Salisbury has a connection with Russia that goes back much further than the poisoning of Sergei and Yulia Skripal. Wiltshire’s council’s pension fund has investments in Russian bank bonds, according to research from Bloomberg. The municipal workers of Wiltshire appear to be financing Russian financial institutions, which could end up being subject to increased sanctions following recent events.
This highlights the difficulties of putting sanctions in place that target a country regarded as a “rogue” nation. Indeed, there are already sanctions in place relating to other issues, so new measures are only likely to be marginal. It also underscores the interconnected nature of the world’s financial system. Most workers will not have any idea what investments are held on their behalf in their pension funds. It is likely that most have some investments in countries such as Russia. Indeed, in a world that is starved for yield, the 7 per cent offered by Sberbank’s ten-year bonds appears very attractive. Then there’s BP, one of the most widely-held shares by UK investors. The oil major owns just under 20pc of Russian energy giant Rosneft following the purchase of its Russian joint venture TNK-BP for $50bn in 2013.
Of course, a real contrarian would probably be buying shares in Russia right now in the hope of grabbing a bargain. Geopolitical crises often provide buying opportunities for investors willing to bet against the crowd. When everyone is buying, a contrarian sells. When everyone is selling, a contrarian buys. However, there is one problem with this at the moment – the tensions between the UK and Russia have hardly impacted Russian assets at all. There has not really been a dip to buy.
The major players in financial markets have obviously been following the situation – and concluded that what’s going on in the UK doesn’t really matter. Global investors have looked at Prime Minister Theresa May’s response and issued a collective shrug of their shoulders. Outflows from Russian exchange-traded funds have been pretty insignificant. Since the poisoning, there has been just £31.2m of outflows from X-trackers MSCI Russia ETF and €22m from Lyxor DJ Russia ETF, for example. In the context of the size of the total funds, this is pretty insignificant.
Markets were probably right to do be sanguine. The united front from western powers in the wake of the poisoning has all but vanished. US President Donald Trump called Vladimir Putin to congratulate him on his recent election victory and didn’t even mention the event. Trump then tweeted that “getting along” with Russia “is a good thing.” The European Union is not going to consider any new sanctions either. From behind the walls of the Kremlin, the west must appear divided and weak.
So, right now, investors in Russia can rest easy. It looks like a new raft of sanctions that could prove troublesome for investors are unlikely. There are also some compelling arguments for investments in Russia. The country is, after all, something of a commodity sweetshop with vast wealth buried under its frozen taiga, steppes and semi-deserts. It is the world's largest producer of chromium, nickel and palladium and the second largest producer of aluminium, platinum and zirconium. Mining contributes approximately 20 per cent of the country's exports. Russia also controls the world's largest supply of natural gas, second-largest supply of coal and the eighth-largest supply of crude oil.
As well as the attractive yield offered by corporate bonds in the country, Russian equities are also relatively cheap. For example, Gazprom, which holds the world’s largest gas reserves, is trading on a current-year earnings multiple of just 4.1 times forward earnings and yielding almost 6 per cent. Rosneft trades on a similar multiple, significantly lower than Royal Dutch Shell’s 14.2. Banking giant Sberbank is trading on just 7 times expected earnings, around half that of HSBC.
Russia obviously has enormous future potential. It has a relatively inefficient economy that has room for significant improvement. The Russian government is also indicating that it wants about 50pc of earnings paid to investors as dividends. With many companies part-owned by the government, this means there is a fair wind around income
However, Russian shares are cheap for a reason. Not only does the country's closed economy limit investor participation, many industries, particularly in the resource sector, are controlled by a few oligarchs who enjoy political support. This makes an investment unattractive for many. There is a general lack of trust in Vladimir Putin and his methods, which increases the risk of future sanctions which could have an impact on valuations. Indeed, just yesterday the Council of Europe anti-corruption watchdog called for more transparency and public accountability amongst parliamentarians, judges and prosecutors in the country. It noted that “corruption has long been a serious pervasive problem in Russia”.
All of this means it is arguable that an investment in Russia risks being a value trap. Such a trap springs when an investor buys into a company or market at a low price, but the stock continues to languish or drop further. Diversification is an important aspect of portfolio construction – and emerging markets offer the potential for stunning future growth ahead of a pedestrian west. However, risks with Russia exist that are not present elsewhere. It is also interesting to place a chart of the oil price over the blue-chip Micex index. The equities basically track the oil price in quite a stark and clear correlation. This implies that you may be better off, in terms of risk, investing in a high-yield western oil stock. You get yields ahead of the 4.6% average in the Russian index and capital returns may be similar. The risk is likely to be lower too. So, maybe forget Russia and buy oil.
A version of this article appeared in Friday’s Daily Telegraph.
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