PA ANALYSIS Russian roulette

Few contrarians are willing to put a gun to their head in what is appearing to be a game of Russian stock market roulette.

PA ANALYSIS Russian roulette


The political jousting between East and West is no doubt lending a grim air to economic headlines, but to what extent should these impact investor decisions? 
“Investors should not base their decisions on the headlines and focus on value. Tensions may escalate further in the near-term, but this crisis looks likely to be resolved diplomatically,” according to emerging market specialist Ashmore’s head of research, Jan Dehn.
Investment experts are understandably cautious about voicing direct opinions on the current state of play for Russian equity focused funds. But from an observer’s perspective two themes are emerging, the macro verses the market view.

Macro environment

Dehn believes that we are still in the escalation phase of this conflict.
“Further escalation is already having economic costs, especially for Russia. S&P’s downgrade of the credit this past week is an example. Further sanctions would be another cost. The Russian central bank’s decision to raise rates by 50bps to 7.5% is a third example. Business confidence will also be hurt by the lingering uncertainty.”
However, he points out that Russia’s credit fundamentals are extremely strong. 
“Net of official fiscal reserves, Russia’s total public debt to GDP ratio at the end of 2013 was just 1.5%. A weaker Ruble actually improves the public finances, thus improving the government’s ability to pay. Besides, Putin is popular. In other words, Russia can stomach a lot of pain, both economically and politically.”
Nevertheless looking forward in 2014, there are indications that Russia’s growth has been impacted by headline-seizing events. 
According to Dilek Capanoglu, chief investment officer and manager of the Allianz Global Emerging Markets Equity Fund, growth is likely to be below potential in 2014.
“Consumption was the key driver of real GDP growth in 2013 and is expected to remain the key driver in 2014, though likely at a slower pace due to expected moderate real wage growth and a weak currency.”
She also highlights the fact that the global oil price remains strong, unlike in the 2009 crisis which was accompanied by a 70% collapse in the oil price. This factor, coupled with a weak Ruble, is conducive to a supportive macro environment. 
“A further de-escalation of the situation could offer upside potential,” she adds.
Russian debt is very low, signalling that the economy’s fundamentals are not bad for the time being. 
“If sanctions were to increase there would likely be short to medium term growth implications. But Russia’s debt is another story,” head of fund research at Brewin Dolphin, Ben Gutteridge, says.
As of 18 April, Russia’s foreign exchange and gold reserves amounted to $482bn, surpassed only by China, Japan, Saudi Arabia, and Switzerland, according to data released by Ashmore and Bloomberg. Net of official fiscal reserves, Russia’s total public debt to GDP ratio at the end of 2013 was just 1.5%.

Market view

When it comes down to buying, selling or holding Russian stocks, the general consensus is a wary one.
“We would need to see more concrete evidence that the geopolitical situation is not escalating before recommending a Russia dedicated fund,” Gutteridge says.
“On generalist emerging market funds that have a typical benchmark position in Russian equities, we would be more comfortable with fund managers underweight in Russian stocks – we wouldn’t want to see excessive exposure.”
As Ashmore’s Dehn summarises, “Given Russia’s ability and willingness to pay, we think the right strategy is to add at weak levels, not to sell at or near the bottom.”
Similarly, Capanoglu says she has reduced the exposure of the Allianz Global Emerging Markets Equity fund to Russia to an underweight positioning but hasn’t sold out completely. She still sees positive prospects for certain stocks.
“We prefer companies with a structural growth, healthy balance sheet and good dividend prospects.”
Within Russia, these include overweight shares in Russia’s largest independent gas producer Novatek and leading Russian oil producer Surgutneftegaz in the energy sector. She is underweight in Lukoil and Gazprom and has zero exposure to Rosneft, Tatneft and Transneft. 
When it comes to consumers, she is particularly upbeat on long-term structural growth in this sector.
“Despite the challenges the consumer faces currently we expect the long-term structural growth theme to be intact. We continue to favour Magnit. The company is in our view best positioned to weather the current environment.”
In the telecoms sector, she has sold out of MTS and concentrated exposure in Megafon, which does not have any Ukraine exposure and is expected to benefit more from data growth.
The fund has no exposure to metals and mining, and the agricultural sectors, but retains stocks in financials such as Sberbank, Russia’s largest bank.
“Given its dominant position in deposit collection it currently enjoys a strong competitive advantage. With that Sberbank seems well placed to benefit from the growth opportunities of an underpenetrated Russian banking sector,” according to Capanoglu. 

Investor decisions

When it comes to making a decision on Russian stocks, a middle-of the way approach seems to be investors’ best bet, with few if any contrarians willing to put a gun to their head. Short to medium-term uncertainty is high and pushing stocks down.  However the long-term economic fundamentals of the Russian economy are strong and signalling profit potential in the long term, assuming that the geopolitical situation does not spiral out of control. Keeping portfolios underweight in Russian equities balances the risk but allows for flexibility of returns should trade sanctions lift. 


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