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Baring Emerging Europe: don’t write off Russia just yet

16 April 2018

Matthias Siller, manager of Baring Emerging Europe, says there are still opportunities to make money in Russia - as long as investors understand the risks.

Baring Emerging Europe (BEE) manager Matthias Siller is standing by his 64% allocation to Russian equities, following a challenging week for the country’s stock market.

Siller believes the investment rationale for holding Russian companies remains intact - even if the country’s economic recovery is likely to be subdued by tough sanctions were introduced by the US this month.

These included a list of seven Russian oligarchs and the companies they run, including Oleg Deripaska. Any assets owned by the seven under US jurisdiction have been frozen and US nationals are forbidden from doing business with them.

The news sparked an 11% drop in the RTS index in the space of a day and it has remained 10% lower since 7 April. Likewise, the rouble has fallen 6% against the US dollar. Investment trusts with significant exposure to Russia also tumbled, including Baring Emerging Europe.

When you throw in rising tensions between Russia and the UK following the poisoning of a former Russian spy and his daughter in Salisbury, as well as Russia and the US locking horns over Syria, it’s easy to see why investors such as our columnist Ian Cowie have been spooked.

‘From our perspective, we distinguish between political implications and the economic situation on the ground in Russia. If you look at the political implications, of course we hope this does not become a “hot war” in Syria, but we do believe it is prudent to apply an elevated risk premium to Russia,’ Siller explained.

The risk premium refers to the amount of risk that an investor is taking on in comparison to buying a government bond, which for all intents and purposes is considered ‘risk-free’. The theory goes that investors should be rewarded with higher returns for taking on this additional risk.

Improving dividends

While the sanctions and growing geopolitical tensions represent bad news, Siller says the prospects for Russia should not be written off altogether.

This is because a number of positive dynamics are at work in the Russian market and Siller believes these have been under-appreciated by investors. Firstly, he points to improving corporate governance standards across both private and state-owned enterprises. This is demonstrated by the growing dividend payout ratio in Russia.

While Russian businesses had previously lagged other emerging markets in terms of distributing income to shareholders, Siller says this has changed over the past four to five years. On average Russian companies distribute more than a third of their net income as dividends. Looking ahead, he expects higher earnings growth will translate into dividend growth.

‘Russia is setting standards for emerging market companies rather than lagging them. So far, this has not been fully appreciated by the market and continues to surprise investors positively,’ the fund manager said.

Two sides to the story

Although the Russian market sold off sharply after the sanctions were announced, Siller described it as an ‘orderly retreat’.

‘In other words it was not a widespread panic. The market has distinguished correctly between exporters and domestically-oriented companies,’ Siller added.

This has led to a bifurcation in the market. On the one hand, companies that are sensitive to the domestic economy have seen their share prices come under pressure as a result of a weaker rouble. However, it has been a different story for exporters, which stand to benefit from currency weakness.

Siller says oil exporters, in particular, can benefit from two factors: a weakening currency which ultimately lowers their costs, and a higher oil price which boosts their margins.

On the positive side, Siller notes that higher market volatility – which he expects will continue – is going to present stockpickers with investment opportunities over time.

Sberbank (SBER.MM) represents the trust’s largest position, followed by energy company Lukoil (LKOH.MM) and gas producer Novatek (NVTK).

After Russia, Poland is the second largest geographical allocation at 16.8%, followed by Turkey at 8.7%. The trust’s largest

Over the year to 11 April, Baring Emerging Europe’s share price has risen by 8.9%, outpacing its competitor BlackRock Emerging Europe (BEEP) and the MSCI Emerging Europe 10/40 index which were down 0.4% and 0.2% respectively. Baring Emerging Europe’s net asset value is up 3.6% over the past 12 months.

In spite of this, the fund has persistently traded on a double-digit discount and today this stands at 10.5%, higher than BlackRock Emerging Europe’s discount of 6.5%. Although this discount is disappointing, Siller expects it will narrow over time as new investors start to appreciate the fund’s growing dividend yield and strong performance coming through. Baring Emerging Europe's dividend yield currently stands at 3.4%.

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