World Cup win could be Russian own goal
Investors looking east should continue to be cautious and avoid being caught up in the football hype.
Saturday 04 December 2010
Novice investors can be forgiven for thinking that the 2018 World Cup will prove a lucrative win for Russia. There may well be an increase in tourism into the country but investors should concentrate on fundamentals rather than focusing on one-off events that are likely to be a net cost to the nation rather than a money-spinner.
For that reason, there was more interesting news for investors in Russia last week when the country's central bank confirmed that annual inflation had risen to 7.8 per cent by the third week in November, breaching the bank's benchmark interest rate. Immediately, the focus shifted to when the bank might hike Russia's main interest rate (something it has not done since 2008), despite reassurances from fund managers that a rate increase is highly unlikely.
Even without Thursday's 2018 World Cup win, excitement for investing in Russia has been building of late, as companies there seem attractively valued compared to their emerging-market peers.
As Robin Geffen, manager of the Neptune Russia & Greater Russia Fund, says: "The Russian stockmarket's current price-to-earnings ratio is eight, and this compares very favourably to 15 in China and 19 in India. At these low levels, the future prospects of Russian companies represent a significant investment opportunity."
However, investors familiar with the BRIC (Brazil, Russia, India and China) story will now see just how volatile the Russian equity markets can be. For those in any doubt, take a peek at the country's stock exchange back in 2008, when the economic crisis in the West swept in like a Siberian wind. The Russian RTS Index – an index of 50 Russian stocks that trade on the Russian Stock Exchange – tumbled 72.7 per cent from 2,313.9 on 11 January 2008 to 631.8 at the end of December.
Those investors mulling Russian opportunities should also be aware that direct investments offer relatively weak investor protection compared to developed Western markets, and that the standard of corporate governance is a recognised problem for many smaller companies.
Despite these perils, some experts believe that through precise stock picking it is possible to achieve significant gains in the long term. Meera Patel, senior analyst at Hargreaves Lansdown, is among them: she holds a Russia fund in her own portfolio as an ultra-long-term play. She explains: "Russia has always been a bit of a basket case, because whichever way you look there will also be something to counteract the pros with a con, and if someone has a five-year time horizon I can't see that they are going to make that much money. For me, that is too short-term.
"But the retail sector is absolutely booming with growth from the rising middle class, and the financial sector is becoming a bigger proportion of the market as well now – so I am not bearish at all. When you buy into Russia, you are not buying into it for three to five years. It is part of a lifelong retirement pot. For me, it will deliver over the next 10, 15 or even 20 years."
Over the past two years, the number of options available to UK retail investors has increased, with additional mutual and exchange-traded funds launched, offering a much wider choice in strategy. Two of the funds with a five-year performance to date – Neptune Russia & Greater Russia and JP Morgan's Russian Securities fund – have delivered decent returns. And while the Raven Russia Property investment trust has not – largely because its investment portfolio is all in property – it has posted decent returns in the past six months as investors return to the sector, making it the best performer.
Over the difficult three-year period which included the worst global economic downturn since the First World War, there was only one fund that managed a positive return – the Neptune Russia & Greater Russia fund, managed by Robin Geffen. The worst performer was the Aurora Russia investment trust, due to its somewhat limited remit to invest in small and mid-sized private firms in financial and consumer services.
In the fund's annual report, published at the end of September, it announced it had taken outright control of Russian storage and records management business OSG. The total investment in the business now stands at £90m, with a view to returning £105m on the investment at sale. This transaction took the total number of investments within the fund's portfolio to five, comprising a 26 per cent stake in Unistream Bank, 24.3 per cent of DIY chain SuperStroy, 95.5 per cent of OSG, and full control of Kreditmart and Flexinvest Bank.
Over the past 12 months, which have been an encouraging time for Russian companies, the Aurora Russia investment trust has remained the worst performer, being the only fund to lose money as at the end of November. But there have been some exceptionally credible performances, though – the average of all IMA funds analysed was £199 on top of every £1,000 invested.
Despite multiple IPOs in the Russian market this year, Emily Whiting, client portfolio manager at JP Morgan Asset Management admits that the JP Morgan Russia fund had not invested in any new entrants in 2010, until last October. "We have seen a lot of IPOs coming to market in recent years, but we don't see them all as opportunities," she says. "New equity in the market hasn't really created new opportunities, because they are lower quality."
Whiting says her fund has also shied away from companies where the government has the ability to control dividend payments. "We don't like companies that suffer from state control, because we will have no control over the cashflow that is coming to us, she says."
Despite her views, rival fund HSBC GIF Russia Equity fund holds Gazprom and Lukoil – both companies with an element of state activity. Predictably, eight out of the 14 UK-recognised funds hold Gazprom, the Russia oil and gas giant, which is majority-owned by the Russian government (50.01 per cent).
More interestingly, the same number of funds have holdings in Sberbank – a Russian bank and consumer credit lender, which offers current accounts, mortgages and credit cards. Sberbank now accounts for 27 per cent of all aggregate Russian banking assets, and was ranked 43rd in the world for financial strength this year based on its Tier 1 capital ratio. The bank now accounts for around half of all retail deposits in the country.
On top of financial services companies, Russian retail stocks are in favour with fund managers now, with five of the 14 funds analysed holding either X5 Retail or Magnit. Matthias Siller, manager of the Barings Russia fund, makes the case for Russian retail stocks, saying that the country is at a crossroads with the development of the sector. He says he opted for X5 Retail instead of Magnit because he considers the latter to be overvalued, even though those funds that held Magnit saw the stock outperform considerably this year.
"Magnit has been very successful, with even higher growth figures than X5," he says. "I congratulate them for doing so, but think the market is wrong to forecast outperformance for eternity. In the past, we have been investors in Magnit, but Magnit compared to other companies is overvalued," Siller says.
Whether an investor opts for a fund or is brave enough to make a direct equity investment through the Russian stock market, there will always be two ways of looking at the opportunities in this volatile region. But while you can dissect the macroeconomics of any region until football comes home, with Russia there will always be negative signals acting as a dampener on investor appetite.
This research is taken from the January 2011 edition of 'What Investment', out in newsagents on 30 December
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