Mark Dampier: A risky but profitable market for the brave
Saturday 12 February 2011
The troubles in Egypt are a reminder to investors in emerging markets that economic and stock market risk can be exacerbated by political issues. The Egyptian stock exchange has been closed for days because of the anti-government protests, so owners of shares listed there do not even have the option of selling until it re-opens. Of course, Egypt is not one of the major emerging markets, rather a "frontier" investment proposition with a nascent, illiquid market. Nonetheless, political risk for those investing in emerging markets is nothing new and it is worth bearing in mind.
Indeed, one of my favourite markets at the moment, Russia, carries a degree of political risk, which is one reason for the inexpensive valuations of many its shares. There are a number of specialist funds investing in Russia and I have been a particular fan of the Neptune Russia and Greater Russia Fund since it launched, but it is always interesting to meet other managers investing in the area. I was especially keen to meet Hugo Bain and Peter Jarvis, the managers of Pictet Russian Equities, a fund that has closely matched the Neptune one in terms of performance.
Although not well known to British investors, Pictet is one of Switzerland's largest private banks and puts significant resources into the EMEA (Europe, Middle East and Africa) region, with dedicated traders, a team of 17 analysts and an emerging market debt team. They have a proprietary system which looks to find undervalued companies where the share price does not fully reflect what the company owns. Some 120 companies are screened by this method, and they follow this up with consideration of regulation within the industry and by meeting key personnel to assess management quality.
There is also a focus on liquidity – essentially how easy it is to trade the shares. The Russian market can be a real roller-coaster and the team has seen two 80 per cent falls from peak to trough, so it likes to be ready to cut a position quickly if it needs to. The portfolio tends to be relatively concentrated between 22 and 35 stocks, and may also include shares of companies in Ukraine, Kazakhstan and Georgia.
The Russian stock market is dominated by energy and commodity stocks and highly correlated to the price of oil, but perhaps not quite in the way you would expect. The Pictet team has identified oil price rises have a relatively small effect on Russian energy stocks, and shares in other sectors go up faster. This is because a progressively higher amount of oil company profit is taken in tax as prices rise. Additionally, a buoyant oil price magnifies the trickle-down effect on consumer spending, allowing retailers and other domestically orientated firms to flourish – so it is these areas that benefit more.
Among the largest holdings in the fund are commodities stocks Norilsk Nickel, and Gazprom. Sberbank completes the top three, but note the fourth-largest stock is Magnit, a food retailer. The food market in Russia is still in its infancy and growing fast, and consolidation has only just begun. So far, Magnit has 3,500 convenience stores and 60 hyper-stores, but it is opening 500 convenience stores a year, which tend to be profitable after one year. This type of stock could prove a big beneficiary from the growth in the economy, especially if the company can move into a position of dominance.
The Russian stock market remains on a remarkably low price-to-earnings ratio of approximately eight times, a large discount to other emerging markets. Some of this discount is deserved because of political worries, but I agree with the Pictet team that it seems excessive. Given the vast reserves of oil and other commodities in Russia, I can see the Russian economy improving further.
Russia is some way behind other emerging markets in creating a consumer culture, as is much of eastern Europe, so if you can tolerate the risk some exposure to a fund like this could prove worthwhile over the long term.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent.
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