Time To Sell Russian ETFs and Stocks

 |  Includes: RSX, TRF
by: Richard Shaw

We recommend selling any remaining positions of Russian funds and companies, even though the Russian market is already down considerably this year.

The Russian market could recover handsomely and make huge profits for those who buy in now, but it may also have significantly farther down to go.

The risk we refer to is not a fundamental risk of Russian national and corporate growth and profitability. In fact, we think the major Russian companies will continue to grow rapidly.

Our concern is that Russia has made a U-turn in its posture toward private capital and toward the West in general, and the United States in particular. That U-turn could be the harbinger of adverse political or even military events that could smash the value of Russian securities held by US and other non-Russian investors.

Whether by investors dumping and running from Russia in the event of conflict, or by Russia expropriating and nationalizing foreign assets, we see material event risk in Russia.

There are other exciting markets that do not pose the geopolitical risk that Russia poses. Investors would be better served by seeking opportunity in those places.

In June of 2007, we wrote about Russian expropriation of western oil company assets on trumped up charges. We wrote about naval tensions between Canada and Russia in July of 2007, when Russia claimed territorial and oil rights to the seabed under traditional Canadian artic waters. And in July 2007, we wrote about country corruption rankings in which Russia was ranked as more corrupt than all the other countries for which there are country funds available to US investors, except for Indonesia.

Russia first threatened and has now announced an arms race with the United States. Russia has threatened Europe with interruption of gas supplies in the middle of winter. The anti-west and anti-US rhetoric in the Russian media is strong and growing. This week Russia said that European and US recognition of Kosovo after its pending secession would create an “international emergency”.

Russian bombers recently buzzed a US aircraft carriers and were confronted by US fighter jets.

The recent declaration of independence by Kosovo has created a volatile and potentially explosive situation which could pit Russia as an ally of Serbia against NATO, who support Kosovo, in a direct or proxy land war in the Balkans (the same place that ignited WWI).

CNN February 23 reported, “Russia — which has not recognized Kosovo’s sovereignty — said it has not ruled out using force to resolve the dispute over the territory if NATO forces breach the terms of their U.N. mandate.” This is not a comforting investment development.

Do you want to be invested in a country in such a potentially hostile situation between Western Europe and the United States? Do you think the Russian stock market would fare well in a conflict situation? Do you have confidence that Russia would respect your property rights in their companies in the event of conflict?

Do think Russia would treat your equity ownership rights better in time of conflict than the shabby way it treated the ownership interests of international oil companies in better recent geopolitical times?

These are not the signs of a fertile investment environment and indicate the potential for so much hostility that Russian markets could turn into a boneyard instead of a playground for investors.

Independent of any judgment about who is right and wrong about this or that matter, we are judging the prudence of US investors holding assets in a country that is in expanding geopolitical conflict with the US, and which is posturing about possible military conflict.

Minimizing risks and losses is an important part of managing investments. If you are a speculator and feel you have knowledge and agility, invest in Russia as you please. Otherwise, we think there are better places to seek high return with less risk.

If you ignore the brewing geopolitics, Russia doesn’t look so bad by some measures. For example, looking at BRIC through the RiskGrades.com site, we see these short-term risk (basically volatility) ratings relative to a global stocks basket:

  • Brazil (NYSEARCA:EWZ) 219
  • Russia (NYSEARCA:RSX) 93
  • India (NYSE:IFN) 271
  • China (NYSEARCA:FXI) 303

For comparison, here are the risk grades for the US, developed non-US markets, and combined emerging markets (including Russia):

  • Developed Non-US (NYSEARCA:EFA) 127
  • Emerging (NYSEARCA:EEM) 185

From this perspective, Russia has been less risky than its fellow BRIC members (Brazil, India and China).

From a geopolitical perspective, however, Russia is in a completely different situation. Neither Brazil, India nor China are rattling sabers about an arms race (we don’t think the Taiwan issue is a hot one at this time). The direct commercial relationships between Brazil, India, China and the US create more interdependency than those between Russia and the US. Brazil, India and China are not expropriating foreign direct investment assets. They are not talking about international emergencies in the context of tensions with Europe and the US.

We could, of course, be wrong like the boy who said the sky is falling, but we would rather be safe than sorry.

The mortgage crisis gave adequate warnings before all Hell broke loose, but the markets did a “hear no evil, see no evil, say no evil” routine up to the bloody end. We think tensions like those surfacing between Russia and the democracies of the West may be the canary in the coal mine. Better to seek return elsewhere.

Charts below show 2008 YTD performance of two Russia funds (RSX and TRF) versus other countries.

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