Bottom-fishing in Russia

Asset Class in Focus

This week’s volatility in Russia’s stock market presents buying opportunities, however the market’s structural flaws mean that investors need cast-iron stomachs to weather more such events in the future.

Bottom-fishing in Russia
Karine Hirn, East Capital Asia

On 6 April, the US government imposed sanctions on 24 Russian nationals, aiming to punish Russian president Vladimir Putin’s inner circle for what the US believes was interference in 2016 US elections, recent poisoning of an ex-spy in the UK and aggressive moves in the Middle East.

One of the most prominent targets of the sanctions is Oleg Deripaska, owner of Rusal, the second largest aluminium company in the world, which is listed in Hong Kong. Rusal stock fell by 54% after the sanctions were announced.

In this round of sanctions, US entities are prohibited from doing business with the sanctioned companies and are required to sell all their holdings by 7 May 2018.

“The sanctions are very toxic,” Karine Hirn, partner at East Capital and Hong Kong-based CEO of East Capital Asia, told FSA. “Nobody who has business in the US should have anything to do with these names.”

The Russian market plunge creates more opportunities than actual threats. You can take an opportunity to do a little bottom fishing

This will present difficulties for companies with a high level of debt, such as Rusal, when it comes to refinancing. Even Russian banks may not be able to help, as many of them have business in the US and will not want to jeopardise it. While Hirn said that Rusal will probably be helped by the Russian government, the situation clearly puts the company in a very precarious position.

(The firm said East Capital did not have investments in Rusal or the other listed Russian companies that were hit by sanctions).

The sanctions reverberated throughout the Russian market, depressing prices of pretty much all stocks, even those not affected directly.

“What we saw on Monday (9 April) was a very strong reaction,” Hirn said. “A number of stocks went down quite a lot because they are seen as a proxy for the Russian market, such as Sberbank, which is a bit of a darling for [foreign] investors.”

Sberbank is also top holding in East Capital’s Russia Fund.

“We’ve been around for 20 years and this is not a terrible time compared to other moments in history,” Hirn said. “We actually think it is so far quite manageable. It creates more opportunities than actual threats. You can take an opportunity to do a little bottom fishing.”

“Fundamentally, the decline [in stock prices] has no impact on companies themselves,” she said, adding that nothing is changing the base of the Russian economy.

“Russia remains one of the cheapest emerging markets globally and it has quite a few very attractive attributes,” Hirn said. In particular, it has a “very high dividend yield, around 6%, and very healthy earnings growth”, especially if you seek out consumer-oriented companies.

She added that the week’s volatility has not caused investors in East Capital’s Russia fund to push the panic button.

“We have not seen a huge amount of redemptions, it’s actually been pretty quiet.”

Few domestic investors

What the sanctions have done is foster negative investor sentiment toward Russia, which would be a top concern if capital flight resulted. The Russian market is dominated by foreign investors, Hirn explained. If there’s a sudden outflow of foreign capital because of sanctions or other reasons, “there’s no-one else domestically picking up the stocks”.

“We hope that the Russian government will spend more time thinking about creating a domestic market, which is more institutionalised,” Hirn said. “Pension fund reform will be needed. They have been talking about it for so long, it’s time to see some action.”

Another worry is the effect the sanctions and investment outflows have on Russia’s currency, the rouble. It dropped by 11% against the dollar on 9 April, then recovered 5% by the end of the week.

“The way the currency reacted was a bit worrying,” Hirn said. “If the rouble remains weak, we’ll have inflation picking up. Will that change the direction of the [central bank’s] monetary policy?”

“Inflation, at 2.2%, is exceptionally low for Russia. Thanks to this low rate, the central bank has been able to be aggressive in interest rate cuts,” Hirn said. “With rates around 7.5%, theres’s more room to cut which would be positive for real estate or construction companies.”

East Capital’s Russia Fund is registered for sale to investors in Singapore and available to professional investors in Hong Kong.

The top two holdings, Sberbank (9.9%) and Lukoil (9.5%) account for about 20% of the fund, according to the 28 February factsheet.

The energy sector makes up 26% of the portfolio, but it is also the fund’s largest underweight versus the benchmark MSCI Russia.

East Capital Russia Fund vs benchmark and category average

Note: Returns in US dollars, Category: emerging Europe funds registered for distribution in Singapore

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