Sanctions bite Russia but some investors are fishing

August 14, 2014

By Andrew Winterbottom

Russian stocks are up today, for the fifth day in a row and at the highest level in two weeks. What’s going on? As we wrote  here earlier in the week, foreign investors have been fleeing this market.  However it could be that some of them are starting to put aside concerns about the potential for further sanctions on Moscow and are scouring Russia’s stock markets for contrarian buying opportunities.

Russian stocks, chronically undervalued, are trading now at a discount of more than 60 percent to broader emerging markets, and to China which by all accounts is the standout beneficiary of the Russian woes. Just how cheap Russian shares are can be gauged from the fact they trade at a discount event to turbulent Pakistan. Here is a link that compares Russian equity valuations with other emerging and developed markets:

While tensions between Russia and the West look to be only increasing, the risks of investing in Russia at present are obvious. But with greater risk comes greater potential reward, says Jonathan Bell, head of emerging market equities at Nomura Asset Management:

Even for the level of risk the market is extremely cheap… We’ve had price movements due to technical behaviour and short-term considerations that don’t necessarily reflect the underlying fundamentals.

Bell likes the IT and domestic brand name sectors – those not in danger of feeling the hit of further sanctions but that have fallen alongside companies that have been hit with Western sanctions, such as Sberbank and Gazprom.

Nomura’s emerging market equities fund has an allocation of 10 percent to Russia, double the country’s weight in MSCI’s emerging equity index.  Another fund with a Russia overweight is JPMorgan Asset Management which says it has hung on to its position there.

In August though, Bank of America Merrill Lynch’s latest monthly survey of global fund managers showed that allocations to Russia had swung back to neutral (from an overweight in early July). Broader emerging markets however gained in favour. That is likely to make the shares even cheaper relative to emerging peers and could well serve as a buy signal. Robert Parker, head of the strategic advisory group at Credit Suisse, says there are pitfalls to being extremely underweight Russia. Investors realised this as Moscow’s dollar-denominated index bounced more than 20 percent between the end of April and end-July as tensions over Ukraine appeared to recede. Parker said:

Russia is the cheapest equity market on the planet… it is completely under-owned. If you get any evidence of a calming of the situation in the Ukraine…there is going to be a very significant rally. It is very sensitive to even a small amount of good news.

Parker says the right strategy on Russia is to very slowly venture back into the market. But he hastens to add:

That, of course, is a very high-risk position.

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