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Ukraine tests Templeton star Hasenstab's contrarian style

Sujata Rao
Thursday, 12 Dec 2013 | 1:48 PM ET

LONDON, Dec 12 (Reuters) - The bet paid off in Ireland and it paid off in Hungary but star bond investor Michael Hasenstab's faith in distressed countries honouring their sovereign debts faces an even bigger test in Ukraine.

For the moment at least the fate of a $5 billion-plus punt on Ukraine government debt by the Franklin Templeton manager does not look promising. Political tensions are roiling Ukraine; less than $20 billion stand between it and a huge devaluation-cum-default combo.

But then Hasenstab, who oversees a team managing around $190 billion at Franklin Templeton, has made a name for himself with similarly contrarian investments.

Many were in unloved markets that eventually paid off big time. That has propelled Hasenstab's flagship $70 billion Global Bond Fund to the top of world bond fund league tables at investment research house Morningstar on a 10-year basis.

Snapping up Irish debt when it traded around 50 cents in the dollar in early 2012, Hasenstab saw it become the best performer in Europe last year. Returns have topped 70 percent since then as Dublin honoured its debts by opting to stick with bailout terms and budget cuts instead of default.

Templeton funds also bought aggressively into Hungary, another volatile credit, building up their holdings to more than 10 percent of the market. Here too they have been rewarded with 40 percent-plus returns over the past two years.

But in Ukraine, where Templeton's funds are sitting on as much as a 30-40 percent share of a market that government figures say is worth $16 billion, many reckon Hasenstab has met his match.

True, Ukraine still comprises less than 4 percent of the flagship Global Bond Fund's assets, while Ireland even today accounts for almost 10 percent.

But the former Soviet republic's debt has been more or less in freefall, with derivatives implying a greater than 50 percent default risk over the next five years.

"They specialise in making a huge bet on one outcome - it worked in Hungary but it doesn't look like it is working in Ukraine," said one European fund manager, who like most investors interviewed for this story asked not to be named while discussing a rival.

Hasenstab declined to comment. A spokeswoman for Franklin Templeton said in emailed comments that the group had "the size to take what may seem like large stakes in a single country, and hold those positions for as long as needed, given how small these positions are relative to the larger diversified portfolios."

Unlike Hungary and Ireland, which made real efforts to slash spending and budget deficits, Ukraine has shown no interest in knuckling down to reform, the European fund manager said.

Nor is its history reassuring; the government's refusal to support state energy firm Naftogaz already propelled what was a quasi-sovereign credit into default as recently as 2009.

"Ukraine is very different from Ireland and Hungary, it's not really an obvious turnaround story," the fund manager said. "It's a big reputational risk for them. I wouldn't like to be in Franklin Templeton's shoes at the moment."

Clearly, yield was a motivation. The sovereign 2020 dollar bond of which Franklin Templeton owns over $500 million, was launched at par with a 7.75 percent coupon.

As recently as March this year the bond had surged well above issue price to trade at 108 points. Since then it has fallen to just 85 cents in the dollar.

But as in Hungary, Hasenstab stepped up buying after the turmoil erupted, adding over $1 billion to his Ukrainian position in August and September, security filings show. Since then though, bond prices have fallen even further, making Ukraine the worst performer on the benchmark.

In recent days some other investors have also crept in to buy, reckoning prices have fallen far enough and betting Kiev will eventually get aid from Russia or the European Union and meet its debt obligations in full.

That could potentially set up a huge bounce in bonds that are currently trading at 80-90 cents in the dollar.

"Hasenstab did well in Ireland. He also did frustratingly well in Hungary...He just stayed there and kept buying to maintain his position in the market," another fund manager with a large international asset management firm said.

Ukraine could be "third time lucky", he added, but it was a brave call.

CONCENTRATED BETS

Hasenstab, 39, has run his flagship fund since 2001, averaging annual 8.5 percent returns in the past decade. Underpinning the gains is his strategy of concentrating bets on what Franklin Templeton terms "out of favour assets".

That approach is par for the course at the hedge funds inhabiting London's Mayfair district. But it's less common at a highly regulated retail fund of the kind Hasenstab runs, which is open to household savers and mom-and-pop investors.

"Hasenstab follows a patient, contrarian and fundamental approach to investing...with a focus on countries with improving credit fundamentals that he believes are not yet priced into their bonds," says Sarah Bush, mutual fund analyst at Morningstar, the fund research firm.

The strategy is not unique: Bruce Berkowitz at Fairholme Capital is an extreme example. He holds a handful of stocks, with just three names AIG, Bank of America and Sears, making up 80 percent of his portfolio

But Morningstar says that since the 2008 crisis, those kinds of big off-benchmark bets tend to be occasional trades, rather than full-on strategy.

Hasenstab's fund has gone through some weak periods but is a top performer over the longer-term, Morningstar's Bush noted.

"That points to the need for patience and a relatively long time horizon when holding the fund," she added.

UKRAINE: "HE CAN TAKE IT"

So how big is the risk in Ukraine?

The country may eventually get outside help. But there is also a chance that any future International Monetary Fund programmes will involve "bail ins" of bond investors, forcing them to bear some of the rescue costs, some analysts reckon.

Franklin Templeton points out that its portfolios is diversified enough to fend off stress in one market - Hasenstab's world bond fund has debt from more than 20 countries.

Ukraine moreover is not in his top 10: by end-September 3.9 percent of its assets were in Ukraine while Poland and Ireland accounted for over 9 percent each.

The stake is still clearly too big to allow Hasenstab to easily exit the Ukrainian market. But he may not need to.

"Hasenstab is stuck there, but because of the size of the fund he can afford to sit there," the second fund manager said.

"It's a position that is part of a $70 billion bond portfolio. You've got the 2023 (Ukrainian dollar) bond trading at 85-90 cents on the dollar so if it goes to zero that would hurt, but he can probably take it."

(Additional reporting by Douglas Busvine in Moscow; Ross Kerber in Boston; Carolyn Cohn and Shadi Bushra in London; Editing by Peter Graff)

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