Third investment anniversary of BEF fund

On third investment anniversary, we would like to thank you for your trust and we commit ourselves to put all our energy, time and effort into further pursue of our main common objective – maximizing returns while minimizing risks.

Main stock Exchange indices in the region of former Yugoslavia have mainly declined in the last three months. Largest decrease has been marked by Serbian BELEX15 (-10.63%), Macedonian MBI10 (-6.71%) and Croatian CROBEX (-5.12%) while largest though modest growth (0.22%) has been marked by Bosnian SASX10. Despite this negative trend, net return of BEF Fund was positive in this period. In May, we created a return of 0.37%, in June we lost 0.91% and in July again regained 1.85% of the value, which means that your return for the first seven months of the year still stands at 10.19%! Total return within 36 months from the start of investing is thus 73.39%.

Year to date BEF Fund created a better return than other mutual funds investing inthe region of Western Balkans. Attached performance comparison of these funds over the past three years demonstrates a huge overperformance of BEF fund. Other funds made 20-30% loss in this period, while BEF Fund generated more than 70% of net income for you. Practically: 100,000 EUR investment in other “Western Balkan” mutual funds three years ago would now result in holdings of only 70,000 to 80,000 EUR, while same amount invested in BEF Fund results in 170,000 EUR. Those of you holding the investment in BEF Fund in this period, now have at least 110% (1.7/0.8) or even more than 140% (1.7/0.7) higher value of holdings comparing to those holding their investment in other “Western Balkan” funds for the last three years.

We emphasize the difference in this return for two reasons. The first reason lies in the fact that the major differences in management quality and consequently in different returns are shown only after a longer period of time. The second one is that we deeply believe (and act accordingly) that really good returns (at minimizing risks) can be achieved only with the medium-term approach to investing (and not just the long-term, as on a very long run money has no value for individual). Scrambling for short-term results and jumping from trend to trend usually ends miserably. The reasons are many – higher transaction costs, typically higher tax liabilities and most important in case of trends capturing – most of such investors purchase securities around their peak and then sell them near their bottom prices.

The answer to the question why BEF Fund has so much higher return than other funds, lies in its active investment management. Unlike conventional mutual funds, which only acts as a passive portfolio investors, we use all possible legal and other legitimate means to minimize risk and maximize returns. In 17 years of experience with stock investing in the region we gained extremely good network of contacts and information sources. Not only are we able to get information faster than others, but we can also, based on our rich experience, properly evaluate and promptly apply it in your best interest.

In the past month some “Balkan” funds performed better than BEF Fund. The main reason is that substantial parts of these funds are invested in Turkey and Romania, where we do not invest. We believe that the best returns with the lowest risks can be achieved only with a strong focus on doing what one does best (we only invest in the countries of former Yugoslavia). We deem that investment fund managers based in former Yugoslavia do not have any special advantage in Romanian and Turkish markets (neither language, culture, networks, access to information sources…), rather the opposite. This is especially true for Turkey, a huge market with fierce competition of very strong domestic and international investors. Similar applies to all other global financial markets – whether they are equity, bond, currency or commodities markets – where former Yugoslavia investment management companies do not have any notable advantages over global players dominating the major global markets. However, great opportunities that lie just in front of us often get neglected, as “they are not trendy”.

We again emphasize that high returns are generated by investing with a longer time horizon. On long-term, stock markets tend toward their mean values, with large fluctuations around them. The longer the large undervaluation of stock market prices endures, the stronger the rise when it comes to it. History of stock markets clearly confirms with numerous examples that the longer the market is squeezed down, so much stronger is then its growth when the tide turns again. As legendary stock market investor André Kostolany wrote repeatedly in his books, this applies to all markets without exception, regardless of their uniqueness.

Western stock exchanges and markets such as Turkey have already increased significantly, and it is now too late to invest there! Now is the time to invest in Western Balkans! We have already written about the vast growth potential of stock markets in BEF Fund investment region compared to global stock exchanges. On one hand global stock indices are rising for already 4.5 years now, since March 2009, despite intermediate corrections due to panic and pessimism. On the other hand, not only have the stock exchange indices in the region of the former Yugoslavia suffered the largest drop in the world since 2007, but there was also no significant recovery in the region in all this time.So while more and more indices are already near or even above their peaks of five or more years ago (among which is for example also XU100 – index of the Turkish Stock Exchange), some stock indices in the countries of former Yugoslavia are only at about 15% of their former peaks.

Foreign investments flows into the region will increase, mainly due to following three reasons: 1. Croatia’s accession to EU and European integration of other countries in the region, 2. extremely favorable investment conditions and 3. excellent investment opportunities by governments and banks disinvesting in their need for liquidity.

We found a recent accession of Croatia to the EU as extremely important. The accession will bring huge investment inflows from European Union, international institutions and private investors. Other countries in the region are imperceptibly but surely alsoapproaching to EU membership. Serbia will became EU associated state as of September 1st and EU membership negotiations will start latest by January 2014. This progress was significantly contributed by achieving mutual relations normalization agreement by Serbia and Kosovo, which is highly significant for the security and development of the entire Western Balkans, as this has saved its greatest current political and security issue.

Regional countries south of Croatia have extremely favorable investment conditions and location for foreign investors. Labor costs and taxes are very favorable, as countries offer significant advantages to employers. In Serbia and Bosnia-Herzegovina production costs are already lower then China (where wages and other costs are increasing). Geographical proximity of European, Middle Eastern and former Soviet Union markets should not be overlooked. With lower transportation costs, greater flexibility (smaller batches and faster delivery) and higher production quality (workforce from Balkan is deemed as above-average quality), the advantages of investing in Balkan are even more obvious.

With obvious need for money as governments, banks and other indebted owners disinvesttheir assets, it is clear that there will be more and more foreign investments in the region, being portfolio investments or acquisitions. The latter are in fact already ongoing for quite some time (at least in Slovenia), though fairly unnoticeably as these were middle-size companies (such asLjubljanske Mlekarne, Etol, Juteks, Fructal). Vendors of these companies fetched a good premium to prior market prices or evaluations. They will now soon be followed by acquisitions of large companies like Mercator, Telekom and Helios in Slovenia and Croatia Osiguranje, HPBand INA in Croatia.

In our view, the most likely regional growth trigger will be a single major acquisition or series of medium-sized takeovers. Similar to a situation a decade ago, even though the world was also then dominated by major crisis (following the burst of bubble): after 2001 takeover of Lek in Slovenia, the immense growth started on Ljubljana Stock Exchange and was then followed by other regional stock exchanges. Even if the fresh investment money will thus primarily originate from acquisitions in Slovenia and Croatia, we expect some of it to spill in regional countries south of Croatia, where it will have significantly stronger positive impact on stock prices, mainly for two reasons: 1. there the liquidity is even lower than in Slovenia and Croatia and any major capital influx will cause stock values to grow 2. without much pressure from selling forfeited shares (as in Slovenia) a free way up is open.

Lagging prices and undervaluation of Western Balkan shares are obvious andoverwhelming (please see the attached indices comparison)! When these indices will raise from current 15% of their 2007 value to only a third of their former maximums, this will mean an increase of 120%, their growth to half of former peaks will represent a growth of 233%, and in case indices would return to their 2007 peaks, this would mean an almost unbelievable 566% growth. Undoubtedly, one might post many reasons for why the share prices in our region are as low as they are. However, in 2007 most investors also had a lot of off the cuff explanations on justifiable stock valuations and on expectations of further growth. In March 2009 there was a lot of expectations of »global financial collapse«, while actually the large growth of global stock markets began and is (somewhere also with intermediate corrections) still ongoing.

As past experiences show, it might soon be too late to participate in excellent returns. Due to presently still low liquidity in the region, market will perform with at least 50% – 100 % return before majority of investors will get aware of that and probable even more before they react to it.

Time to invest is now! Once Balkan will be on front pages of the news reports it will be too late! By then we will reap superior returns!

Kind regards,

Balkan Emerging Frontiers Fund