Putting his trust in the profitability of heading east

The head of a new fund launched by John Govett tells Tom Stevenson why he has turned bullish on eastern Europe's prospects
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It would be hard to imagine anyone better placed to set up an eastern European investment fund than Peter Kysel. On holiday in Wales in 1968 he turned on the radio to hear that his native Czechoslovakia had been overrun by Soviet troops.

As he was listening to the reports, underfed Russian soldiers were emptying the cupboard at his grandfather's holiday home outside Prague. It seemed a good opportunity to complete his education with an engineering and economics degree from Oxford.

After spells at Charter Consolidated, Touche Remnant and Lloyds Merchant Bank, he watched from a distance the collapse of communism in Europe and the velvet revolution at home, before heading back east in 1992 to advise the Slovak Minister of Finance on how to regulate the country's new capital markets.

The following year he moved to Komercni Banka, the largest bank in the Czech Republic, as managing director of its investment banking division. If anyone has a feel for the fast-emerging capitalist economies of the former eastern bloc it should be Mr Kysel.

His enthusiasm for the investment opportunities in eastern Europe now has an outlet in the New Europe Investment Company, a fund he is launching for John Govett, the 80 per cent-owned associate of Allied Irish Banks. Investors who have burned their fingers in a string of hyped markets around the world in recent years will take some persuading of the investment case. But Mr Kysel thinks the argument is compelling.

"Before deciding to launch the fund we had to be convinced of the answers to four questions. Was the macro-economic environment favourable? Was there anything actually to invest in? Did we have the skills to take advantage of the opportunities? And did we have the right investment policy to maximise our success?" Mr Kysel said.

As far as the economic background is concerned, he sees all the countries in the former Soviet orbit as having been through a three-stage transition. First, they had to destroy the structures in place during the centrally planned communist years. That occupied the years 1990-1993, during which GDP typically fell by 15-20 per cent a year, inflation soared and production collapsed.

That traumatic period was followed by about two years of stabilisation in 1994 and 1995. Only since the beginning of this year have the countries entered into the final phase of accelerating and sustainable economic growth. Mr Kysel expects growth rates in many regions to be about twice those of the developed world over the next decade or so, perhaps 5 or 6 per cent a year. Inflation is under control and budget deficits better than in many western European countries.

"The dynamic growth of countries and companies in central and eastern Europe is often mistakenly compared with the emergence of Third World economies," he said. "Experience shows the conditions and the speed of transformation are more similar to the reconstruction of the German economy after the last war."

Why have they been so successful? "The most radical reformers have been the most successful in achieving transformation into functioning capitalist economies. Market reforms in the region have been reinforced by significantly undervalued currencies, by work forces with first world education and skills who are paid Third World wages, by rapid productivity improvements and by their close proximity to the major consumer markets."

The next prerequisite, a sensible universe of companies in which to invest, has been given an enormous boost by mass privatisation programmes that have created 125,000 new privately owned companies. With many shares in the hands of private individuals, they are likely to be liquid, tradeable investments. Certainly, there are more than enough available shares to create a sensible portfolio of say 50 shares.

Mr Kysel is too modest to say as much but he is also plainly confident in his ability to run the fund. During his most recent spell in Prague, he was responsible for listing the first company on the stock exchange, he organised the first rights issue, the first bond issue and the first project financing. He was on the ground during the years in the early 1990s when "there was no point in throwing money at those markets and losing it" and believes he has called the moment to turn bullish.

The key to profiting from eastern European markets, Mr Kysel believes, is to understand their structure and allocate assets appropriately. More than two-thirds of their capitalisation lies in slow-growth energy, utility and financial groups, which offer at best limited participation in the rapid growth of the region. The best opportunities for growth lie in medium- sized companies serving export markets or the fast-developing consumer markets at home and it is these companies Govett's new fund will target. There are also good opportunities in capital goods manufacturers and service companies. Spotting those requires an experienced presence on the ground, rather than the trainee fund managers usually sent to cut their teeth on emerging markets.

Even Mr Kysel's enthusiasm, however, does not shut his eyes to the risks: "A big difficulty is how the rules are applied and enforced. In the Czech Republic they will be applied bureaucratically, but in Russia ... they are, well, more laissez faire about these things."

He also notes the political risks of a country like Russia where there are 140 nationalities often at each others throats, limited liquidity in some smaller capitalisation stocks and an unavoidable currency risk. But he remains incurably optimistic about the region and the potential of its companies.