Russian macro story woos investors despite sanctions sell-off

Russian markets tumbled on Monday in response to US sanctions, but investors have described the country’s macroeconomic management as “exemplary” and said the market sell-off is a buying opportunity.

Russian macro story woos investors despite sanctions sell-off

The dollar-denominated RTS index opened the day down 3.18% while the rouble-based MOEX Russian index was down 2.55%. The rouble initially fell 4% before recovering slightly.

The US announced on Friday it would be freezing assets of seven Russian oligarchs and the 12 companies they own or control, 17 senior Russian government officials, and a state-owned Russian weapons trading company and its subsidiary, a Russian bank.

The sanctions were a response to a series of adversarial actions by the emerging market economy, including its alliance with the Syrian government, subversion of Western democracies, continued occupation of Crimea and malicious cyber activity, said Treasury secretary Steven Mnuchin.

However, Ashmore head of research Jan Dehn says the market sell-off is a buying opportunity for investors, just as it was when the country faced sanctions for the 2014 annexation of Crimea, albeit a period of weakness could last for some time.

“There would have to be the mother of all escalation before I would think there is a major risk,” Dehn says.

He adds there was nothing in the sanctions so far to indicate they would include sovereign debt.

Blackrock Emerging Europe investment trust manager Sam Vecht says they have not made portfolio changes in response to the current round of sanctions. They continue to hold a slight overweight in Russia, which is the largest country allocation in the investment trust at 55.1%.

“Thus far our focus has been on macroeconomic stewardship of the country, which has been exemplary,” Vecht says.

The Emerging Europe investment trust has returned 13.6% over one year and 63.3% over three years, compared to 14.1% and 63.5% respectively in the Investment Trusts Europe Emerging Markets sector, which only includes one other company, Barings Emerging Europe.

Strong Q1

Russia’s sell-off represents a change in fortunes from the year’s first quarter. The day before the US Treasury announced the sanctions on 6 April, Russia’s RTS index had rallied 4.9% in the year-to-date, according to Thomson Reuters Lipper data.

Neptune Russia and Greater Russia, managed by Robin Geffen, was the fifth top performing fund across sectors in Q1 2018, according to FE data released last week. It returned 5.5% over the three-month period to 30 March. In contrast, the Investment Association Global Emerging Markets sector as a whole lost 4.2%.

However, on Monday the fund’s second-largest holding, Sberbank, fell 17% and its three-month performance had dropped to 2.3% (see table below).

Russia’s relatively strong performance in Q1 could be due to a lack of exposure to technology compared to developed markets and other emerging market countries, Architas investment director Adrian Lowcock says. The oil price has also been supportive, he adds.

“The key thing with the current situation is it’s quite early days. You could see the sanctions become more severe and you could see them bite more significantly,” he says.

There are currently four dedicated Russia funds in the Investment Association sectors, according to FE Analytics. JP Morgan Russia is the largest with $669.1m (£473.4m) assets under management, followed by Neptune Russia and Greater Russia, which holds £201.7m, and HSBC GIF Russia Equity, which holds $270m. The Barings Russia fund is comparatively smaller at $52.3m.

Performance of Russian funds

Baring Russia1.4%3.8%81.2%
HSBC GIF Russia Equity-0.5%0%64.6%
JPM Russia-2%-2.3%45.7%
Neptune Russia and Greater Russia2.3%11.2%75.1%
MSCI Russia Large Cap index-1%5.1%51.6%
Source: FE as of 9 April 2018

Architas invests through global emerging market funds rather than country specific funds to avoid risks like sanctions, which are “part and parcel” of investing in Russia, Lowcock says.

The funds with the largest allocation to Russia in the IA Global Emerging Markets sector are Neptune Emerging Markets (13.2%), Pictet Emerging Markets High Dividend (12.7%) and the Polar Capital Emerging Markets Income fund (10.8%).

Russia represents 3% of the MSCI Emerging Markets index and 63 funds out of the total 97 in the sector have a larger country allocation than that, according to FE.

Macroeconomic management

Russia’s macroeconomic policies are some of the “most orthodox one can find anywhere in the world”, Vecht says. “That has allowed inflation to fall significantly,” he says.

Dehn echoes that, describing Russia as “probably the most solid credit in the world” and its policy response to the triple whammy of geopolitical, sanctions and oil price shocks in 2014 as “immaculate”. “It turned out in retrospect to be a valuable buying opportunity for those investors who went in at that time,” he says.

Dehn points to the central bank’s foreign exchange reserves totalling $430bn, enough to cover 85% of all dollar liability, as an example of its strong macroeconomic management and describes central bank governor Elvira Nabiullina as the top in the game.

Index providers shedding Russia from benchmarks would provide an even bigger buying opportunity, he says.

“In that case you want to hold most of your dry powder until most of the forced selling is out and then you buy. You’re going to get a technical flow and that’s just going to deepen the value opportunity. Then you want to buy even more but you want to buy later.”

Speaking at an event last month, Templeton Emerging Markets Investment Trust lead manager Chetan Sehgal said they had invested in Russia in 2017 and it had “paid off”, but that they would be keeping an eye on potential sanctions against Russia in light of Salisbury’s nerve agent attack.

Sehgal said Russia was “by far” the cheapest market on an absolute basis and even though its market had performed well its price to earnings still sat at 6.9x. The fund holds 9.3% in Russia equities.

ESG failure

However, not everyone has reason to be positive on Russia.

Theo Holland, co-manager of the Kames Emerging Market Bond Opportunities fund, says governance was impacting their investment case for Russia from an ESG perspective.

Holland raises concerns about the “encroachments of the state” on banks and corporates.

He says: “It is hard to see past the Russian government’s centralising instinct, and its controversial foreign policy decisions, which have rebounded heavily on the Russian economy in the form of sanctions.

“These factors act as a persistent drag on the investment case for Russian debt.”

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