Here's a good test for amateur economists. Which country saw industrial production increase over the last 12 months while most other nations have seen it contract? It is a country that represented less than 1 per cent of global GDP 10 years ago but nearly 3 per cent today. A further clue: It is likely to be the fifth-largest economy by 2025, overtaking the UK along the way. The answer is Russia.
Despite these amazing facts relating to its growth, Russia is one of the cheapest markets in the world. According to Robin Geffen, manager of the Neptune Russia & Greater Russia Fund, the Russian market traded at a median discount of 22 per cent to other major emerging markets between 2003 and 2008. However, since the financial crises, perceptions of risk have changed and it now trades at a 48 per cent discount. Many investors view Russia with suspicion – not least due to concerns over corporate governance and the rule of law. While these concerns are valid, it does mean Russian equities tend to be overlooked and offer opportunities.
Now Russia is clearly not a market for widows and orphans. Volatility is par for the course, partly due to politics and, more significantly still, fluctuations in the price of oil, upon which much of the Russian economy depends. The Russian stock market has a strong correlation with the oil price, though, interestingly, this does seem to have broken down so far this year with the price of oil rising and the Russian market falling.
Given the high level of foreign ownership in the free float of Russian stocks, it seems they are vulnerable to violent "risk on" rallies or "risk off" falls – and the level of volatility is too much to stomach for many investors. Yet valuation should, in the end, be the safety net, and I would suggest valuations in the Russian market are discounting an awful lot of poor news while largely ignoring the good news.
Last year's merger of Micex and RTS, Russia's two major stock exchanges, signals Moscow's intention of becoming an international financial centre, and it should mean domestically listed shares are easier to trade. Co-operation between Russian oil company Rosneft and US counterpart Exxon Mobil could also point to a thawing stance on resource nationalism, which could help Russian firms exploit the wealth of natural resources available.
Russian finances have also come a long way. During the credit crisis, oil revenues fell, and at the time Russia was a net debtor to the value of $150bn. It has since put that sharp economic contraction behind it, turning the budget deficit to a budget surplus. Corporate and household debt has also fallen rapidly, so the Russian economy could be better cushioned from external shocks going forward.
Following the improvement in finances, the government is spending heavily on infrastructure and the Neptune fund's exposure to industrial and transport companies such as Globaltrans could benefit. The fragmented retail sector remains an area of opportunity too. X5, the largest supermarket chain in Russia, only has a 5.4 per cent share of the market. There is potential to acquire smaller rivals and build a dominant national chain. The technology sector is also interesting, and Yandex (an internet search engine with 60 per cent share of the Russian market) is a key holding in the fund. Russia has a huge internet market but penetration is still only 45 per cent.
Clearly, energy is still an important theme, and 35 per cent of the fund is in this sector. Russia is one of the few places where crude oil production is still rising. Due to its proximity and thirst for energy, China is a key trading partner and exports to it have risen tenfold in the past decade.
Neptune Russia and Greater is not an investment for everyone, but for those seeking strikingly low valuations and possessing the patience and stamina to withstand the volatility I believe Russia remains a fascinating investment story. The forthcoming listing of Sberbank on the London market may well be a welcome catalyst for international investors to look more closely at this market. Many will be surprised to find that Sberbank is Europe's third-largest bank – seemingly without the problems that most European banks have on their balance sheets.
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