By John Mauldin
In last week's special Thursday edition of Outside the Box, World Money Analyst Managing Editor Kevin Brekke interviewed WMA contributor Ankur Shah on emerging markets, but they didn't touch on one very important emerging market: Russia. So this week I have brought Kevin back to sound out the views of Alexei Medved, WMA's Russia and CIS contributing editor.
And right off the top, Alexei tells us two significant and surprising things about the Russian market:
One should look at investing in Russia from at least two time perspectives: long term, meaning 10 plus years, and a medium time horizon of 1-3 years.
Long term, Russia is still the best performing major stock market in the world for the period 2000–2013, when measured in U.S. dollars against the major market indexes. It is well ahead of not only all developed markets, but also the markets in China, Brazil, and several other emerging markets that were and are much more a centre of attention by Western media and investors. This long-term outperformance was achieved despite the fact that 2013 was not a good year for Russian equities, with the RTS Index down 5% in 2013.
Medium term, the Russian market remains the most undervalued. The average P/E is about 4.5, significantly below other emerging markets and way below the multiple on shares in the developed markets.
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World Money Analyst: I am very pleased to speak with Alexei Medved. Alexei is the Russia and CIS contributing editor at World Money Analyst, and I caught him at his office in London. Thank you for joining us today.
Alexei Medved: My pleasure, thank you for inviting me.
WMA: As you and I have discussed before, Russia remains a little understood market for many Western investors. Can you talk a little about the investment backdrop for Russia?
Alexei: One should look at investing in Russia from at least two time perspectives: long term, meaning 10 plus years, and a medium time horizon of 1-3 years.
Long term, Russia is still the best-performing major stock market in the world for the period 2000–2013, when measured in U.S. dollars against the major market indexes. It is well ahead of not only all developed markets, but also the markets in China, Brazil, and several other emerging markets that were and are much more a centre of attention by Western media and investors. This long term outperformance was achieved despite the fact that 2013 was not a good year for Russian equities, with the RTS Index down 5% in 2013.
Medium term, the Russian market remains the most undervalued. The average P/E is about 4.5, significantly below other emerging markets and way below the multiple on shares in the developed markets.
WMA: How has the Russian market held up so far this year, with emerging markets under pressure?
Alexei: Since the start of this year, the Russian market has underperformed other markets, down 8% in US dollar terms. This, to a large extent, could be explained by a noticeable decline of the ruble against the US dollar (-5.5%).
As you know, so far this year many emerging markets and emerging market currencies have been punished significantly, as Western institutional investors became worried about macroeconomic pressures in some of the emerging economies, like Turkey and Argentina. These countries have problems that are real and serious: too much external debt, a trade deficit, a budget deficit, declining foreign currency reserves, etc. So, it is understandable why foreign investors withdrew a lot of money from these markets recently.
What is hard to understand is why they also withdrew significant amounts of money from the Russian market. In my view, it is primarily because most investors continue to view emerging markets as a single class of investments. So, when they withdraw money they do it across the board, in all emerging markets. This is generally not the best approach. In contrast, investors do not approach developed markets as a single class, but differentiate between the countries.
WMA: Using your examples of Turkey and Argentina, how does Russia compare in terms of the macro picture?
Alexei: The macroeconomic position of Russia is vastly different from that of Argentina or Turkey. For starters, Russia has a positive trade balance and a balanced budget, unlike these and many other emerging and developed countries. Russia also has a very low debt load, with the ratio of external government debt-to-GDP around 10%, much lower then the roughly 95% in the US and even higher in some European countries. Further, the unemployment rate in Russia is around 5.5%, meaning the country is essentially running at full employment.
The unrefined "sell everything that's emerging" approach apparently in play by Western institutional investors has led to the Russian market being unjustifiably punished. The good news is that the punishment has created even better investment opportunities for investors who can avoid “heard mentality.” There are solid, profitable Russian companies that are trading today at very low valuations.
WMA: One of your areas of expertise is the use of short-dated, US-dollar-denominated Eurobonds to capture higher yield and manage risk. Can you explain this strategy a little for our readers?
Alexei: Of course. I think Russia and the CIS also present a good opportunity for fixed income investors. Given my serious worries about a possibility of rising inflation and yields in developed markets, we recommend investing only in relatively short-term bonds (under 4 years). Our [Alexei's independent business] weighted portfolio maturity is now under 2 years. One can either invest in Russian sovereign debt or the safest corporate bonds and receive somewhat higher yields than in comparable developed economy bonds. Investing in bonds that do not have an investment grade rating from one of the major rating agencies is another option.
Based on our local knowledge, we particularly like some high-yield bonds where we have a decent understanding of the company and believe that the bonds will be repaid, despite fairly low ratings from the credit agencies. This way, we invest in bonds that offer 10%-12% yields.
WMA: Switching to issues of politics and governance, many observers are concerned about issues of corruption in Russia, making it difficult for an investor to navigate the market. Has the current government embraced reforms on this?
Alexei: Obviously, one has to be very careful when considering investing in Russian equities or bonds. For investors that lack knowledge about the country, I do not recommend they attempt a do-it-yourself approach to selecting Russian shares. A better approach is to either invest through an index fund or to seek share selection advice from people who specialize in the Russian market on a day-to-day basis. This is in spite of the fact that over the last decade, Russia to some extent became much more investable.
Back to your question, corporate governance has generally improved, although perhaps not as much as some investors would like. The government is taking steps in this direction, yet a lot remains to be done. As Russia recently became a full member of the World Trade Organization (WTO), and its market is opening up to external competition, Russian companies will have to become more efficient to compete, and thus more profitable for investors wake up to the reality that Russia is a serious global player that's here to stay. This opens up even more opportunities for investors.
WMA: The January issue of World Money Analyst highlighted the importance of taking a longer view on markets and investments, something that you and I agree on. You've made some great recommendations at WMA, and recently advised to take profits on two stocks that were held for a year or longer. Can you briefly go over these trades?
Alexei: Yes, as I said earlier, one has to look at these opportunities on a medium- to long-term investment timeline and not attempt to trade these markets, as one’s investments can get unjustifiably punished, as is happening now. We have been active in the Russian market for over 20 years and certainly maintain such an approach when we look at investments to recommend to our clients. Once the investment is made, we monitor it on a constant basis, as one cannot just “salt it away.” Once the shares reach our target price, we sell them and move on to the next opportunity.
In the January 2014 issue of WMA, I recommended taking profits on two positions. The first was the shares of Russian airline Aeroflot, recommended in the January 2013 issue. By January 2014, its shares had moved up nicely on the back of stellar company operating results. We advised to sell the shares and realized an 84% gain, including the dividend, in 12 months.
The second was the shares of AFK Sistema, a large cap (US$18 billion) company that restructured itself from a conglomerate into essentially a private equity fund. I recommended its GDRs in the July 2012 issue. By January 2014 the shares had moved up significantly, and I advised to sell in that month's issue of WMA. We pocketed a total return of 63% in 18 months.
These returns are particularly remarkable against a negative 5.6% return of the Russian RTS Index in 2013.
While we still like both of these shares, their significant appreciation had reached our price targets, so it was time to cash in some chips. And seeing that these shares are now trading lower, we got out at the right time and preserved the investors’ profits.
WMA: We can't talk about Russia and not mention the ruble. Investing in certain currencies – like the Canadian dollar and Norwegian krone – has been in vogue for several years on the premise that these are "resource currencies" supported by the natural resource wealth of the issuing country. With Russia's vast mineral and commodity wealth, should we consider the ruble a commodity currency?
Alexei: Given that Russia is a large producer of oil, gas, and some other commodities, to some extent the ruble should be seen as a commodity currency, perhaps even a petrocurrency. So, if one believes that the oil price is likely to decline significantly and stay low for years to come, one should not buy Russia. However, if one believes that the oil price trend is flat to up in the medium and long term, Russia will do well macroeconomically.
WMA: Next to the emerging markets, another big issue is developments in Ukraine. You have covered Ukraine for World Money Analyst subscribers. The country seems to be caught in a conflict about alliances: to enter into a closer economic alignment with Moscow, or shift to stronger ties with the EU. What are your thoughts on this and the investment implications for Ukraine?
Alexei: It is very sad that the situation in Ukraine has deteriorated as far as it has. Some lives have been lost. Ukraine is torn between the current government that is leaning towards the Customs Union with Russia, and a large proportion of the population, perhaps a majority, which would support a closer cooperation with the EU.
Ukrainians are also fed up with perceived government corruption and diminishing civil liberties in the country. In December, Russia provided a US$15 billion rescue package to Ukraine and immediately disbursed US$3 billion. It remains to be seen which way the current situation will be resolved.
However, there are some corporate bonds in Ukraine that should be relatively immune to this political turmoil. One of the companies we like in Ukraine is MHP, the largest chicken meat producer in Europe. The company is fairly insulated against possible further depreciation of the local currency, as it sells 37% of its products abroad. After the recent sell off in Ukrainian bonds, one can buy the Eurobond of MHP priced in US$ with a maturity in April 2015 and a yield-to-maturity of 10.6%. Such a high yield on short-dated paper is very hard to find elsewhere.
WMA: Any final thoughts for investors about the opportunities in Russia?
Alexei: The latest sell off of Russian shares represents an opportunity to buy quality companies at discount prices. Today, we can see compelling value in world class companies with assets not just in Russia but globally (including the USA), good corporate governance, and nice dividends. In short, I agree with Warren Buffet: “Buy when others are fearful.”
WMA: Alexei, thank you for sharing your valuable insights into the dynamic Russian market.
Alexei: You are welcome. My pleasure.
Learn more about World Money Analyst here.
The article Outside the Box: World Money Analyst Update on Russia was originally published at mauldineconomics.com.
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