As perhaps the most volatile of the major emerging markets nears full recovery from its 80% plunge, stocks are cheap and JP Morgan Russian Securities is backing domestic consumers.
There is an advert on television promoting Thorpe Park’s “Saw”. This horror movie-themed rollercoaster is billed as the “most terrifying ride in the world, testing the nerve of all who dare ride it.” That it may be, but it’s not as scary as investing in Russia.
During 2008 the Russian market collapsed faster and further than almost anywhere else. Those who bought at the peak of the market lost 80% of their money – and that’s if they could find anyone willing to take their shares off them.
Now the rollercoaster has climbed the other side, with values approaching their peak again. Should we be preparing for another plunge? Or is it different this time?
Emily Whiting, a client portfolio manager at JP Morgan, is quick to acknowledge that Russia is perhaps the most volatile of the major emerging markets. She works with Oleg Biryulyov, the manager of JP Morgan Russian Securities, an investment trust with assets totalling £315m, but is part of a team that oversees $2 billion (£1.3 billion) in Russian equities. That makes it the biggest foreign equity investor in the country.
”There is a compelling story in terms of domestic consumption, which by global standards is still in its infancy”
“Russia is not a particularly well supported or advanced market, and there are not a lot of local investors,” says Whiting. “At any sign of trouble a lot of investors pull out. That 80% fall in 12 months is something the Russian market has done before. But since then it has pulled back by around 120%.”
Like Neptune’s Russia fund, the JP Morgan fund leaned heavily towards domestic consumption rather than the oil economy. Biryulyov is a relatively long-term (for Russia) stockholder, with a two-to-three year time horizon for most stocks.
The MSCI index for Russia comprises 38% energy stocks and 22% materials, indicating just how much of a resource bias there is. Yet JP Morgan doesn’t hold a single share in Gazprom, the market’s biggest stock.
“We’re overweight in consumer stocks, staples and discretionary and underweight energy and oil. Indeed, many of the consumer discretionary stocks we invest in aren’t even in the index,” she says. (article continues below)
Gazprom is 9% of the market, but Whiting says: “It’s a stock we don’t like because of the level of state intervention.”
Despite the market’s recovery, Russia is still on most valuations cheap. It’s on a price/earnings (P/E) multiple of 6.5, up from the lows of 4-5 in 2008 but still a long way below the current emerging market average of 12.
However, one has to be cautious of these measures. India always looks expensive on market P/Es (it’s currently on 14.2 times 2011 earnings), while Russia always looks cheap. That probably says more about the level of local support than which direction the market is about to take.
The fund’s biggest holding is Magnit, Russia’s largest food retailer. It’s a remarkable growth story, having started life in 1998 in Krasnodar in south-west Russia. Now it’s a chain of more than 3,000 convenience stores and 25 hypermarkets with the slogan “Always Low Prices”, and in autumn is planning a £185m secondary share offering in London. It has more than doubled in price over the past year and has a market capitalisation of over £1 billion.
One concern about investing in consumer stocks is that visitors to Moscow will see a booming retail environment – but how far does it stretch through the income scale and across this vast and diverse country?
“Moscow is the leader, but what we like about retail is that it is broadening into second-level cities,” says Whiting. It is estimated that between 1999 and 2008, wages in Russia rose sevenfold in dollar terms.
This week HSBC Asset Management put out a glowing note on Russia, the largest overweight position in its Bric [Brazil, Russia, India, China] fund. “Russia is unloved and undervalued by the market at present,” says Nick Timberlake, the firm’s head of global emerging market equities. “There is a compelling story in terms of domestic consumption, which by global standards is still in its infancy. The evidence shows that consumer spending has been more resilient than the broad economy during the recent turmoil.”
The oil price remains a big driver in the Russian economy and is, of course, substantially below its $145 record in July 2008. But Whiting says that as long as oil is above $60-65 a barrel it is a strong contributor to growth. Unfortunately, much of the oil revenue that went into Russia’s stabilisation fund was subsequently squandered on defending the rouble, although it has also helped to plug a federal budget deficit.
It means some of the more ambitious infrastructure projects drawn up during the oil boom have been halted or moderated. But Whiting says there is a “massive investment” going into the Sochi winter olympics in 2014. The resort town, near the Black Sea coast, will see construction on a scale not far off London’s 2012 effort – with a 69,000-seat main stadium, a 12,000-seat ice palace for ice hockey and a similar size venue for ice skating. Spending is pencilled in at $10 billion, but as everyone knows, that will soon rise.
Financial stocks are also a key part of the JP Morgan Russia portfolio. The biggest single holding is Sberbank, at 12% of the fund. “It has always been our largest holding,” says Whiting. “In some ways it’s part of the consumer story – Russia still has a very low penetration of retail financial products such as credit cards and mortgages. It’s not going to happen overnight, it’s a slow-burn story, but it will get there.”
During the financial crisis many regional banks came close to collapse, but consolidation has helped the sector.
MTS, Russia’s leading mobile phone operator, is the fund’s third-largest position. Whiting acknowledges that the days of super-growth are over, with mobile phone penetration in Russia similar to France, but she says there is still substantial revenue growth in prospect.
She also says management discipline in Russia has improved. But domestic politics will remain something that investors will need to be aware of.
“We are the top foreign investor and Oleg Biryulyov is a native Russian who has been managing money there for more than a decade. He gets invited to the Kremlin. The JP Morgan name means a lot of people want to work with us.”