14-21 Cover Feat Jan 11 L 16/12/10 18:14 Despite analysts having voiced mixed opinions over the prospects for Russia, Joe McGrath discovers how to make the country work for you onger-term investors looking for the next big thing will have seen the many positive stories about the BRIC economies (Brazil, Russia, India and China), but those looking for countryspecific investments have encountered mixed reviews. Russia, in particular, has seen a deluge of dedicated commentary, with analysts reacting to increasingly stark news about its economic position, including a deceleration in the country s growth. According to the country s Economic Ministry, gross domestic product (GDP) grew by 2.7 per cent for the third quarter, compared with 5.2 per cent in the three months to the end of June. While this figure suggests a slight decline, this remains quite a reversal from 2009, when the Russian economy contracted by 7.9 per cent more than any other emerging market country. Commentators pounced last month when 14 Page 14 www.whatinvestment.co.uk the Russian 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. As a result, the focus has now shifted to when the Russian Central Bank will hike the main interest rate something that has not happened since 2008. Commentators pounced last month when the Russian Central Bank confirmed that annual inflation had risen to 7.8 per cent If you are in any doubt about how volatile investing in Russia can be, just 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 at 11 January 2008 to 631.8 at the end of December. Investors thinking about concentrating on Russia should also be aware that direct investments offer relatively weak investor protection compared with developed Western markets. Additionally, the standard of corporate governance is a recognised problem with many Russian companies, particularly small- and mid-cap concerns. That said, those willing to keep hold of funds for a period of ten years or more may still find considerable value in the country, and not just in oil companies. Robin Geffen, manager of the Neptune Russia and Greater Russia fund, says that Russian companies are extremely attractively valued when compared with their emerging market peers. He explains, The Russian stock market s current price-to-earnings ratio is eight.
14-21 Cover Feat Jan 11 16/12/10 18:14 Page 15 This compares very favourably with 15 in China and 19 in India. At these low levels, the future prospects of Russian companies represent a significant investment opportunity. While Geffen s long-term record clearly shows that there is money to be made, it is understandable that so many industry commentators are warning investors to be cautious. Fund selection However, those who remain convinced may want to consider the new variety of funds that are currently on the market. 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. Table 1 shows the performance of funds concentrating uniquely on Russia in the form of investment trusts, IMA funds and exchange-traded products. The data in this table clearly supports analyst and economist recommendations that investors must look at Russian investments as a longer-term play. Two of the funds with a five-year performance to date Neptune Russia & Greater Russia (open-ended) and JP Morgan s Russian Securities fund (closedended) have delivered decent returns. And while the Raven Russia Property fund has not, due largely to the fact that its investment portfolio is purely in property, it has enjoyed a decent performance over 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. PROVIDER AND FUND EXCHANGE-TRADED FUNDS The worst performer during this time was the Aurora Russia investment trust, due largely to its somewhat limited remit to invest in small and mid-sized private companies in the financial and consumer services sectors. As these areas were among the hardest hit in the country, it is relatively easy to see how the fund is severely underwater during this period. Thankfully, the news has been much more positive in the past six months. The fund had made a modest 23 for every 1,000 invested over that period. 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 Table 1: Performance of Russia funds db x-trackers - MSCI Russia Capped Index 932 - - - ishares - MSCI Russia Capped Swap - - - - Source - RDX 897 - - - ETF AVERAGE 915 - - - IMA FUNDS Baring - Russia (US$) 901 1,215 - - HSBC GIF Russia Equity 911 1,156 - - JP Morgan Russia 940 1,229 827 - Neptune Russia & Greater Russia 955 1,196 1,014 2,339 IMA FUNDS AVERAGE 927 1,199 920 2,339 INVESTMENT TRUSTS Performance over: 6 months ( ) 1 year ( ) 3 years ( ) 5 years ( ) Aurora Russia Ltd 1,023 847 365 - JP Morgan Russian Securities 1,053 1,532 958 2,370 Independently Managed - Prosperity Russia Domestic 946 1,644 959 - Raven Russia Property 1,130 1,208 550 524 INVESTMENT TRUST AVERAGE 1,038 1,308 708 1,447 What the table shows: Performance of ETFs, IMA funds and investment trusts, based on an initial 1,000 investment. Figures are correct as at 30 November 2010. Returns are total return, offer-to-bid and rebased in sterling where necessary. Source: Trustnet OSG. The total investment in the business now stands at 90 million, with a view to returning 105 million on the investment at sale. This transaction took the total number of investments within the fund s portfolio to five, including 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. The past 12 months have been an encouraging time for Russian companies, but the Aurora Russia investment trust still remains the worst performer, being the only fund to lose money as at the end of November. www.whatinvestment.co.uk 15
14-21 Cover Feat Jan 11 16/12/10 18:14 Page 17 All IMA funds analysed managed a positive return, making an average 199 on top of every 1,000 invested Credible performers There have been some exceptionally credible performances, though. All IMA funds analysed managed a positive return, making an average 199 on top of every 1,000 invested. One of the better performers over one year has been the JP Morgan Russia fund. It has shied away from the new listed companies on the Russian Stock Exchange (RTS), which, its managers believe, have not added any significant investment opportunities. 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 October. She says, We have seen a lot of IPOs coming to market in recent years, but we don t see them all as opportunities. New equity in the market hasn t really created new investment opportunities because they are lower quality. The Russian market is driven increasingly by global factors and Russia Table 2: Top ten holdings of funds investing in Russia Aeroflot Bank St Petersburg Bashkirenergo Cherkizovo Group CTC Media Cynepctpon Dixy Group Dragon Oil Flexinvest Bank Gazprom Kazkommertsbank Kpegummapm Lukoil M Video Magnit Magnitogorsk Iron Mechel Steel MHP MMC Norsk Mobile Telesystem Mriya Agro MTS Norilsk Nickel Novatek Novolipetsk OSG Records Management Polyus Gold Rosneft Oil RusHydro Sberbank Sistema Surgutneftegaz Tatneft Transneft Unistream Uralkali Vimpel Communications VTB Bank Wimm Bill Dann Foods X5 Retail IMA RUSSIA FUNDS HSBC GIF Russia Equity Baring Russia JP Morgan Russia Neptune Russia & Greater Russia RUSSIA INVESTMENT TRUSTS Aurora Russia JP Morgan Russian Securities Prosperity Russia Domestic Raven Russia Property EMERGING EUROPE (1) BlackRock Emerging Europe Fidelity Emerging Europe MEA Schroder SISF Emerging Europe BRIC FUNDS (1) Allianz RCM BRIC Stars Franklin Templeton BRIC HSBC GIF BRIC Markets TOTAL 1 1 1 1 2 1 1 1 1 8 1 1 5 1 3 2 2 1 3 6 1 1 2 1 2 1 1 7 1 8 4 2 3 1 1 1 1 1 1 3 What the table shows: The ten largest holdings of Russia funds within various IMA sectors. Funds marked 1 invest outside Russia, so ten holdings will not be shown. Source: What Investment www.whatinvestment.co.uk 17
14-21 Cover Feat Jan 11 16/12/10 18:14 Page 18 has plateaued this year. Growth has been restricted as a result of the austerity measures that have come in. There was a lot of uncertainty before the second round of quantitative easing [in the US], and people have taken a lot of risk off the table. Russia is historically one of the most volatile markets and, in most years, is either in the top or bottom five performers. Whiting says that her fund has also shied away from companies where the government has the ability to control dividend payments. She says, We don t like companies that suffer from state control because we will have no control over the cash flow that is coming to us, but other people take a different view. Despite her views, rival fund HSBC GIF Russia Equity holds Gazprom and Lukoil both companies with an element of state activity. Whiting says, If Gazprom outperforms the market, we will typically underperform. Just because a company is posting X amount of profits, you will not always see the return in dividend because the government has some control. Holding on Table 2 shows a breakdown of the top ten holdings of all funds analysed plus Emerging Europe and BRIC funds that offer limited exposure to Russia. Those funds with holdings outside Russia have not had their entire top ten included. Predictably, eight out of the 14 funds analysed held oil and gas giant Gazprom, which is majority owned by the Russian government (50.01 per cent). More interesting, perhaps, is that the PROVIDER AND FUND IMA FUNDS same number of funds own Sberbank a Russian bank and consumer credit lender, which offers current accounts, mortgages and credit cards to the domestic market. Sberbank now accounts for 27 per cent of all aggregate Russian banking assets, and the Financial Times magazine The Banker ranked the institution as 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. JP Morgan s Emily Whiting says that Sberbank, and the Russian financial Table 3: Fees and charges HSBC GIF Russia Equity 3,214 116-1.75 Baring Russia 3,214 111 5 1.50 JP Morgan Russia 22,499 1,506 5 1.50 Neptune Russia & Greater Russia 1,000 365 5 1.75 EXCHANGE-TRADED FUNDS Minimum Fund size Fees (%) investment ( ) ( million) Initial Annual db x-trackers Russia Capped 1 share 171-0.45 ishares MSCI Russia Capped Swap (1) 1 share ND - 0.74 Source RDX 1 share 162 - ND What the table shows: Minimum investment, fund size and cost of IMA unit trusts and OEICs and London-listed ETFs offering exposure to Russia. Exchange rate used: 1 USD = 0.6428 GBP. (1) ishares products annual fee is the TER. Source: Financial Express as at 29 September 2010. Russia is historically one of the most volatile markets and, in most years, is either in the top or bottom five performers services industry more generally, is in for a boom over the coming years. She explains, Sberbank is a very well recognised bank with a solid capital ratio. This is one of the stocks that was hit hard in the financial crisis, but it has picked up. In addition to financial services, Russian retail stocks are very much in favour with fund managers now, with five of the 14 funds analysed holding either X5 Retail or Magnit. Matthias Siller, manager of the Baring Russia fund, makes the case for Russian retail stocks, saying that the country is at a crossroads with the development of the sector. Siller 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. He explains, Magnit has been very successful, with even higher growth figures than X5. I can only congratulate them for 18 www.whatinvestment.co.uk
14-21 Cover Feat Jan 11 16/12/10 18:15 Page 21 doing so, but I think the market has it wrong by forecasting outperformance for eternity. In the past, we have been investors in Magnit, but Magnit compared with other companies is overvalued. We have undertaken analysis of the retail market and we prefer X5 to Magnit. Siller also expects to make considerable gains from one of Barings unique holdings, RusHydro Russia s largest global hydropower provider. He explains, It is a cheap asset. There are low energy prices in Russia, which are partially state controlled. RusHydro, as a low-cost energy producer, is bound to benefit from any increase in electricity prices that follows. Siller took the holding in 2008, and has an investment horizon of between seven and 15 years for the company. He says, This is the cheapest provider of electricity that you can buy globally. And if you are environmentally minded, it is not just the cheapest, but it is sustainable too. Excluding the popular energy companies, telecommunications group Mobile Telesystems is one of the most popular holdings among fund managers. The company specialises in mobile, broadband, pay-tv and entertainment services to Russia, Central Asia and Eastern Europe, and has around 100 million subscribers in Russia and surrounding regions. On 29 November 2010, managers had their confidence in the stock underlined when ratings agency Fitch affirmed the company s bond ratings at BB+ and revised the credit outlook from stable to positive. When you buy into Russia, you are not buying into it for three to five years. For me, it will deliver over the next ten, 15 or even 20 years Weighing up the prospects 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 the country. First of all, you can dissect the macroeconomics of any region until the cows come home, but with Russia there will always be negative signals to extinguish investor appetite. However, experts believe that through precise stockpicking it is possible not just to make a return, but to achieve significant gains in the long term. Meera Patel, senior analyst at Hargreaves Lansdown, is among them, and 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 life-long retirement pot. For me, it will deliver over the next ten, 15 or even 20 years. www.whatinvestment.co.uk 21