Tags

, , , , , , , , , , , , , , ,

Continued from here:     So why the interest in Russia? Well, for me, pretty much any emerging/frontier market’s preferable to those in the developed world these days! Everywhere I look, I see better growth, better demographics, better government finances, lower debt and no currency debasement… And all this for stock market valuations that are similar to/cheaper than Western markets. There are a number of markets I feel are particularly attractive – for example, I’ve highlighted Vinacapital Vietnam Opportunity Fund (VOF:LN) before as a good stock pick for exposure to Vietnam. With my continuing bullish view on oil and other commodities (and the inflation risks posed by global QE), Russia presents a compelling market opportunity.

So how does Russia actually stack up these days? Well, first one needs to realize how far it’s come. In the past 10 years GDP has more than quintupled, Russia’s now a Top 10 global economy, and average GDP per capita (in nominal terms) is around $16,700. This last stat’s v interesting – $17 K goes pretty far in what’s still an emerging market, and it explains the booming Russian middle class, something many investors have under-estimated.

The Russian economy’s in excellent shape: Inflation’s at a post-Soviet era low of 3.7%, unemployment’s at 6.6%, GDP is forecast to grow 3.5%, and the rouble’s estimated to be 20-30% under-valued on a PPP basis. Perhaps the Russians will have won in the end..?! Oil, natural gas, metals and timber account for over 80% of Russia’ exports. From a government perspective, things look good also, with the budget deficit forecast to be about 1% of GDP, the Debt/GDP ratio’s around 10% and Russia’s FX/gold reserves have topped $500 billion. For investors, Russia’s looking pretty tasty too, with market capitalization nearly $1 trillion, daily trading volume at $6 billion, and valuation standing at a 6.6 P/E, a 1.1 P/B and a 1.9% dividend yield.

I’d have preferred to see a higher GDP growth rate (amusing when you think of what we see/can expect from the US & Europe!), but the Russian economy’s now about $1.9 trillion and can’t escape the law of large numbers. However, the rock bottom valuation of the stock market more than compensates for this. As I’ve mentioned before, even if you think a low P/E is deserved (which I don’t, here), this low valuation offers an asymmetric risk/reward scenario as news develops, unexpected events occur, and sentiment changes…

I wasn’t particularly fazed by the political uncertainty, and protests, in the lead-up to the elections. Despite the media hoo-hah (trying to scare up a story where one didn’t really exist), it was obvious Putin would win. There was a small risk, at worst, he might have been forced to build some alliances, and make some concessions, to attain and consolidate victory. But, of course, that wasn’t necessary in the end. There’s nothing particularly alarming about the social/political protests either – I see no real sign of a fundamental rejection of government, the focus would appear to be on political corruption, the lack of political choice and election fraud, the wish for a greater/more organized democratic voice/input etc.

Not to belittle it, but this is exactly what you might expect from younger/well-educated/better traveled people, and/or a burgeoning middle class. It may take some years, but their aims will eventually be subsumed into a more coherent and better organized democratic/political movement. But, for the moment, protest’s an intoxicating (considering Russia’s history) step for many towards broader democracy. Putin’s been smart enough to recognize this, and it explains why he hasn’t responded more forcefully to the protests. I think it will also be a key inspiration for his domestic strategy during this new term of government.

My only disappointment really with the election run-up was the lack of any real retracement in the market! I had hoped this would occur, and present better buying opportunities. Once again, I guess you should look to the markets, rather than the media, if you want to be better informed of a political outcome..!

So, the macro picture looks excellent, what funds make sense on a micro basis? First, I’ll discard the Ukraine/Kazakhstan/Mongolia funds. Yes, their discounts (to NAV) are attractive, but this mainly reflects their exposure to unlisted stocks. There’s nothing unique or compelling enough about these funds to warrant choosing them over a decent Russia-focused fund. I’ll keep my eye on Origo Partners (OPP:LN) as a China-focused play, however – this recognizes that even as it becomes more Mongolia-focused, its portfolio companies will be dependent on China as an end-market.

I’ve already highlighted my general distaste for Russia & Eastern Europe funds, but let’s take another quick look. East Capital Explorer’s 34% discount to NAV’s attractive, vs. an average 9% for the other funds. However, its poor NAV history and investment in sub-funds/unlisted stocks eliminate this fund for me. Of the rest, Central Europe & Russia Fund and Baring Emerging Europe (BEE:LN) are the obvious stand-outs for longer-term performance, but I’d prefer the Baring fund based on its substantially better performance in 2008.

Now to the Russia funds: In terms of their poor long-term performance, I’m discarding EOS Russia, ENR Russia Invest, Vostok Nafta Investment and Aurora Russia. Prosperity Voskhod Fund has been a decent performer, but Templeton Russia & East European Fund and JPMorgan Russian Securities are better known and have much longer histories. Of these two, long-term performance’s neck-and-neck, but I think the JPMorgan fund’s got the edge as a UK investment trust’s far less of a tax/administrative headache (vs. a US closed-end fund), and it’s got almost 4 times the assets. Surprised by my last point? Don’t be! Most investors will inevitably buy the largest cap stock, and so should you, unless a smaller cap stock offers significantly more upside potential.

Renaissance Russia Infrastructure Equities is a bit of a special case. Its discount’s attractive, Renaissance is admired as a Russian (and increasingly, African) expert, but its NAV history is mixed and it’s got a 25% exposure to unlisted stocks. However, it offers a fairly unique proposition – exposure to Russian infrastructure. Yes, infrastructure companies/funds haven’t lived up to their promise in the West. But blame cash-strapped governments, and the credit boom, for that! Governments needed low costs and high returns from infrastructure projects/deals, while PE fund mind-sets and cheap credit justified ever-escalating prices. Poor projected returns on equity then required ever-increasing levels of debt to justify the deals, thereby exacerbating the financial risks involved. In emerging markets, it’s a very different story – infrastructure’s rightly regarded as an equity growth play, not a bond-like investment to be grossly levered up.

This opportunity exists in other markets too (Vietnam Infrastructure (VNI:LN), on a 45% discount, is enticing), but Russia offers an interesting political dimension. I think two key planks of Putin’s developing/new strategy will be a i) a wave of privatization to decrease the role of the state in the economy, and more importantly, ii) a substantial and sustained investment in infrastructure projects. This investment’s required anyway, but what a marvelous ‘story’ it will be to seduce and appease the Russian public – everybody loves the effects of a spending spree! It will promote growth and employment, offset any potential hiccups in oil/natural resource revenues and/or global growth, and the government has the robust finances and debt capacity to fund it.

I’ve now built up a 3.2% position in JPMorgan Russian Securities (JRS:LN). At today’s GBP 597.5p price, it now trades on an 8% discount to NAV. Unlike my individual company stock picks, I obviously have no specific Fair Value Price Target – I’m relying on my bullish oil/commodity view, continued Russian growth (and financial strength), and an improvement in market sentiment and valuation multiples. However, I see no reason a stock market rating similar to the US & Europe can’t be attained in due course – this implies a potential doubling, or greater, in value.

I’ve also built up a 2.1% stake in Renaissance Russia Infrastructure Equities (RIEL:LN). It’s a smaller allocation as I was focused on building up JRS as my primary Russian exposure, and because it’s a more specialized fund. At today’s $0.54 price, it now trades on a 28% discount to NAV. Similarly, I don’t have a Fair Value Price Target, but with 25% of the fund currently invested in unlisted stocks (which should reduce) I prefer to calculate my own adjusted NAV. Applying a 35% ‘haircut’ to its unlisted exposure, I’m tracking this fund based on an adjusted NAV which is at 91% of NAV. Therefore, the implied discount to my adjusted NAV’s at a slightly lower 21%.

I may well increase my total (5.3%) Russia exposure further (and I’ll also be monitoring Aurora Russia (AURR:LN) as a possible event-driven opportunity). If we do see a substantial spike in oil (or commodity) prices, I may then consider reducing my overall Russian exposure (hopefully, taking profits!?). This reduction strategy might, however, then include increasing my RIEL stake at the expense of JRS.

Advertisements