Second chance to tap into Russian equities

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Second chance to tap into Russian equities

The Russian market continues to erode the strong returns it delivered last year, mainly pressured by weaker oil prices. The MSCI Russia index has underperformed both global markets and emerging markets year-to-date, losing 18.3% in sterling terms.

That's in contrast to last year when Russia was one of the best performing markets. In 2016 MSCI Russia returned 84.7%, which coincided with Brent crude's rise of 81.8%. As the Russian economy is heavily dependent on oil and other natural resource exports, the rebound in commodity prices in 2016 significantly benefited the economy and the equity market.

Given 2016 was preceded by two years of very poor market performance, investors should consider whether it's worth investing in Russia after such a big swing in returns. But it can offer some rewards for those comfortable with such volatility.

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Turnaround story

Since 2014, investors have tried to ignore the Russian market after the US and EU introduced sanctions over Russia's military action in Ukraine and the annexation of Crimea. Sanctions contributed to market outflows and the collapse of the Rouble. Additionally, the fall in oil prices mid-2014 hit the Russian economy hard, sending the country into recession.

But 2016 was a turning point for Russia - a year of recovery and adjustment to lower oil prices. The equity market rallied as the oil price stabilised and the country showed signs of returning to growth.

And investors' outlook towards Russian markets has improved since Trump's election in the US. It was expected he wanted good relations with Russia and could lift sanctions against the country. However it's still unclear how the US administration will deal with Russia and if there is a possibility of reconsidering sanctions given Russia's unwillingness to cooperate with the US and Europe.

A strong investment case for Russia

Despite the market's hectic performance, the Russian economy continues to recover from the recent recession. GDP growth was revised up to 1.5% this year after two years of declines, and company earnings are set to grow 14% by 2018. These should will be the primary drivers of future market returns.

With inflation falling and interest rates expected to be cut further, the consumer should see an increase in disposable income. The country's economic fundamentals are well positioned to improve further before the presidential election and next year's football World Cup.

The outlook for Russia will be even more positive if the oil price continues to recover given it's the country's biggest export. Oil has rebounded from unsustainably low levels of under $30 per barrel and is currently trading at around $48 barrel, a level that is well above Russia's budget breakeven of $40. Higher oil prices would boost economic growth and the performance of Russian equities.

There are other factors supporting the Russian stockmarket.

Any possibility of sanctions being removed would immediately translate into Russian companies having access to cheaper capital markets and allow joint ventures, largely in the oil and gas industry, which have been on hold since 2014.

Current Russian equity valuations do not appear as stretched as those of developed markets, and they remain the cheapest among major emerging market peers on a price/earnings (PE) basis. On 6.1 times forward earnings, Russian equities trade at a 50% discount to the MSCI EM Index (PE of 12.7X) with a dividend yield 6.7%, much greater than the 2.5% dividend yield of the MSCI EM index of 2.4%, according to JP Morgan.

Not for the faint-hearted

While Russia is currently one of the cheapest and fundamentally attractive emerging markets, investors should remember that it remains a high risk, high return asset class as it is volatile and heavily biased to energy sectors.

The market is still down 18.4% year-to-date and only returned 1.4% over the last five years. However, it is up more than 200% over the past 15 years. Patient investors have been rewarded over the longer term.

Investors looking to gain exposure to Russia might consider Money Observer Rated Funds BlackRock Emerging Europe (BEEP) or Aberdeen Eastern European Equity, both of which have a large allocation to the country, at 60% and 43% respectively.

Unlike other funds focusing specifically on Russia, these funds invest in assets to gain better diversification across different markets in Eastern Europe, and, therefore, performance is hurt less by economic troubles in any single country. The funds offer exposure to the biggest players in the Russian market: energy giants Gazprom, Lukoil, Rosneft and Novatek, retailers Magnit and Lenta and banking group Sberbank.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise.The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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Aberdeen Estrn Eurpn Equty
1 Year (%)13.56
3 Year (%)31.88
5 Year (%)27.50
Rating5 star(s)

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