Russia – plenty of bad news, but it’s in the price

We started suggesting that Russian stocks were cheap enough to buy last year. It seemed to us at the time that given the choice of buying, say US equities, at cyclically adjusted p/e ratios way above long-term averages and buying Russian equities at prices way below long-term averages, it made sense to go for the latter.

Good long-term investing is all about buying cheap things and then waiting for a catalyst of some kind to drive them higher. Our hope had been that that catalyst would be a significant improvement in corporate governance and a rise in dividend payouts from state dominated companies (see our cover story on that here).

So far, as most investors will know, it hasn’t quite worked out like that. Instead, the crisis in the Ukraine at one point pushed the Russian market down by 12%.

So what now? It might sound simplistic, but for now our view is simply that what was cheap is even cheaper, something that can only be a good thing for long-term investors. This crisis will have an impact on how international investors view Putin (not in a good way) and many are also predicting at least a “mild recession” (Morgan Stanley) as the effects of uncertainty kick in.

But for us, the real thing to bear in mind is this: Russian equities now trade on a price/earnings ratio of only four times and are, says the FT, “among the cheapest if not the cheapest in emerging markets” most of which are on at least eight or nine times earnings.

Russia doesn’t suddenly need to create the stability and economics of Norway for its stock market to rise in the medium term. It just needs to improve a little bit. It is, says Luca Paolini of Pictet, also in the FT, all about “expectations vs reality.”

Stephanie Flanders is with us on this one too: she is well aware of the political risk premium that has to be built in; but nonetheless, at these prices, she says, “you don’t have to take a very optimistic view of Russia’s future to see some potential upside in Russian assets”. There’s an awful lot of bad news in the price.

I’ve suggested buying the JP Morgan Russian Securities investment trust in the past and you can now get it on an even bigger discount to its net asset value now than you could then.

Some readers think this it is a terrible fund – its performance has been poor and it is heavily invested in value rather than in growth (think energy over retail) companies thanks to the fact that the board has been attempting to lower the risk profile of the company. This, to one reader, seems absurd. After all, he says, if you don’t fancy a little risk, why invest in Russia?

I take the point, but one of the reasons we want to be in Russia in the first place is for the value stocks – our hope is that better corporate governance will do huge favours for the prices of the likes of Gazprom. I’m sticking with my holding in the trust for now.

 


  • CKP

    The JPM Russian IT has a pretty high TER. Russian ETFs tend to have quite high fees too. The prospectuses of these funds that invest in Russian listed equities make for some alarming reading. They highlight “investing risk specific to Russia” such as lack of legal clarity and enforcement, poor corporate governance, lack of shareholder protection and fucidiary duty … the list goes on. It leaves you in some doubt as to whether you can believe the numbers in their corporate reports. Still, given that there are few fund managers willing to stick their necks out betting on Putin’s kleptocratic economy, there is undoubtedly some value to be had. Personally I have gone for Raven Russia (RUS.L) and Highland Gold Mining (HGM.L) which are both London listed but operate in Russia. Whilst not bargain basement, I think they both benefit from some “Russia discount” and hopefully have better corporate governance than a typical Moscow listed stock.

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