There is a very compelling case to be made for adding Russia to a long term investment portfolio. Bad news has dominated the Russian headlines for more than a year, and Russian stocks are trading at historically low valuations. But as the adage goes, the best time to buy straw hats is in the coldest depths of winter. And right now Russian blue chips offer an exceptional opportunity for appreciation with relatively limited downside risk.
Russia is an exceptionally volatile market. When it falls, it falls hard. When it goes up, it goes up just as dramatically. When times are good, overly enthusiastic investors tend to ignore problems like Russia’s dependency on commodity exports and its endemic corruption. And when times are bad, they’re overly pessimistic and the problems are all they tend to focus on. And right now, things are bad, but not as bad as they might seem. Now is the time to take advantage of rock bottom share prices, and wait for the seasons to change in your favor.
Two factors more than any others have hammered the Russian market. Oil prices have collapsed, falling from over $100 a barrel just over a year ago to the mid-40s today. And in the aftermath of Russia’s annexation of Crimea, US led economic sanctions have cut off Western financing and cutting edge technologies to major Russian firms.
Oil prices are notoriously sensitive to global changes and supply and demand. But given the dynamics of production costs, an eventual rebound to $65 or higher is far more likely than a drop to $25. And a lifting of sanctions is likely in the next year or so, as a tentative political settlement over Ukraine takes hold. Either could be a catalyst for a huge upswing in the Russian market.
And in the meantime, most Russian companies are actually turning a profit. The Russian market trades at a depressed price-earnings ratio of merely seven. If earnings momentum turns around, and Russian assets are repriced at more normal valuations, shares could easily double or more. Unfortunately, there are limited choices for investing in individual Russian stocks. However, it is relatively easy to get Russian exposure by buying a Russian ETF.
The most liquid Russian investment available is Market Vectors Russia (NYSE: RSX), an exchange traded fund that holds a portfolio of major Russian blue-chips. It closed yesterday at 15.36. In the last year its low was 12.50 and it has traded as high as 24.03. In the frothy markets of early 2008 it fetched as much as 59.58 a share, and in the subsequent market meltdown in early 2009 it traded as low as 10.34. It is heavily weighted towards oil and gas, with six of its top ten holdings including major O&G producers such as Gazprom, Lukoil, Novatek, Tatneft, Surgutneftegaz, and Rosneft (energy comprises 45% of the total portfolio). Its other top ten holdings include retailer Magnit, metals producer Norilsk Nickel, and Russia’s leading bank Sberbank. It has $1.7 billion in assets, has an annual expense ration of .61%, and pays a 4% dividend.
One of the few other alternatives is the Templeton Russia and East European Fund (NYSE:TRF), a closed end fund that is mostly invested in Russian stocks. TRF went public in 1995 at 15 a share when Russia was a hot investment, roared to 64.75 within two years, then fell to below $5 in the 1998 financial crisis before climbing all the way as high as 88.83 in 2006. It closed yesterday at 9.69. Templeton has announced plans to liquidate the fund before the end of the year because of a lack of investor interest.
This is a raging contrarian buy signal, in my humble opinion. Basically, when the Russian market was hot, investors twice bid up TRF shares to sky high levels. Now that the market is in the doldrums, Templeton is throwing in the towel. In essence, people hate the idea of owning Russian assets so much that a long term cheerleader of that market is calling it quits.
Russian stocks are extremely cheap right now. They may get cheaper if oil drops further or Russia escalates support for war in Ukraine. But I believe it is much more likely that oil prices recover sometime over the next several years and that sanctions are eventually lifted. But by the time these happen, the good news will already be reflected in much higher share prices. So the time to buy is now, when everybody else is discouraged. And when summer comes around again, you can sell the straw hats you bought for a hefty discount for a very rewarding premium.