Current valuation levels of Russian debt and equity do not yet reflect the economic turnaround of Russia
Rising oil prices, a drop in inflation, and strong GDP growth have helped Russia to emerge from a recent recession with better economic prospects than it has seen since before the global financial crisis. With stocks in the country remaining remarkably cheap despite offering some of the most attractive dividend yields in the developing world, Russia’s market is fast becoming an increasingly pivotal part of any savvy emerging market investors’ portfolio. This year has seen the end of a two-year recession for Russia. This began in 2014 when its currency - the ruble - collapsed as a result of sanctions imposed by the US government alongside a global drop in oil prices to less than $30 a barrel. In March 2015, during the worst throes of this recession, Russia’s central bank was forced to raise interest rates to as high as 17pc in order to protect its currency as inflation hit an eye-watering 16.9pc. Since then, Russia’s inflation has declined dramatically, hitting a historic low of 2.7pc in October this year, well below the government’s target of 4pc. In line with this, Russia’s government has allowed interest rates to fall back to 8.25pc, with many expecting further cuts in the near future. With the help of stabilising crude oil prices, which have returned to more than $50-a-barrel since the recession, Russia’s GDP growth has also bounced firmly back into positive territory in 2017. Indeed, in the second quarter it hit 2.5pc, its fastest rate in nearly five years. Russia’s government remains confident that GDP growth will come in at least 2pc for the whole of 2017 before extending to 2.5pc next year. Its stock market - the RTS - was among the top emerging market performers last year, delivering impressive dollar returns of 50pc. It has continued to rise in 2017. But with markets failing to account for these economic improvements in their valuation of the country’s markets, shares remain highly discounted; the economist, Robert Shiller recently claimed that Russia has one of the lowest price-to-earnings ratios in the world, at around half that of its emerging market peers. In the final quarter of last year, Russia received a welcome boost as a result of the election of Donald Trump as US president. With Trump in tow, many felt that sanctions introduced in 2014 as a result of Russia-Ukraine crisis were much more likely to be lifted, and shares soared. Although relations between Russia and the US remain frosty for now, many have pointed to the country’s recent decision to make the ruble a floating rate currency as an effort to properly open up to foreign investment. The nation is throwing more weight behind structural reform. A particularly interesting development came in April, when its government demanded that state-owned companies pay out half of their profit in dividends this year. Although the move was chiefly driven by a need to cover the federal budget, it also came as a boon to private investors in affected companies. Perhaps coincidentally, the move falls in line with a general trend of increasing Russian dividend payouts in recent years. Since 2014, dividends on a $100 dollar investment have risen from around $2.5 to $3-4, making the country one of the most lucrative hunting grounds in the world for income investors.
With more than half of the RTS index comprised of oil companies and Russia itself currently positioned as a leading exporter of natural gas, the country’s short-term outlook is likely to remain relatively stable if analysts’ expectations of a broadly flat oil market are correct. But now that the days of $100 oil have passed, an alternative way of getting exposure to the country’s large dividend yields can be found in its increasingly wealthy population and jump in consumer spending. With inflation currently in a trough and low interest rates turning consumers away from saving, household spending increased by 4.3pc in the second quarter of 2017, while retail sales have snapped out of a record 27-month period of contraction and rose to near-three-year highs. When a 150-million strong population decides to spend more on luxury goods, services and holidays, the beneficiaries will be sectors such as housebuilding, retail, and air travel rather than commodities. A particularly effective way of gaining exposure to this trend while remaining part of the country’s commodity narrative is through an exchange traded fund (ETF) which directly invests across the whole Russian stock market. By exposing themselves to both commodity and non-commodity stocks, investors can potentially cash in on more than one investment trend while limiting downside risk in the event of another drop in oil prices. With much of Russia’s growth story yet to fully pan out, a diversified exposure to the country’s market trends as they continue to develop is the perfect way to cheaply broaden income streams within a wider emerging market portfolio.
The value of your investment and the income from it will vary and your initial investment amount cannot be guaranteed. Compared to more established economies, the value of investments in Emerging Markets may be subject to greater volatility due to differences in generally accepted accounting principles or from economic or political instability. Investment risk is concentrated in specific sectors, countries, currencies or companies. This means the Fund is more sensitive to any localised economic, market, political or regulatory events. Overseas investments will be affected by movements in currency exchange rates.
This publication has been prepared by ITI Funds – a division of ITI Asset Management Holding Ltd. It is provided for information purposes only, and ITI Funds makes no express or implied warranties, and expressly disclaims all warranties of merchantability or fitness for a particular purpose or use with respect to any data included in this publication. ITI Funds will not treat unauthorized recipients of this report as its clients. Prices shown are indicative and ITI Funds is not offering to buy or sell or soliciting offers to buy or sell any financial instrument. Without limiting any of the foregoing and to the extent permitted by law, in no event shall ITI Funds, nor any affiliate, nor any of their respective officers, directors, partners, or employees have any liability for (a) any special, punitive, indirect, or consequential damages; or (b) any lost profits, lost revenue, loss of anticipated savings or loss of opportunity or other financial loss, even if notified of the possibility of such damages, arising from any use of this publication or its contents. Other than disclosures relating to ITI Funds, the information contained in this publication has been obtained from sources that ITI Funds Research believes to be reliable, but ITI Funds does not represent or warrant that it is accurate or complete. ITI Funds is not responsible for, and makes to warranties whatsoever as to, the content of any third-party web site accessed via a hyperlink in this publication and such information is not incorporated by reference. The views in this publication are those of the author(s) and are subject to change, and ITI Funds has no obligation to update its opinions or the information in this publication. The analyst recommendations in this publication reflect solely and exclusively those of the author(s), and such opinions were prepared independently of any other interests, including those of ITI Funds and/or its affiliates. This publication does not constitute personal investment advice or take into account the individual financial circumstances or objectives of the clients who receive it. The securities discussed herein may not be suitable for all investors. ITI Funds recommends that investors independently evaluate each issuer, security or instrument discussed herein and consult any independent advisors they believe necessary. The value of and income from any investment may fluctuate from day to day as a result of changes in relevant economic markets (including changes in market liquidity). The information herein is not intended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of future results.