On adversity and opportunity in Russia and Ukraine

One of the guiding principles of our investment process on the Global and International Value Equity team is: "Adversity creates opportunity." We believe we create value for our clients not by investing where all the news is good. Instead, we look to invest where the news is bad (or appears to be), but where some combination of an improvement in the environment, or effort by management, should make it better.

By the measure of frequency and depth of adversity, Eastern Europe in general, and Russia and Ukraine in particular, are close to the world’s "gold standard." Today’s events are occurring in and around what was termed, in the title of a noted book1 on the region, the world’s "Bloodlands." From the Elbe to the Volga rivers, more than 100 million people violently perished between 1930 and 1945. Ukraine (meaning "borderlands") alone, stitched together from the frontiers of Polish, Austrian, Czarist, Soviet, and Ottoman Empires, was also the site of Stalin’s and the Soviets’ greatest atrocity, the "Terror-Famine in Ukraine" when as many 7.5 million people died along with lesser atrocities such as the ethnic cleansing of the Turkic Tatars from Crimea. Not surprisingly, ethnic, religious, and linguistic divisions within the region are severe.

A level of trust between individuals and companies, a trust which we take for granted in the West, is deeply lacking. More recent adversity included the traumatic years after the breakup of the U.S.S.R., violent commodity price fluctuations, the 1998 Russian currency collapse, rampant corruption, capture of many of the "commanding heights" of the economies — especially in oil and gas — by unscrupulous oligarchs, and more.

But there have been, and there remain, major economic and investment opportunities within the region. The oil, gas, and mineral wealth of Russia are well known. Europe gets one fourth of its gas from Russia, of which nearly one third transits through Ukraine2. This oil flow will not cease because of a dispute in Crimea. Additionally, Ukraine has barely scratched the surface of what many think are substantial hydrocarbon resources. The agricultural wealth and potential is much less known: In spite of much instability, the U.S. Dept of Agriculture expects the Ukraine to be the fifth biggest exporter of wheat by volume and the third largest shipper of corn this year.3

Russia, by comparison, has far to go in recovering from 70 years of Soviet mismanagement. Official per-capita incomes may be low, but the streets of Kiev, Moscow, and St. Petersburg are full of automobiles and aspiring consumers. The rise of a middle class Russia has resulted in an increase in automobile ownership and private transport. In 2013, Greater Moscow had a population of over 11 million people and 7 million cars.4

Indeed, Russia is now the third-largest auto-producing nation in Europe, after Germany and France.5 Too many people have come too far, in our opinion, and enough of them remember the unspeakably horrible history that either they or their parents lived through, to want to throw it all away in continued violence and revenge.

That said, another one of our guiding principles is: We love growth opportunities in emerging markets. But, with rare exceptions, we prefer to access these growth opportunities through the activities of well-run, well-governed companies based in developed markets. It is said that when asked for his stock market forecast, the famous J.P. Morgan replied: "It will fluctuate." And emerging markets, including and especially those in Eastern Europe, will indeed fluctuate due to the volatility of commodity prices, the dysfunction and unpredictability of their politics, and prevalence of state or family owners with interests very different from those of Western shareholders.

So, with occasional exceptions such as our holding in Russia’s leading wireless player, we will participate in the opportunities in Russia and Ukraine via positions in companies based outside the region. These include a Danish company that just happens to be the dominant beer company in Russia, as well as a generic pharmaceutical company in Germany whose business is booming in Russia. We will attempt to capture opportunities when adversity rears its head, but when we believe the odds for improvement are good. And, as a percentage of our portfolios, we won’t put more than a few eggs (lovely Ukrainian and Russian Easter eggs) in that one basket.

1Timothy Snyder, Bloodlands: Europe between Hitler and Stalin (New York: Basic Books, 2010).

2Source Reuters: March 3 2014 Russia is Europe's biggest gas supplier, providing around a quarter of continental demand, which at current daily flows of 270 million cubic metres (mcm) is worth almost $100 million a day. Around a third of Russia's gas is exported through Ukraine.

3Source: WSJ, Tuesday, March 4, 2014 (p. C4) article by Tony Dreibus and Neena Rai entitled: "Wheat Sprouts on Crisis." The key sentence in the article reads: "The US Dept of Agriculture expects Ukraine to be the fifth-biggest exporter of wheat by volume and the third largest shipper of corn this year."

4Sources: Autostat, PwC estimates, Pearson Education.

5OICA 2013, International Organization of Motor Vehicle Manufacturers, Paris France, www.oica.net

The views expressed represent the Manager's assessment of the market environment as of March 2014, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager’s views.

Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and summary prospectuses, which may be obtained by visiting our fund literature page or calling 877 693-3546. Investors should read the prospectus and the summary prospectus carefully before investing.

IMPORTANT RISK CONSIDERATIONS

Investing involves risk, including the possible loss of principal.

International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.

Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.

Diversification may not protect against market risk.

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