Calling the Moment to Return to Russian Equities

Emerging Markets, EBRD Editions, May 14 2014

Those who are waiting for an opportunistic moment to buy into Russian equities may be a little late: it’s already happened.

“On the equity side, people do see value in Russia now,” said Charles Robertson, chief economist at Renaissance Capital. “They already stepped in after Crimea: the market has risen since then, and it has been quite a good call.”

Robertson said he was seeing less interest in Russian debt, but said that despite the considerable outflows from Russia – said to be $60 billion in the first quarter according to Russia’s finance ministry, and possibly much more – contrarian investors had been looking closely at its stock market. The biggest impediment, he said, could be investors being prevented from following their convictions. “The difficulty is: what are the compliance departments going to say? While investors may think it’s a good time to buy, often the risk department says no.”

Other analysts begrudgingly admitted that Russia would bring occasional opportunity. “We have repeated the governance-related reasons not to invest in Russia at tedious length in the past,” said John-Paul Smith, strategist at Deutsche Bank, who has suggested that Russia should not be considered a mainstream emerging market. “But whilst the market is fundamentally uninvestable for non-dedicated investors, equities are locked in a very volatile trading range which will, from time to time, give rise to contrarian buying opportunities.” Smith said there were precedents for equity markets selling off dramatically in response to political events, then rallying sharply once much of the foreign money has gone.

One other issue is that such is Russia’s weight in MSCI indices, many fund managers don’t have the option of leaving it completely anyway. “You can’t just exclude Russia,” says Vadim Khramov, economist at Bank of America Merrill Lynch. “Surveys tell us that people were on average overweight Russia relative to the index before the crisis, and a little bit underweight now, but it is a substantial part of the emerging markets index. It’s also relatively high yield, so investors have to buy Russia to keep up with the index.”

When investors do return, where should they go? One argument is the so-called ‘New Russia’ stocks, such as those in the IT and high technology sectors, which should benefit from high literacy and education in Russia, as well as cellphone and internet penetration, a large proportion of R&D technicians in the workforce, and sufficiently high GDP per capita to afford devices such as smartphones.

“Those stocks have fallen the most,” said Robertson. “They were the ones the foreigners were owning so they tended to get trimmed in February and March.” Robertson also noted the Russian trend towards a more autarktic model – that is, a self-sufficient political or economic system. “If you get that, as in China, you could see that benefiting the locally owned groups,” he said, citing Russian internet company Yandex as an example. “If Facebook or Google is penalised because it’s not Russian enough and they believe it’s full of CIA agents, Yandex could benefit as the only medium for internet searches.”

The bigger state-backed oil and gas utilities, directly affected by sanctions, may take longer to win back investor support. “The question is how much reform happens in those companies, and whether that’s a priority for the government now,” Robertson said.