOOMbERG, bLOOMbERG PROFESSIONAL, bLOOMbERG MARKETS, bLOOMbERG NEWS, bLOOMbERG ANYWHERE and bLOOMbERG TRADEbOOK are trademarks and service marks of bFLP or its subsidiaries. Nothing herein constitutes an ofer or a solicitation of an ofer to buy or sell a security or ﬁnancial instrument or investment advice or recommendation of a security or ﬁnancial instrument. bloomberg believes the information herein was obtained from reliable sources but does not guarantee its accuracy. Communicated, as applicable, by bloomberg Tradebook LLC; bloomberg Tradebook Europe Ltd., authorized and regulated by the U.K. Financial Services Authority; bloomberg Tradebook (bermuda) Ltd.; bloomberg Tradebook Services LLC. This communication is directed only to market professionals who are eligible to be customers of the relevant bloomberg Tradebook entity. Please visit http://www.bloombergtradebook.com/pdfs/disclaimer.pdf for more information and a list of Tradebook afliates involved with bloomberg Tradebook products in applicable jurisdictions. Neither bloomberg Finance L.P. nor any of its afliates (“bloomberg”) is a Nationally Recognized Statistical Rating Organization (NRSRO) in the United States or an ofcially recognized credit rating agency in any other jurisdiction. bloomberg’s ratings have not been solicited by issuers, and issuers do not pay bloomberg any fees to rate them or their securities. Customers should not use or rely on bloomberg’s ratings to comply with applicable laws or regulations that prescribe the use of ratings issued by accredited or otherwise recognized credit rating agencies. bloomberg’s ratings and related data are not investment advice or recommendations of an investment strategy or whether to “buy,” “sell” or “hold” an investment. For information on the bLOOMbERG PROFESSIONAL service, contact the sales ofce in your region: New York 212-318-2000, San Francisco 415-912-2960, Frankfurt 49-69-920410, Hong Kong 852-2977-6000, London 44-20-7330-7500, Sao Paulo 5511-3048-4500, Singapore 65-6212-1000, Sydney 61-2-9777-8686, Tokyo 81-3-3201-8900. March 2014, volume 23, number 3. bLOOMbERG MARKETS (ISSN 1531-5061, USPS 008-897) is published monthly with an extra issue in December by bloomberg Finance L.P., 731 Lexington Ave., New York, NY 10022, and distributed free to subscribers of the bLOOMbERG PROFESSIONAL service. POSTMASTER: Send address changes to Circulation, bLOOMbERG MARKETS, P.O. box 1583, New York, NY 10150-1583. Periodicals postage paid in New York and at additional mailing ofces. ©2014 bloomberg Finance L.P. bloomberg Finance reserves the exclusive right to reproduce or authorize reproduction of articles. Advertisers and ad agencies assume liability for all ad content.

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How the world advances

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