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Week 8, 2017Russian Equities: Get ready for lift-off, or not!  My colleague Blair Campbell, a Portfolio Manager in our Guernsey office, recently met with a specialist Russian equity fund manager, and the opening line in his presentation pack was “Russia (specifically Russian equities) look as good as they have in a decade, going into 2017….”. We all know fund managers like to talk up their own book, but this did get us thinking a little more carefully about other regions/countries which could potentially offer attractive returns from this point in the cycle and, most significantly, at attractive valuations (unlike some other regions/countries – specifically in developed markets, which are now starting to feel a little over fair value).

Looking at its return profile, the Russian Index is still significantly below the highs of 2007: -61% in US dollar terms, and this is after a very positive 2016 (+59%). Therefore, our preliminary assumption would be that the initial phase of the market’s recovery has been mainly driven by ETF flows. Increasingly, from this point forward, our expectation is that stock-picking (alpha generating) managers will likely drive performance.

Looking at Russia’s fundamentals, it currently has a current account surplus, a low government debt/GDP ratio and pretty healthy looking FX reserves – all of which compares favourably when viewed next to most other developed economies. Against this solid backdrop, Russian equities are currently substantially cheaper than the broader market, with an average P/E of 6 and offering an attractive dividend yield of +4.5%. Buying Russia today could very well provide significant outperformance in the long run – that is if you can stomach potential bouts of market volatility in the short-term!

Chart 2

Chart 1In short, Russian equities have a number of potential tailwinds:

  • Cheap valuations on a price to earnings gauge to other emerging markets, both on a relative and absolute basis.
  • Entering a potential cycle of loosening monetary policy with expectations of interest rates cuts.
  • Favourable economic fundamentals.
  • Moreover, and importantly, a positive shift in market sentiment.

However, when investing in any emerging market, one also needs to look for political stability and credible corporate governance; overbearing bureaucracy, poor infrastructure and corruption should also be towards the top of the due diligence checklist – Russia certainly has all of these issues at the fore! The first matter of note is the prospective shift between Russian and Western relations, following the recent appointment of President Trump. It may be a too early to conclude if this is going to have a positive or negative outcome, however. On the back of this, you also have to consider the upcoming 2018 Russian elections, where economic and political agenda go hand-in-hand. Putin appears, at present, to be the only plausible candidate. Moreover, one must also keep a close eye on the continual fractions over Ukraine, which could cause considerable market volatility should the status quo deteriorate; on top of this, further economic sanctions could also follow.

In Conclusion

We all know that potential high returns are often associated with higher risk investments; however, emerging markets are, in our opinion, the likely area to find returns that outperform those of the developed nations, over the longer-term, due to basic demographics and growth expectations. While Russia offers the potential for high returns, its market is heavily dominated by energy companies (proxy on the oil price), the state of regulations is still under development, and there are political risks (as noted above) that are larger in Russia than in other countries. Consequently, the striking feature of investing in Russia – the risks and rewards – are both potentially high.

The Contrarian Investor






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