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Dmytro Kulakovskyi
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Recent Finance graduate passionate about equity and fixed income research seeking to acquire experience in the fields of his interest.
  • Emerging markets: case for Russia 0 comments
    Dec 10, 2010 5:10 PM
    Why Russia?

    I get the impression, that, in spite of the tremendous growth in attention towards emerging markets observed over the last decade, the informational coverage of some of the largest emerging markets remains far below the level, which the recent performance of those markets would suggest. Since 2000 leading Russian stock indices rose twice as fast, as NASDAQ rose in the 90’s, but attention to Russian market and other emerging markets as a whole pales in comparison to the media coverage of a single industry, IT, a decade ago. Not that Russian market deserved as much attention, but still, it appears somewhat unreasonable, that there are twice as many mentions of Google on seekingalpha than there are mentions of Russia.

    Two indexes most commonly used to track Russian stock market are RTSI and MICEX. On the graph below you can see the above-mentioned performance and how it compares to that of other emerging markets and S&P500:

    Of course there are numerous reasons for the poor informational coverage: Russian market is not as liquid, not as transparent and, as implied by pricing on money markets, not as stable, as OECD markets, and, hence, not as attractive to a wide range of investors. Below we will examine what essential implications those factors have from a stand point of individual investors.

    Liquidity

    Every major sector on Russian market has numerous companies publicly traded at more-than-sufficient volumes (at least as far as individual investing goes). With total market cap exceeding $700bln Russian stock market provides more investment opportunities than any other Eastern European market (for comparison, total market cap of publicly traded Polish companies is $150bln). Average trade volume for the companies listed on MICEX toped in 2008 at $24mln. But what’s worth mention here is that it’s significantly skewed towards resource-intensive industries. In fact, oil and gas industry alone accounts for about 50% of the total market cap. But with the total market capitalization of $700bln the remaining half of it still provides you options to choose between. Specifically, the rest is broken down as follows:

    (http://quote.rbc.ru/rbc100/2010/01/chapter3.shtml)

    The list of stocks with highest trade volume also reflects the skew:



    Obviously, the skew towards mineral resources imposes excessive market sensitivity to commodities prices, which leads to higher volatility.

    As there is no way I could cover every sector in this post, for detailed information on weights and performance of particular sectors I would forward you to finam.ru (http://www.finamrus.com/).

    Macroeconomic outlook

    Over the decade both macroeconomic and political outlooks of the country have been steadily improving, causing drop in the values of national risk metrics.  

    I don’t expect my readers to be deeply familiar with economic history of the region, so I would start with data on some of the basic macroeconomic indicators:




    As indicators attest, performance of Russian economy in terms of GDP growth, inflation, external trade and exchange rate stability has significantly improved since 2000 compared to that observed in the 1990’s. These trends were taken into account by credit rating agencies resulting in improvement of Russian sovereign rating (S&P ratings):


    According to S&P BBB rating is an “investment” grade (as opposed to speculative BB+) and suggests “adequate capacity to meet financial commitments, but more subject to adverse economic conditions”.

    That being said, Russian economy still does exhibit several troubling trends, which I will try to outline:

    1. Overreliance on natural resources: according to IMF research soaring oil prices and increase in oil extraction account for up to 80% of federal budget revenue increase (“Budgetary Impact of Oil Prices in Russia” by Goohoon Kwon), which obviously imposes significant market-wide sensitivity to oil prices. O&G- exports-to-GDP ratio between 1998 and 2006 increased from 0.1 to 0.2. In 2007 73% of exports fell at fuels and metals. Although officials seem to realize the problem and do embark on various diversification programs, no material result has been attained so far.

    2. Unstable capital flows: in spite of investment grade S&P rating institutionainvestors still treat Russian economy as highly speculative, which translates into volatile cycles of net capital inflows and outflows.


    External shocks have severe effect on Russian economy, since possible internal demand deterioration is likely to overlap with capital outflow, which would lead to financial markets being sucked out of cash dry. It was exactly what happened in 2008, which led to sharp decline in stock prices and spike in interest rates.

    Such conditions contrast with what we can see in OECD economies, where global recessions are usually accompanied by capital repatriation and interest rates decrease.

    3. Institutional concerns: the country is well known for its corrupted government, lack of business ethics, and power of special interest groups. According to recent research (Le Monde) bribes and kickbacks amount up to 50% of GDP. Transparency International places Russia at 146th position in its Worldwide Corruption Perception ranking (on par with Sierra-Leone and Kenya). As a result, due to the unpredictability of regulators and courts’ bias any investment bears additional unquantifiable structural risk.
     
    As follows from the above, just as any emerging market Russian market is, without a doubt, riskier than those of developed economies. But the risk itself doesn’t say much, since it’s balance between risk and expected return, that differs attractive investments from potential disasters. We can illustrate this relation using quarterly coefficient of variance (calculated for weekly changes in the index) as a measure of risk and quarterly change in average (arithmetic) value of the index as a return measure.





















    Charts above show that being more risky Russian market has demonstrated (on average) significantly better performance, which suggests that at least for some risk-tolerant investors exposure to Russian market may lead to improvement of risk-return profile. Another point worth mentioning here is correlation between Russian and American stock markets, which amounted to 73% for years 2004-2010 (calculated for weekly changes). Imperfect correlation yet again suggests attractiveness of Russian market for the purpose of portfolio optimization.

    Trading Russian stocks

    Trying to spark some interest towards the topic, it’s necessary to expand on how individual investor can access Russian stocks.

    Most popular options include:

    1) Trade Russian companies listed on American Exchanges. Those include: Michel steel (NYSE:MTL), Mobile TeleSystems (NYSE:MBT), Vimpel-Communications (NASDAQ:VIP), Wimm-Bill-Dann Foods (NYSE:WBD), CTC media (NASDAQ:CTCM) and numerous companies traded OTC;

    2) Trade Russian-oriented ETFs:

           a. RSX: mostly exposed to Russian O&G industry;

           b. RBL: industrial materials and energy make up more than 60% of the holdings;

    3) Theoretically, you can find either a Russian broker licensed to work with non-residents, or an American broker licensed to work on Russian exchanges. Practically, this option seems to be beyond typical investor’s reach, since high transaction cost and Russian non-resident capital gains taxes will dramatically affect your performance.

    In the view of above, in subsequent posts I will probably focus on telecommunication industry and metal producers, as those stocks are relatively easy for American investors to get exposure to and are largely uncovered by English-speaking media.

    Below you can find sources used in this posting and internet portals, which might come in handy to those looking to analyze Russian market by themselves.

    Links

    Comprehensive resources in eng:

    http://www.finamrus.com

    http://www.micex.com/

    www.rts.ru/en/

    http://www.gks.ru/wps/portal/english

     Related articles:

    http://www.speroforum.com/a/38471/Russia---Corruption-takes-50-per-cent-of-Russias-GDP

    http://techfarm.blogspot.com/2007/07/invest-in-russian-stocks-from-us.html

    http://www.marketoracle.co.uk/Article219.html

    www.tradingeconomics.com/poland/market-c...



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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