Some ways to make money in Russia

Opalesque Exclusive: Some ways to make money in Russia Benedicte Gravrand, (gravrand@opalesque.com)

Opalesque Geneva: There is convergence between Russian and the world economy. Russia's Micex index lost more than a quarter of its value and the RTS index of 50 Russian shares fell around 40% in the last five months, said the BBC. The Russian government says investors are pulling back because of falling oil prices and global economic turmoil; others are blaming internal political turmoil – increased by long-standing finance minister Alexei Kurdrin’s exit, which might lead to a government reshuffle. But some insiders say the latter factors are minor, at least for the domestic market. Russia is simply struggling in a worldwide economy that is slowing down, just like (almost) everywhere else. Here are some view points on the opportunities that can be seen in Russia, gleaned at yesterday’s JetFin conference in Geneva. UralSib: growth on consumer demand Slava Smolyaninov, Strategist at UralSib Capital, a Russian research firm, thinks that manufacturing is the driving force for Russia’s recovery; the ruble depreciated on the back of August volatility and it follows oil price – and oil does not help anymore he said, as its purchasing power has no upward trend. So growth is really driven by strong consumer demand, with improving confidence and credit expansion. Leaving out natural resources, the areas of growth with the most potential are Banking, IT, Telecom, Media, Utilities, Transportation, Food retail, Pharma. The key long term risks are found in the high level of bureaucracy, the low efficiency of state expenditure, the lack of motivation to modernise, and poor demography (contraction of active population). There is also a clear negative trend in diversification, and lack of competitiveness, he added, referring to the World Economic Forum’s Russia Competitiveness Report 2011. The WEF’s report says that almost two decades after transitioning from a planned to a market economy and following a decade of buoyant growth, Russia was hit hard by the 2008 crisis. Oil prices collapsed and its financial sector from narrow liquidity. The government moved rapidly to protect the economy through stimulus measures and, since then, recovery has been slowly underway. The WEF reportedly places Russia in a "transition" stage between stage 2 "efficiency driven" and stage 3 "innovation driven" along with 17 other countries. The corruption perception has increased too in the last few years, Smolyaninov continued, but it cannot get any worse – and so it can only improve. Valartis: Russia is cheap once again There is a strange dichotomy between emerging markets (EMs) and developed markets (DMs) in terms of asset allocation. According to Timothy McCarthy, head of asset management at Valartis SA, a Geneva-headquartered independent asset manager focused on EMs that manages CHF1bn, asset allocation in EMs is too small. Indeed, EMs have 75% of the world land mass, 87% of the world population, 85% of the global oil reserves, 89% of the global gas reserves, 74% of the global FX reserves, 10% of the global external debt, and 52% of global PPP Adjusted GDP (he puts all countries not part of the DMs in EMs). Furthermore, policy rates have peaked in EMs where they have troughed in DMs, and in EMs, people are motivated to improve their lives, whereas DMs people are "bloated on excess consumption." He noticed this in his 18 years living in EM countries. Now we are seeing outflows from EMs ($20bn YTD) following strong inflows in ’09 and '10. According to EPFR Global Data, Russia-focused funds had their second-biggest weekly outflow in two years, amounting to $443m during week-ending Sept.28. Russia, vs. EMs, stands out as being once again one of the cheapest countries, McCarthy continued, as it generally trades at a discount. Oil
prices and money supply are economic factors for growth in Russia; and inflation is declining, so monetary policy may ease soon. Valartis anchors its investment methodology in fundamentals and favours liquidity. The firm’s election-cycle strategy will focus on less exposure to politically sensitive sectors (electricity, telecom, gas), more exposure to political beneficiaries (food retailers, banks, transport and infrastructure). Its outlook for Russian on a 12-month basis us upbeat (43% on equity); and oil price will probably be around $90 p.b. (Brent Crude (ICE) is now up 0.40 at $104.35 and Light Crude (Nymex) is up 0.31 at $82.45, said the FT this morning). EME: favourable stock picking environment Russian returns are down, risk is up and correlation is close to 1, claimed Carl Meurling, co-founder of EME Partners, a $70m long/short equity fund manager based in Stockholm. And volatility is much higher and will likely remain so. In the last four years, nobody made money in Russia, he said. However, the market there is sophisticated enough to allow long/short equity investing. The high dispersion of equity returns can be a strong advantage, and correct stock-picking is key to strong performance. Trading costs are decreasing, so there is no need to "buy and hold" anymore. Meurling suggest keeping a constant low directional exposure to the market, as exposure to Russia also means exposure to other markets. He added that one should not believe it is possible to time the Russian market… hardly anybody can do this. Building a comprehensive approach to risk management is also necessary when investing in Russian equities, as there are liquidity and currency risks. "All these measures will lead to consistent risk adjusted returns," he concluded. EME’s Emeralt fund was up 15% YTD as of 31-Dec.2010. Dashevsky: event-driven strategy the only to invest Russian, in the long term, is very risky and possibly not very profitable, according to Steven Dashevsky, founder of Dashevsky & Partners, a new independent investment management advisory firm based in Moscow. So one must focus on specific trades and events to make money. Durring the "Putin area" (from 2000 on), he said, the Russian market went up almost five times between 2000 and 2005, outperforming other EM countries, due to deleveraging, improved balance sheet and massive reforms. From 2006 to last week, the market stopped its growth, annual volatility was 6% and the market underperformed oil prices. The RTS index went from 1,556 in Oct.06 to 1,367 on 28-Sept.11 (with a slump to below 500 in early 2009), whereas the MSCI World Index went from 1,372 to 1,122 in the same period. According to Dashevsky, the problem is quite simply corporate governance. In Russia, the shareholders (portfolio investors) are the last to receive any cash –as management, controlling shareholders, government and employees come first. 94% of the equity market is represented by the state and by the few oligarchs. So there is no incentive for investors to invest in companies. Which is a shame since foreign inflows and outflows directly affect growth. However, in most corporate actions (mergers, buybacks, share consolidations, dividend distributions, spin offs), the shareholder rights are better protected. In special situations with foreign investments, legal misbehaviour is less likely for example. And laws and regulations or other motivations that force business owners to behave legally are good for investors. For this reason, special sits and event-driven funds can outperform in down markets, says Dashevsky. He quoted the example of PepsiCo buying a Russian company called Wimm-Bill-Dann. PepsiCo announced the acquisition, all minorities bought out at the same terms as majority owners, and an 18% profit on the rising share price was made.