While membership of the BRIC club has done Russia’s profile no harm, comparison with three fast-growing countries has not always been flattering.
China, India and Brazil are expected to be among the world’s five largest economies by 2050. And with its ageing population, its dependence on oil and gas and its continuing corruption, many question whether Russia deserves its place at this table.
Sticking to his original concept, BRIC’s originator, Jim O’Neill – now chairman of Goldman Sachs Asset Management – has rejected calls for Russia to be jettisoned.
In a paper marking the tenth anniversary of the idea, he said, in terms of GDP, Russia has the potential to beat not just the other BRICs but all other European countries.
Key to this is reducing oil and gas dependency, and Oleg Biryulyov, manager of the JPM Russian investment trust, highlights several challenges on the path to increasing the economy’s natural growth rate.
He notes four key areas to improve: reducing the size of the state; allowing debate; investing in infrastructure; and reforming the savings system.
“The size and the structure of the Russian state are heavy ballast for the economy,” adds the manager.
“The solution requires decentralisation and privatisation. Meanwhile, Russia’s geographic scale is also more of a liability than an asset for the state today, so upgrading infrastructure is a huge task.”
Equity key
The key for investors is how the country’s equity market will fare in the coming years – and most specialists remain bullish. After a strong start to 2011, buoyed by rising oil prices, the region underperformed through mid-year as the eurozone continued to implode, but clawed back losses in Q4 as tensions in the Middle East pushed commodities back up.
Despite this, market watchers claim Russian equities are currently trading 40% to 50% below their historic levels and other emerging markets, against a 25% average, with the risk premium even higher after recent political turmoil.
Jupiter’s Elena Shaftan, who runs the Emerging European Fund, says external factors will continue to dominate short term, but huge pessimism is already priced into the market.
“While global economic and political concerns are likely to preoccupy investors in 2012, if one can take a pragmatic view, this year might prove to be the buying opportunity of a decade, despite bouts of volatility,” she adds.
Major changes
HSBC Global Asset Management also sees current valuations as an attractive entry point and has Russia as the largest position in its BRIC Equity Fund, at 32%.
HSBC’s investment director, Soren Beck-Peterson, says that after December’s parliamentary elections, which were seen as rigged, we may be witnessing the beginning of major changes in Russia.
“Events are difficult to predict in the short term, but it looks as though Russia’s urban middle class is seeking a political voice and authorities are prepared to listen,” he says.
Beck-Peterson says one healthy development is that Russia is beginning to privatise some state-owned companies, increasing the free floats of several large banks and energy firms.
“The government will want to maximise the price of its stakes and may try to increase transparency, disclosure,” he adds.
Growing trend
Michael Konstantinov, who runs Allianz RCM’s BRIC Stars portfolio, sees rising dividends as a growing trend in the country.
“Last year, Russian corporates returned cash to shareholders at a record pace,” he says. “If you combine share buybacks and dividends, the 2011 payout was 9% above the previous record year of 2008.”
Konstantinov says this improvement, mainly from the private sector, shows a sea change in the attitude of Russian corporates.
“Corporates are healthier than ever, with lowered debt and strong cash flow, and increasing payout illustrates an increased willingness by government and the private sector to push for better corporate governance and a greater shareholder recognition,” he adds.
Strong domestic economy
At stock level, HSBC sees some of the most exciting opportunities in oil and gas, and financials. Ed Conroy, who runs the group’s Russia fund, says: “[The country’s] oil stocks trade on four or five times consensus forward earnings, which is around half the multiple of other major oil stocks.”
On financials, he says the banks are a good, cheap way of playing a strong domestic economy, with margins high and asset quality improving.
“We think, structurally, the Russian banks are capable of generating 20% return on equity or more and currently trade around book value,” he adds.
Among the less positive managers on Russia is BlackRock’s director of emerging markets, Sam Vecht, who pared back exposure on his Eastern European trust coming into 2012.
While positive on the upside for a number of individual companies, he cites concerns around the political environment.
Among wealth managers, Investment Quorum’s chief investment officer, Peter Lowman, says direct Russian exposure tends to be too specialist for most clients and uses broader EM funds. But he follows the Neptune Russia and Greater Russia fund run by Robin Geffen, citing the latter’s experience and track record.
“For us, Russia comes down to a call on the oil price and political instability,” he adds. “It was down more than 20% in 2011 but January was good for EMs.”
Strong valuations
Mark Dampier, head of research at Hargreaves Lansdown, has the Neptune fund on his Wealth 150 list of favoured portfolios, noting the strong valuation story.
“In the short term, there could be further volatility, but if and when the problems in the eurozone are resolved, global markets should start to show an improvement and EMs such as Russia could benefit from a substantial re-rating,” he says.
“Geffen believes the Russian economy is set to grow by more than the UK’s over the next five years. It has one of the world’s largest resource bases and is poised to benefit from growth in other EMs.”
Like most of his peers, Geffen believes the fate of the Russian index will be driven in the short term by attempts to resolve Europe’s debt crisis.
“With the MSCI Russia trading on a lowly 4.9x earnings and 0.8x book value, the market is well placed for any improvement in risk sentiment,” he adds.
“The Russian market offers a cheap way to access a rebound in emerging market-led global growth in 2012.”
On the political situation, Geffen expects continuity in the shape of Putin and Medvedev swapping roles.
“The fact United Russia maintained its legislative majority but fell short of a super-majority also indicates the administration will be keen to support real income growth ahead of presidential elections and the outlook for the Russian consumer should remain supportive in this environment,” he adds.
PA Summary
Russia is still burdened by problems of political risk, corruption, a reliance on oil and natural resources and poor infrastructure.
There is evidence of restructuring around a settled political environment, better forecasts for income growth and improved domestic consumer outlook.
Corporate strength, on the other hand, is improving with lower debt and increased cash flows from companies also paying increased dividends
