What’s Right with Investing in Russia?
Art by Harry Campbell
For Western investors, Russia seems like a cesspool of a place to put money into. But believe it or not, a case can be made for investing in the nation, albeit selectively.
Yes, this sounds a lot like the old joke about the mothers who are bragging about their grown kids’ achievements: one is a doctor, another an investment banker, and yet another a law partner. When they come to the mom whose son is incarcerated, she remarks: “Well, he’s a model prisoner.”
Russia remains a country where the rule of law is shaky, oligarchs allied with President Vladimir Putin have enormous sway, sanctions for international meddling burden commerce (such as those imposed for meddling with the US’s 2016 election), and oil exports make up much of the economy, exposing it to commodity fluctuations.
So what’s to like?
After a severe two-year economic downturn, caused by the slide in oil prices and the sanctions, Russia’s gross domestic product is expanding again, rising toward 2% annually. The recession ended by early 2017. What’s more, the oil slump is over: Brent crude, the standard per-barrel measure outside the US, is back to $73 from half that in 2016. The RTS Index, which measures Russian stock performance, is up 54% in the past two years, although it is off slightly in 2018 (down 1.2%) after the latest round of sanctions.
“There’s slack in the economy, inflation is low, and oil is coming back,” said Phil Torres, global co-head of emerging markets at Aegon Asset Management.
After the sanctions cut off the country from some vital trade and financial support, the Kremlin set about the goal of making it self-sufficient, with a decent amount of success. “Russia’s not as bad as you’d think,” Michael Reynal, CIO of Sophus Capital. “They are immune to global trade now, with enough agricultural and industrial goods.”
From an investor’s viewpoint, here’s what is working in Russia:
Its fiscal and monetary policies are sound. The Ministry of Finance and the Bank of Russia, its central bank, have worked hard to contain inflation and to pull the country out of its recession. The Kremlin has turned to China for help with infrastructure spending. Standard & Poor’s recently upgraded Russian government bonds to investment grade status (BBB-) from junk (BB+).
To be sure, some of the authorities’ methods would not fly elsewhere, such as their consolidation of banks under the Kremlin’s hand. “The big question is will Putin let the finance ministry and the central bank keep doing the job they’ve been doing?” Aegon’s Torres asked.
It has a friend in the Oval Office. The Trump administration has indeed gone after Russian misdeeds, as seen by the latest sanctions targeting some of its companies and oligarchs. Still, President Donald Trump has been a champion of Putin, earlier this year congratulating the Russian leader for winning reelection in a contest that some regard as fixed.
At the Group of Seven (G-7) meeting earlier this month, Trump called for re-admitting Russia. The G-7 used to be the G-8 until it threw out Russia in 2014 for its annexation of Crimea. While no one sees the sanctions going away soon, having the world’s most powerful person as an advocate could well pay off at some point.
It has a number of well-run companies. Most important, if Western investors can navigate the sanctions, there are some solid corporations in Russia. The trick is to avoid ones associated with Putin’s cronies, said Mohammed Elmi, portfolio manager for international fixed income at Federated Investors. Otherwise, a company could end up hit with sanctions, harming its value.
An example is United Company Rusal, Russia’s biggest aluminum producer, whose majority shareholder is tycoon and Putin pal Oleg Deripaska. The business remains under sanctions. “With guys closely associated with Putin, you have to add a risk premium to Russian corporate bonds,” Elmi said.
A good stock to own is Magnit, the supermarket chain, said Fiona Manning, a senior investment manager at Aberdeen Standard, which has a UK-based fund that invests in Russia. “This is a good quality company with good logistics,” she said. The only possible downside is that state-owned bank VTB owns about 18% of the grocer. But to some Western investors, it’s safe, just so long as the government and Putin’s cronies have a minority stake.
The energy company Lukoil is a cleaner prospect. Manning said that it has no links to Putin. “They play an excellent game, with good corporate governance and disclosure,” she said.
Certainly, any company operating is Russia will have some dealings with the Putin regime, not to mention his moneyed associates. And the hope is that Putin’s overseas adventures will draw to a close, allowing more normal relations with his country’s businesses. “At the end of the day,” Federated’s Elmi said, “they still need capital markets” from elsewhere.