There are more at­trac­tions to Rus­sia this year than the World Cup

While it may not win pop­u­lar­ity con­tests, there are some great fun­da­men­tals in its mar­kets

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All eyes will be on Rus­sia next month as the foot­ball World Cup kicks off so it is a good time to con­sider the mer­its and meth­ods of in­vest­ing in the coun­try.

To tackle the ele­phant in the room straight off, Rus­sia has re­cently been the sub­ject of eco­nomic sanc­tions from the US which, ac­cord­ing to Mat­tias Siller, man­ager of Bar­ings Emerg­ing Europe (BEE), were done with an ‘ul­te­rior mo­tive’ other than to ruin Rus­sia’s econ­omy.

Artjun Divecha, head of as­set man­ager GMO’s emerg­ing mar­ket eq­uity team, agrees. He says if the in­tent was to hurt Rus­sia eco­nom­i­cally, sanc­tion­ing com­pa­nies like Sber­bank and Gazprom would have had a much more ‘pro­found im­pact’.

WHAT ARE RUS­SIA’S FUN­DA­MEN­TALS

While there are sev­eral po­lit­i­cal is­sues which ob­scure the Rus­sian in­vest­ment case, on a val­u­a­tion level at least it’s ex­tremely cheap, trad­ing on at an av­er­age price-to-earn­ings of around 7-times while of­fer­ing a yield of about 5%. The econ­omy is dom­i­nated by the re­sources sec­tor, Bar­ings Emerg­ing Europe hav­ing a large hold­ing in Lukoil.

Siller ex­plains with a ‘dou­ble whammy’ of a cheap cur­rency and ris­ing oil prices these sorts of com­pa­nies’ rev­enues are climb­ing while their cost base is com­ing down. This is also in­creas­ing the lev­els of free cash flow these en­ergy com­pa­nies which he adds is im­por­tant as the com­pa­nies are car­ry­ing much debt.

‘It’s a jackpot with the cur­rency,’ says Siller.

Bar­ings Emerg­ing Europe is highly ex­posed to Rus­sia with over 60% ex­po­sure. Siller says one at­trac­tion to the coun­try’s eq­uity mar­kets is what he de­scribes as the ‘de-syn­chro­nised busi­ness cy­cle’.

He ex­plains while most large mar­kets are in a late cycli­cal growth stage, Rus­sia is on the ‘cusp’ of an early stage re­cov­ery which along with at­trac­tive valu­a­tions is an­other’ pull’ to the coun­try.

One of the largest of Bar­ing’s trust’s po­si­tions is in Sber­bank which has had to be re­duced to co­in­cide with the trust’s di­ver­si­fi­ca­tion rules.

Cor­po­rate gov­er­nance is not just im­prov­ing it has im­proved

Rus­sia’s re­la­tion­ship with“the world is now ap­proach­ing truly awful

PROGRESS ON COR­PO­RATE GOV­ER­NANCE

One el­e­ment of Rus­sia’s draw for in­vestors may sur­prise; it’s progress on cor­po­rate gov­er­nance, al­beit from a low base. ‘The main rea­son I‘m con­fi­dent on Rus­sia Inc. is that cor­po­rate gov­er­nance is not just im­prov­ing it has im­proved’ ac­cord­ing to Siller.

He says this is true of both state-owned and pri­vate or­gan­i­sa­tions and a good ex­am­ple of progress is the level of div­i­dends be­ing paid out. He says that Rus­sian com­pa­nies dis­trib­ute a third of their earn­ings as div­i­dends and ex­pects a higher pay­out ra­tio go­ing for­ward. JPMor­gan Rus­sian Se­cu­ri­ties

(JRS) is a pure Rus­sia-fo­cused trust man­aged by Oleg Biryu­lyov and did fall foul of the US sanc­tions in­tro­duced by the US on 6 April. While Bar­ings trust hold’s Sber­bank, the bank has lim­ited deal­ings with com­pa­nies the US im­posed sanc­tions on.

By con­trast the JPMor­gan trust had around a 1% ex­po­sure to Rusal which was di­rectly sub­ject to US sanc­tions.

This con­trib­uted to its net as­set value briefly dip­ping by 7.5% in April.

Un­like Siller, Biryu­lyov is less con­vinced of Rus­sia’s cor­po­rate gov­er­nance pedi­gree. Ac­cord­ing to a note from bro­ker Nu­mis, the man­ager has con­cerns over the run­ning of com­pa­nies like trans­port firm Transneft and VTB Bank.

Both Siller and Biryu­lyov share pos­i­tive views of the eco­nomic state of Rus­sia though. The lat­ter has in­vested in some large cycli­cal stocks to play the re­cov­ery theme. The val­u­a­tion met­rics of en­ergy gi­ant Gazprom too tempt­ing for ei­ther to ig­nore, trad­ing on a price to earn­ings of just 4-times while pay­ing a div­i­dend yield of around 6%.

Both man­agers are skilled stock pick­ers be­liev­ing this the best way to play a volatile mar­ket such as Rus­sia, es­pe­cially as the po­lit­i­cal is­sues show no sign of abat­ing quickly.

RUS­SIAN RISKS

Rus­sia was the best per­form­ing coun­try in the MSCI Emerg­ing Mar­kets in­dex in the first quar­ter of this year be­fore the US in­ter­ven­tion.

The is­sue with geo-po­lit­i­cal ten­sions is that there can be a dis­con­nect be­tween the is­sues and the eco­nomic en­vi­ron­ment. Siller says that ‘po­lit­i­cal risk is un­cor­re­lated’ and Ni­cholas Ma­son, In­vesco Per­pet­ual’s emerg­ing mar­ket eq­ui­ties fund man­ager says the rise in po­lit­i­cal ten­sions will not ‘de­tract us from in­vest­ing in fun­da­men­tally strong Rus­sian com­pa­nies’.

The re­cent spike in po­lit­i­cal ten­sions none­the­less had neg­a­tive im­pacts on funds that had hold­ings in Rus­sia. JPMor­gan Rus­sian Se­cu­ri­ties is trad­ing on a 16.28% dis­count with Bar­ings Emerg­ing Europe on a 12.59% dis­count.

GMO’s Ar­jun Divecha ob­serves: ‘We’ve al­ways said that you make more money when things go from truly awful to merely bad than when they go from good to great. Rus­sia’s re­la­tion­ship with the world is now ap­proach­ing truly awful’. (DS)

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