Investing outside the core markets of central and eastern Europe is a game for specialists. Karine Hirn, chief executive of the distribution arm of the Stockholm-based specialist East Capital, says: “We think it's a very exciting market, but the way to invest is not to sit at your desk and find out stuff by reading annual reports, because there's a lack of information. You need to be out visiting companies.”

East Capital was set up in 1997, and almost immediately discovered the kind of pitfalls facing a specialist with a focus on a promising, but volatile, region. “The first five years were very difficult,” Ms Hirn says. “We launched our first fund in 1998. You can imagine what it's like to launch a few months before the total collapse of the Russian stock market.” A decade later, the company now has €5.7bn under management.

Great expectations

The company's aim was to create a way for mainstream investors to access the region. “You either had the big banks with their index approach, or you had the offshore funds that we respect a lot, but which aren't that investor friendly. You'd have, at most, monthly or quarterly valuations. We wanted to do the same things as these guys but in an investor-friendly way.”

But even a specialist has to make compromises when faced with liquidity constraints, and East Capital has had to launch similarly restricted offshore funds to access the region's smaller markets. Aimed at longer-term investors, the company's private equity fund enforces a four-year lock-in.

Still, the most exciting investment stories are to be found outside the mainstream, she argues. “There are still some interesting growth stories in central Europe. Poland is a clear case because of its strong macro situation – but there are so many more attractive markets, more attractive especially because they are growing so much faster and are being ignored by most asset managers.”

Romanian banks, for example, are attractive but expensive, since the country's long-term growth potential is well recognised. East Capital's regional focus allows it to look over the border at Serbian banks. “We bought into Serbian banks at a price to book value of a third of the level in Romania. Serbia has a higher level of country risk, but it's still the same kind of growth story in the long term.”

The challenge is to understand and research investment opportunities without the infrastructure available to asset managers working in more mainstream markets. “To invest in smaller markets, you need your own research and analysis,” Ms Hirn says. “There's very little being written, and what there is is often of poor quality.” The effort pays off, however. “You really come across fantastic companies with great stories.” The key is to recognise the limitation of the markets in question. Conceding that the markets themselves, and the absolute levels of growth they offer may make them uninteresting to large institutional investors, she maintains that the attractive returns can be obtained. “Some of the big players think it's just too risky to invest in these markets.” The risks can be managed, however. “We would not start a Serbian fund with daily liquidity and we don't have an open fund for Ukraine. The market is not liquid enough to do a good job dealing with daily in- and outflows when markets are extremely shallow.”

As diverse as possible

Part of the trick is to maintain a high degree of diversification. “Our east European fund, which stood at €1.3bn in December, has 200 holdings – far more than the 40 or so you'd expect in a typical fund.” The company's approach also involves disregarding the index – protecting the company's funds from havoc wrought by stampedes of volume investors. “Indices can be a proxy to what you don't want to have in portfolios – the highly-valued companies where you'll have most volatility because they are still dominated by volume investors.”

The company's investment universe includes 29 countries, and it invests in 24 of them. Belarus, Moldova, Albania, Tajikistan and Kyrgyzstan have all proven too difficult to access. Elsewhere, private equity has proven an effective way of investing in even the smallest countries, including Bosnia-Herzegovina and Montenegro.

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