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Hedge Fund Report: Betting It All on Russian Gas

A small hedge fund exists to buy shares of Gazprom.

Speculation can take different forms. You can reach for big returns in far-flung lands, invest in sectors with a lot of historical volatility, or eschew diversification by betting all your money on a single stock.

Gazinvest, a hedge fund based in the Bahamas, does all three. The $16 million investment vehicle exists simply to bet on


, the Russian gas monopoly whose shares are mostly off limits to foreign investors. Gazinvet's manager, GEM Global Equities Management, a $250 million emerging markets shop, claims the fund has returned 150% this year through October.

Gazprom has a small presence in U.S. markets. Just over 3% of its stock is represented by American depositary receipts that trade over the counter on the pink sheets. The rest of its float trades in overseas markets that are inaccessible to U.S. investors, although that is expected to change someday when the Russian government makes good on a pledge to liberalize the ownership rules. Since Gazprom's ADRs trade at a 20% premium to their local-market counterparts, many speculators expect to see a pop when the ownership door swings open.

Enter Gazinvest, which claims to use its contacts with local brokers and derivatives to build an economic interest in the stock. While costly from a tax and fee standpoint, the strategy could pay off if and when the stock gets a wider constituency. Ender Oztas, a principal with GEM based in Istanbul, predicts that "Gazprom will be one of the biggest emerging markets stocks tradable by international investors."

For now, Gazinvest has ups and downs. Last month, the fund had a negative return of 11%. "This was a correction after the stock jumped up in September," says Oztas. Its history is similarly volatile. Since its September 2003 founding, the fund has gone from $10 million in assets to a peak of $70 million last year. Its current size is less than half its assets at the start of the year, a decrease that reflects investor drawdowns. "The risk perception on Russia is not so good. We had some redemptions," Oztas notes.

Phil Flynn, senior market analyst with Alaron Trading, says people have been burned by such speculation before. "I'm not invested in Russia. I was very disappointed in Russia after Yukos. It was a step in the wrong direction," he says. With Gazprom, which is still majority owned by the government, the same dangers remain.

Tremont Capital Management's asset flow report shows that, for the third quarter, long/short equity, event-driven and emerging market hedge funds were the strategies that attracted the most money: $5.6 billion, $3.9 billion and $2.9 billion, respectively. The gains in emerging markets were due to the popularity of Eastern Europe, China and Brazil, said Tremont's CEO Robert Schulman.

Follow the Money

Wondering how to keep from getting burned in hedge fund implosions like Bayou and Wood River? "It's easy," says one fund of funds manager. "Check the auditor." Wood River's inaccurate claim that its books were reviewed by a unit of

American Express

wouldn't have been difficult to uncover, he says. Bayou's auditor allegedly was a "sham" company.

Audit is the new buzz word. "If it's not a Deloitte & Touche or an Ernst and Young, we don't even bother," says one hedge fund manager. Investors should also make sure that the fund administrator is independent from the hedge fund. It's common sense. But many times, the role of those administrators who value the assets is overlooked.

Friendly Competition

Societe Generale, the French investment bank, spun out its event-driven team into a new hedge fund called Amber Capital. The fund will be run by Joseph Oughourlian and Michel Brogard, who already oversee the 16-people team.

The spinout is part of a trend. As happened at Deutsche Bank, high-profile portfolio managers are occasionally leaving a bank's proprietary desks to create their own shop -- with the go-ahead of their bosses. The underlying reason is that talent would eventually leave the bank anyway and it's in the best interest of institutions to cut a deal with their best traders before it happens.

In some instances, the bank seeds a new spinoff and managers pay the money back over time. In others, the bank offers its prime brokerage, lending and clearing facilities to the new entity.

Carl Icahn was again in the activist spotlight last week when

Time Warner


partly gave ground to his request and agreed to boost its buyback plan to $12.5 billion from $5 billion. The billionaire investor also disclosed a 15.58% stake in

BKF Capital

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and said in a 13D filing that the shares look undervalued after some recent setbacks.