There are not many equity markets in the world that are as unloved as Russia, which is now the cheapest country in the MSCI Emerging Markets index as foreign investors are staying firmly away from its stock market.
As of the end of April, the MSCI Russia index traded at a price-to- earnings ratio of 6x and a price-to-book value of 1x, compared to a 12.2x forward p/e ratio for the MSCI Emerging Markets index and 23x for its most expensive constituent, India.
Yet investors may be surprised to find that Russia has also been one the best-performing markets over the last three years, returning 75% in sterling terms, while over the last 12 months to 9 May the MSCI Russia index has risen 18% compared to a negative return of -1.7% for the MSCI EM index.
Investor sentiment towards Russia does not seem to be driven by these return figures; rather, it is governed by its reputation on the global arena and fears of the impact of geopolitics on its stocks. Yet while Russian equities are prone to high levels of volatility, investors may be missing out on attractive returns by avoiding this market completely.
Russia has been under-owned by foreign investors ever since the first sanctions were imposed on a raft of its companies and officials back in 2014 by the US and the European Union as a response to Russian military intervention in Ukraine.
These sanctions, coupled with plummeting oil prices, hit the economy and the currency in the second half of 2014, with the rouble going into freefall and the country experiencing a financial crisis as a result. At the time, Russia’s finance minister said the oil price falls coupled with sanctions had cost the economy $140bn.
Fast forward to April 2018, and US President Donald Trump’s administration has imposed fresh sanctions on seven Russian oligarchs and 17 top government officials over “malign activity”, including allegations of meddling in the US elections, reigniting fears of a negative impact on the economy.
At the same time, news headlines around the poisoning of Sergei and Yulia Skripal in Salisbury in March 2018 only added fuel to the fire, resulting in Russia being deeply unpopular with UK investors ever since then.
Ben Yearsley, director at Shore Financial Planning, said: “[President Vladimir] Putin is the reason why valuations are where they are. If there was less meddling on the international arena for a decent period of time, there could be a big rise in Russian stocks.”
However, despite the risks around sanctions and geopolitics remaining on the horizon, there are reasons to be optimistic on the outlook for Russia.
Experts agree that the country’s central bank did a good job of guiding the economy through the crisis. In 2014, the bank took drastic action by increasing interest rates by 6.5 percentage points to 17.5% to halt the rouble’s collapse but has since reduced this to 7.75%.
Additionally, Russia has adopted a new fiscal rule, under which the base oil price for budget calculations is just $40 per barrel, which makes the budget more resilient to economic shocks and means Russia enjoys a current account surplus.
All this has helped the economy strengthen, with GDP growth of 2.3% in 2018, its fastest since 2012, while the rouble has also strengthened since the start of 2019 to trade at around 65 roubles per US dollar.
As a result, commentators share a positive outlook for Russia’s economy, while many also suggest the lack of hot money flowing into the country via ETFs makes it more resilient to shocks than emerging market peers.
Hugh Bain and Christopher Bannon, managers of the Pictet Russian Equities fund, said: “The Russian economy is being run in a highly prudent and orthodox way, both the finance ministry and the country’s central bank have pursued sensible policies over the past few years. Russia’s debt to GDP ratio is low, and the government’s budget is in surplus.
“One would be very hard- pressed to find an economist in disaccord with Russian monetary and fiscal policy. The fiscal policy in particular has aided in stabilising the rouble and crucially decoupling its volatility from that of oil price movements. From a longer-term perspective, the highly unlevered nature of the Russian economy is encouraging as a new prospective credit cycle would be very positive.”
Matthias Siller, manager of the Baring Emerging Europe fund, also foresees the improving reputation of the Bank of Russia will attract foreign investment into the country in the coming years.
“After guiding the economy through a tumultuous period of reduced oil revenues and the imposition of economic sanctions, this firm foundation has built confidence within the country’s banking sector, with banks not only performing well, but innovating the way they interact with customers,” he added.
That is not to say investors should not be mindful of the risks the country is still facing, including its continued heavy reliance on the oil price for GDP growth and the risk of further sanctions, which managers name as their key concern.
However, Barings’ Siller said: “Ultimately we see real opportunities arising in Russia, and are confident of capturing the considerable upside available in the equity market.”
Dividend and income opportunities
While Russian stocks are undoubtedly cheap, this is not the only thing going for them: over the past two years, Russian companies have become some of the highest dividend payers globally, and this is expected to continue.
Oleg Biryulyov, portfolio manager of the JPMorgan Russian Securities investment trust, said: “The Russian market yields 6% from dividends, with room for potential further increases given many companies are still distributing a relatively low proportion of free cash flow.”
An example, owned by many fund managers, is Sberbank, which trades on a 1.1x book value and 5x p/e ratio with a 7% dividend yield, while growing across all channels and offering a 20%+ return on equity, according to Yearsley.
“It is not the only stock with similar characteristics,” Biryulyov said. “Underlying earnings of Sberbank and share price tend to track over time, yet despite 15%+ earnings growth last year, the share price fell sharply.”
Pictet’s Bain and Bannon added: “Russian exporters are currently in a sweet spot for free cash flow generation, benefitting from a weak rouble and relatively favourable commodity prices. On top of this, capex programs have been by and large curtailed and distribution policies are highly favourable to minority shareholders.
“As for domestic firms, there are great businesses with solid fundamentals trading at near distressed valuations, and it is not unusual at all to find companies with double-digit dividend yields.”
On a sector level, managers have their eye on the strong growth in Russia’s e-commerce sector, including online advertising and other internet services, where Russia boasts a number of regional leaders.
The Russian banking sector is also looking promising, especially in the area of fintech, while troubled lenders have bee pushed out of the market as a result of a “government clean- up”, according to Chetan Sehgal, lead manager on the Templeton Emerging Markets investment trust (TEMIT), which holds an overweight position in Russia at 8.9% versus the 3.8% weighting in the MSCI EM index.
He added: “Russian consumers have also been borrowing more and the mortgage business is in its infancy. In some cases, restricted access to Western technology
has spurred Russian companies to invest in building their own ecosystems, which contributes to more sustainable growth.”
For many investors, returns alone are not enough to make an investment decision, and in an increasingly ESG-focused world Russia does not have the best reputation. Yet experts say many Russia companies have seen big improvements in corporate governance in recent years.
Sehgal said: “For example, many companies have increased dividend payouts and undertaken share buybacks to improve shareholder value. That has come as a welcome step, in an environment where all things Russian are viewed with scepticism and share-owners have rewarded these efforts.”
To that end, investing through an active fund or investment trust allows a fund buyer to select a manager who will not compromise on ESG issues.
JP Morgan’s Biryulyov said: “We are looking for companies with long-term growth opportunities. We also pay particular attention to corporate governance factors which can have a material impact on share prices.”
Active or passive?
Another reason to invest in Russia through an active vehicle is an active manager’s ability to invest outside the benchmarks, according to Pictet’s manager duo.
They said: “We would consider the construction of major Russian indices to be highly inefficient, as it excludes numerous non-domestically listed Russian companies and is heavily skewed towards the exporting sector. Active funds tend to have a much larger picking pool which has historically facilitated outperformance.”
They added that stock picking among domestic mid-caps has historically been a key source of alpha generation for the Pictet Russian Equities fund, with the picking pool for the strategy consisting of 50 stocks compared to just 20 securities in the index.
Performance of Russia-specific funds and funds overweight to Russia in IA universe
|Fund||1 Year||3 Year||5 Year|
|Artemis Global Emerging Markets I Acc GBP in GB||-2.36||62.73||-|
|Baring Russia R Inc GBP TR in GB||6.57||61.03||57.45|
|Fidelity Emerging Markets Retail Acc in GB||-4.63||43.25||54.22|
|HSBC GIF Russia Equity IC USD in GB||12.42||74.06||66.35|
|JPM Russia A Dis NAV USD TR in GB||12.72||62.01||56.65|
|Lazard Emerging Markets A Acc TR in GB||-5.34||40.55||32.01|
|Neptune Russia & Greater Russia C Acc GBP in GB||18.10||94.51||67.74|
|Pictet Russia Index I GBP in GB||17.21||70.59||54.11|
|Pictet Russian Equities I GBP TR in GB||13.42||82.86||76.47|
|Index : MSCI Emerging Markets TR in GB||-1.65||55.84||52.05|
|Index : MSCI Russia TR in GB||17.67||74.76||58.43|
Over three and five years, the active fund has significantly outperformed both the passive Pictet Russia index and the MSCI Russia index, according to FE (see performance table above).
Yearsley also suggested investors seeking targeted exposure look at the Neptune Russia & Greater Russia fund, which has returned 94% over three years to 9 May making it the top performer among peers, though he cautioned investors to “prepare for volatility with Russian investing”.
Less adventurous investors could increase their exposure to the Russian market by picking an emerging markets fund with an overweight to Russian stocks: he suggests Fidelity Emerging Markets (11.7% in Russian equities), Artemis Global Emerging Markets (7.1%) or Lazard Emerging Markets as viable options.
And while ETFs may not be the preferred choice for exposure to the region for most investors, savvy traders could consider these vehicles for the opportunity to trade more actively around the country’s market volatility.
However, being an emerging market, these tend to have quite high management fees, so this should not be the primary reason for buying – for example, the sterling-denominated Lyxor MSCI Russia UCITS ETF has a TER of 0.65%. With a three-year return of 80% according to TrackInsight, the ETF has underperformed both Neptune’s and Pictet’s active funds.
Performance of all trusts in AIC universe with more than 5% in Russian equities
|Fund||1 Year||3 Year||5 Year|
|Aberdeen Fund Managers Ltd Aberdeen Emerging Markets Investment Company Limited Ord 1p TR in GB||-1.14||50.96||50.36|
|Ashmore Investment Management Ltd Ashmore Global Opportunities Ord NPV GBP TR in GB||-8.49||-2.82||21.14|
|Baring Asset Mgt Baring Emerging Europe PLC Ord 10p TR in GB||8.37||68.84||45.69|
|Franklin Templeton Emerging Markets Investment Trust Plc Ord 25p TR in GB||3.52||77.56||50.50|
|Genesis Fund Managers IT Genesis Emerging Market GBP TR in GB||3.21||51.79||45.29|
|JPM JP Morgan Global Emerging Markets Income Trust plc ORD 1P TR in GB||9.43||59.80||43.15|
|JPM JP Morgan Russian Securities plc TR in GB||18.67||83.29||69.79|