The Great Bear Comes Back
A stabilising oil price and attractive valuations sees investors looking at Russia again, but it pays to tread carefully
3 min read
Coutts currently has a positive long-term view on Russian equity.
Three years ago, Russia fell out of favour with emerging market (EM) investors after the US and European Union imposed far-reaching economic sanctions over military intervention in Ukraine. Its economy depends heavily on the energy sector, and the fall in the price of oil from mid-2014 also hit hard, sending the country into a deep recession.
Last year the Russian stock market rallied as the oil price stabilised and the country showed signs of returning to growth. President Trump’s willingness to have a positive relationship with Russia also boosted sentiment. The geopolitical risk premium came down, which pushed up asset prices.
As a result, EM funds have been increasing their exposure to Russia to take advantage of strong equity returns. However, the political climate remains volatile and the US has recently issued new sanctions against Moscow over its alleged interference in last year’s presidential election.
Become A Client
When you become a client of Coutts, you will be part of an exclusive network.
AN ECONOMY IN TRANSITION
Another risk for investors is that Russia is one of the world’s leading energy producers and a top exporter of industrial metals. Its reliance on commodity exports makes it vulnerable to boom and bust cycles that follow the volatile swings in global prices. Although growing again, the economy is unlikely to enjoy the average 7% expansion it enjoyed from 1998 to 2008 as oil prices rose rapidly.
Russia has undergone significant changes since the collapse of the Soviet Union, moving from a centrally planned economy towards a more market-based system. However, it remains predominantly statist, with a high concentration of wealth in the hands of officials. The protection of property rights is still weak and the state continues to interfere in the free operation of the private sector.
This situation creates ongoing concerns about corporate governance with allegations of corruption and bribery. The Russian government owns significant chunks of many of the largest businesses, including gas producer Gazprom, banking giant Sberbank and utility company Rosseti. Other companies are less connected to the Russian state than they are to Russian billionaires with close ties to President Putin.
THE COUTTS VIEW
Many Coutts portfolios have had an allocation to Russian equity since valuations fell to attractive levels in 2014. As contrarian investors, we saw this as an opportunity invest. The Russian market rallied in 2016, rising 56% in US$ terms, providing a solid short-term return, but we still see a long-term investment case.
We prefer to invest actively through an active fund manager that understands the region. As already noted, with about half the country’s revenues coming from energy, index funds and ETFs have a high exposure to commodity prices making them vulnerable to external factors. That risk can be managed by a stock picking strategy informed by local knowledge. Transparency is also a problem, and so a locally based analytical resource is vital to providing accurate information.
A locally managed fund also avoids many of the other risks and complexities associated with investing directly in Russia, such as tax concerns, execution risk and strange trading hours. The country’s stock market, the Russian Trading System, is only open from 10am to 11.50am Moscow time and investors need a licence to trade.
Many investors are still waiting for key economic reforms to increase productivity and foster new sources of growth as well as make Russia’s financial markets more transparent and easier to access. In the meantime, selective investment opportunities are available, providing global commodity prices remain stable.
Stabilising oil prices and a growing economy has seen Russian equity return to favour among emerging market investors. While we have a long-term positive view on the market, an active manager with local market knowledge will help investors navigate some of the systemic difficulties involved in investing in Russia and reduce risks associated with the countries heavy reliance on energy.
About Coutts investments
With unstinting focus on client objectives and capital preservation, Coutts Investments provide high-touch investment expertise that centres on diversified solutions and a service-led approach to portfolio management. Our investment process is as disciplined as it is creative – ensuring tailored solutions with robust results.Discover more about Coutts investments