Russian Equities, is it a good moment to invest in this market?

We have asked the fund managers of HSBC Global Investment Funds - Russia Equity, Pictet-Russian Equities and Liontrust Russia Fund, to give us an overview of their strategies and to tell us if it is a good moment to invest in Russian Equities.

Investor Relations Specialist

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Is investing in Russian Equities a good idea? As Emerging markets offer a wide range of opportunities for investors, Russian equities staged a strong recovery year to date, up some 30% against flat performance of the broader emerging markets universe. Russia in many respects has been immune, with an effort to improve capital allocation and production efficiency. The combination of a weaker ruble and increased investment in other sectors has helped to diversify Russia’s economic growth drivers and produce wider benefits.

Looking at these investment opportunities we have picked the funds with better 5 year returns as per Morningstar, and have asked their Portfolio Managers (HSBC Global Investment Funds – Russia Equity, Pictet-Russian Equities and Liontrust Russia Fund) to give us an overview of their strategies, and to tell us if it is a good moment to invest in Russian Equities.

HSBC Global Investment Funds – Russia Equity 

Helen King, Lead Portfolio Manager Russia Strategy HSBC AM

The HGIF Russia Equity fund seeks to generate alpha by investing in Russian companies that offer long-term value. Bottom-up research forms the basis of the investment process and aims to balance financial and sustainability factors in the analysis. Whilst the approach is predominately long-term and bottom-up, the investment process allows flexibility to take tactical sector and/or style factor positions to exploit macro and investment trends.

Russian equities staged a strong recovery year to date, up some 30% against flat performance of the broader emerging markets universe. This partially offsets the underperformance over 2020 when the collapse of commodity prices (particularly oil), US sanctions and taxation changes weighed on the market. We see strong catch up performance potential from improving corporate and macro fundamentals with tailwinds from the oil price above US$60/bbl and diminishing sanctions risk, whilst valuations remain compelling.

Solid corporate fundamentals: Corporates remain cash generative, under-leveraged and continue to pay high dividends, with double digit forward earnings growth. Within the commodities space, Russian companies sit at bottom of global cost curves. Of particular note is the elevated cash flow generation in the energy sector from the high oil price coupled with a weak rouble, providing investors which near record dividend yields.

Strong macro: Russia’s macro backdrop remains solid relative to most emerging market peers, with very low levels of sovereign debt, a current account in surplus and high currency reserves. GDP contracted only 3% in 2020 despite the twin shocks of COVID and collapse in the oil price, demonstrating Russia’s macro resilience. Consensus expects a rebound of 4.0% in 2021 with the recovery extending into 2022.

Rapidly emerging new economy sectors: Russia’s well educated, tech savvy population drives world class new economy innovation. The tech sector, including internet, e-commerce, social media and fintech, has risen from zero in early 2020 to over 12% of the index today.

Increasing sustainability focus: At the sovereign level, Russia has been a laggard in embracing sustainability, however since Russia joined the Paris climate agreement in 2019 we are now seeing increasing positive momentum on the policy front. This is accompanied by a proliferation of corporate commitments from the bottom-up, with rising disclosure and well defined targets and timelines.

Compelling valuations: Equity market valuations remain attractive, trading on consensus forward P/E of 7.9x, a 40% discount to broader emerging markets, and a dividend yield of 8%, a significant premium over EM peers.

The HGIF Russia Equity fund is positioned to benefit from the ongoing cyclical recovery, with exposure to energy, selective commodities (steels and aluminium) and financials. To capture the huge runway for growth arising from increasing online penetration and digital transformation the fund is overweight tech, with exposure tilted toward e-commerce and fintech.

Pictet-Russian Equities

Hugo Bain, Portfolio Manager Pictet-Russian Equities

Positive outlook for Russian equities for next 12 to 24 months. The outlook for Russian equities is positive for next 12 to 24 months.  They trade at a high risk premium and are underweight in the portfolios, especially of domestic investors, despite the way Russia has changed in the last ten years and the fact that it has likely have overcome the episodes of international sanctions.  Moreover, Russia in many respects has been immune, with an effort to improve capital allocation and production efficiency.  In any case, it is difficult to sanction it effectively, given Europe depends on its energy supply.  In the future it must be a structural rather than a cyclical investment.

Indeed, paradoxically, international sanctions have helped keep the ruble weak and with it a fiscal surplus since 2016, as state expenditures are produced in depressed local currency and revenues in hard currency.  In addition, Russian commodity exporters have virtually no debt and are in a good position to take advantage of the recovery in global demand this second half of 2021.  Also, the profits of domestically focused companies are likely to remain resilient.  To this is adds  high foreign exchange reserves, very low debt and strong capacity to relax fiscal or monetary policy.  A significant decline in interest rates has already happened.

What is actually different today is the high dividend yield.  Historically, their oil companies were very inefficient.  But state-owned companies were ordered to pay dividends, which has spread to other sectors.  Currently, instead of increasing capacity in projects not always beneficial, they compete in consistent dividend policies.  In our portfolio the dividend yield has reached 8%. The sustainability of these payments is underestimated by the market.  We have even seen state-owned oil and mineral gas companies in dialogue with investors, especially on environmental issues -a significant part of the Russian economy is related to mineral extraction-.  It is also a country with very high education and intellectual capital.

Our investment is value based, focused on the generation of free cash flow of companies.  The greatest weights currently, as result of selection, are energy, materials and finances.  Recently in materials, there has been good performance of steel companies as Evraz, with very well managed leverage levels and MMK.  Aside, we have started Roz Agro, one of the largest vertically integrated agricultural businesses in the country. We have also bought shares of the mining company Raspadskaya, majority owned by Evraz, which products are sold in 80 regions and countries of the Commonwealth of Independent States of former Soviet republics, Central Asia and Europe. It controls 15% of the domestic sugar market and is the second largest producer of pork. Among the main positions in the portfolio is Gazpron, which provides about a third of the gas that Europe receives through gas pipelines -very difficult to replace with liquefied gas-, which in recent years has increased the dividend payment ratio.

Liontrust Russia Fund*

Thomas Smith, Manager of the Liontrust Russia Fund

Russia has made huge strides in recent years towards improving its economic stability. This is largely due to the introduction of the Budget Rule and actions taken by the Central Bank. The Budget Rule has materially reduced the oil price’s impact on the economy and sharply decreased the ruble’s correlation with the oil price. Therefore, revenues generated from oil sales above the budget oil price of $43.30 (for 2021) are transferred first into the National Welfare Fund and are then invested in the National Projects the government has listed over the past couple of years.

The combination of a weaker ruble and increased investment in other sectors has helped to diversify Russia’s economic growth drivers and produce wider benefits. Despite the immense disruption caused by the pandemic in 2020, Russia experienced a milder recession than most economies other than southeast Asia. Key reasons for this include low leverage, conservative monetary and fiscal policies before the pandemic and the limited role of SMEs in the Russian economy. 

The economy contracted by 3% in 2020 and is expected to grow by more than 4% this year. As central banks around the world begin winding down quantitative easing and raising interest rates, Russia’s twin budget and current account surpluses distinguish it among emerging markets. Brent crude prices at $80/bbl are nearly twice the average price of last year which will support both the economy and the budget. The synchronised global economic recovery and specific focus on infrastructure in many parts of the world bodes well for other commodities too. Most major metals markets have tightened considerably over the past year and, in the medium term, the surge in the adoption of electric vehicles and the increasing share of renewables in power generation will continue to support copper, nickel and cobalt markets. Russia’s low-cost producers across a range of metals will see margins expand towards record levels this year. 

The Liontrust Russia Fund aims to identify Emerging Leaders. These are companies well positioned to prosper in a world of rapid change and with the resources and capabilities to generate enhanced returns. Successful Emerging Leaders must create true value for customers and capture some of it for shareholders. We take a best-in-class approach to Russian companies, aiming to find attractively valued companies with sustainable competitive advantages. Given the lack of competition from multinationals, Russian companies across various sectors can earn returns on capital in excess of international peers. Russian benchmark indices have gradually diversified in recent decades but remain concentrated. 

This creates an environment in which active managers can add value. This approach has helped the Liontrust Russia Fund to outperform its MSCI Russia 10-40 Index comparator benchmark throughout the contrasting market conditions of 2020 (+0.4% vs. -4.6%) and 2021 (+19.1% vs. +18.0%)*. The Fund has also outperformed its benchmark over the longer term and is ahead over three and five years. Russian benchmarks remain heavily weighted to energy, with many sectors of the economy underrepresented or not represented at all. The Liontrust Russia Fund continues to provide diversified exposure to sectors that are not present in the benchmark, focusing instead on corporates that can generate value for shareholders and offer attractive returns to long-term investors.

*This fund is only registered in UK and Switzerland

You can read more articles like this in our Equities section.

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Russian Equities, is it a good moment to invest in this market?