It is hard to think of a more contrarian investment than Russia. Not only is President Vladimir Putin the bête noir of Western governments, but hydrocarbons account for 40% of the market. As a result, Russia, according to Priyesh Parmar of Numis Securities, “is the cheapest major global equity market, trading on a historic price/earnings ratio of just 9.5 and offering a yield of around 5%”. The only investment trust specialising in Russia, the £300m JPMorgan Russian Securities (LSE: JRS), is on a 12% discount to net asset value (NAV) and yields 4.6%.
Its manager, Oleg Biryulyov, is upbeat. His portfolio has a 72% overlap with the benchmark index and is priced, he says, on 7.9 times forward earnings and a price/book ratio of 1.2. The forward dividend yield is 7.6%, yet annual earnings growth is expected to average over 7% in the next five years. The state’s budget is based on a $40-per-barrel oil price so, with a price above $60, finances are healthy. He does not expect political change nor any shift in the regime of Western sanctions. “The market is [at] its historic high but is still very cheap.”
It is hard to see why the West singles Russia out as public enemy number one. It is less of a military threat to its neighbours than China, faces no accusations of genocide, and the state is significantly less repressive and intrusive. Putin enjoys provoking the Western establishment but is broadly popular at home. Internal political dissent is not tolerated but there is no guarantee that any alternative government would be an improvement.
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Governance has improved
Biryulyov says that “the correlation of the Russian market to commodities is declining”, but it is clearly still significant. “A poor environmental profile is inevitable,” but he seeks to compensate through a focus on sound corporate governance. For example, Gazprom, the largest holding at 15% of the portfolio, was “uninvestable” a few years ago. Since then, improved capital allocation and a shift from being run as a nationalised to a commercial company has boosted cash generation and led to a likely rise in dividends from 40% to 50% of earnings.
Tom Holland of Gavekal Research points out that “if all the world’s cars were to go electric tomorrow, all oil-fired power stations were decommissioned and all oil-fired boilers... scrapped, the world would still need 66 million barrels of oil per day[mbpd] – two-thirds of 2019’s demand – to propel its trucks, ships and planes, and to feed its industries”. Oil (and gas) will not fade into irrelevance for decades, yet Western firms are running away. Russia looks the best place for investors to benefit from the cash generation of a declining industry.
Balancing growth and value
JRS also has large holdings in Lukoil and Rosneft, and in miners, with Norilsk Nickel worth 11% of the portfolio. Two steel producers account for 6% and total commodity exposure is nearly 60%. With giant bank Sberbank comprising 13%, this implies a value style but Biryulyov has deftly switched between value and growth. In 2020, growth companies Yandex (Russia’s Google), EPAM (a Belarussian IT outsourcer), and Detsky (a children’s retailer), were the best performers.
The market is extremely volatile. The trust’s NAV fell by 46% in 2014 but rose by 45% in 2019. This year has started well but there should be far more to go for. Thereafter, who knows? Russia’s domination by Mafia-style oligarchs does not encourage entrepreneurs – hence its modest rate of economic growth. Capital that could be invested at home leaves the country so the small and midcap segment of the market is undeveloped. That may change in time to make JRS a great long term investment but, for now, investors can focus on the shorter term.
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