Russia: Down, but not outAug 6, 2018

Russia has been revelling in the success of hosting the world’s biggest football tournament this summer. But the country’s latest brush with US sanctions remains fresh on investors’ minds. Chetan Sehgal, lead manager, TEMIT, senior managing director and director of portfolio management, Franklin Templeton Emerging Markets Equity, discusses why—and where—we see investment opportunities in Russia.

Chetan Sehgal

Chetan Sehgal, CFA
Lead Manager, TEMIT
Senior Managing Director, Director of Portfolio Management
Franklin Templeton Emerging Markets Equity

Russia has been in the spotlight lately, for reasons good and bad. Hosting the world’s greatest football tournament this summer has brought a positive buzz to a country freshly stung by US sanctions in April. Mixed headlines aside, we believe Russia continues to offer long-term investment opportunities for discerning stock pickers.

Start with the big picture. Russia has defied the worst expectations since sanctions first hit in 2014, thanks to its fairly self-sustained economy. Though the country has traditionally been a big commodity exporter, we think global demand is likely to persist. Any curbs on Russia’s ability to sell its oil, gas or metals would bring pain to the country, but could also adversely impact several global industries.

The spike in aluminium prices following the latest sanctions on Russian producer Rusal is a case in point. Notwithstanding the initial tumult, signs of a compromise have emerged. Rusal has been taking steps to get off the sanctions list by revamping its board and management, amongst other measures in the works.

Russian companies are also weaning themselves off foreign capital markets. Faced with greater scrutiny and a tougher fundraising environment abroad, many are turning back home to borrow in the rouble debt market. Meanwhile, several Russian businesses with domestic and foreign listings are considering delisting overseas as geopolitical concerns weigh on their stocks. So far, capital flight from Russia seems to have abated, and there has been greater domestic liquidity and domestic asset ownership.

In international relations, Russia is building new political and economic alliances. For example, consider its role alongside the Organization of the Petroleum Exporting Countries (OPEC) in swaying global oil output, or its agreement with China to supply the latter with gas. Even with sanctions, Russia’s influence cannot be ignored.

Steady giant

Overall, Russia’s economy has proven resilient. A sharp recovery in oil prices has helped, as have prudent macroeconomic and monetary policies. The government expects a budget surplus this year amidst rising oil and gas revenues. Economic growth could reach 1.5% to 2% in 2018 1 , potentially exceeding the 1.5% expansion in 2017 2 . And inflation continues to hover near a record low, giving the central bank room to trim interest rates. In this benign climate, consumer spending remains healthy.

These strengths had buoyed Russian equities and the rouble in recent times—until April. The MSCI Russia Index gained more than 9% in the first quarter to become one of the period’s standout emerging-market performers. But new sanctions forced the index nearly 6% lower in the second quarter, taking its year-to-date return to just over 3%.

Strong companies

What should investors make of Russia’s stock market then? Broadly speaking, its fundamentals appear compelling. Metrics for the MSCI Russia Index reflect earnings growth potential and undemanding valuations. 3 Also worth noting is its relatively high dividend yield as more Russian companies improve corporate governance and increase payouts.

What’s more, Russia remains home to some of the world’s largest energy companies, which enjoy cost advantages and offer exposure to potentially higher oil prices at compelling valuations.

We have also seen strong trends buoying certain companies. Stellar growth in e-commerce, online advertising and other internet services in Russia has turned local internet firms into global leaders. In banking, a government clean-up has pushed troubled lenders out of the industry, paving the way for established institutions to gain market share. Russian consumers have also been borrowing more.

In some cases, restricted access to Western technology has spurred Russian companies to invest in building their own ecosystems, which contributes to more sustainable growth.

Balanced assessments

Without question, investing in Russia has its challenges. One is geopolitical uncertainty, driven in part by worries of further sanctions. Second, oil prices may not remain at current levels and the rise of electric cars could ultimately affect demand. Russian companies also have a corporate governance gap with their Western peers to close.

But with potentially higher volatility comes potentially higher returns. We believe Russia continues to offer interesting opportunities for investors with the resources to undertake rigorous research and thorough assessments of economic and political risks.

We seek companies that show sustainable earnings power, trading at what we think are attractive valuations. Well-diversified portfolios comprising such companies have a solid chance of weathering market changes, be they good or bad.

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The comments, opinions and analyses expressed herein are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The information provided in this material is rendered as at publication date and may change without notice, and it is not intended as a complete analysis of every material fact regarding any country, region market or investment.

What Are the Risks?

All investments involve risks, including the possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.


1. Source: Bank of Russia, July 2018

2. Source: Bank of Russia, March 2018

3. Source: Bloomberg, as at 30 July 2018