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Investing in Russia? Seriously?

by internationalbanker

By Elizabeth Frasier-Nelson – elizabethfnelson@internationalbanker.com

Russia probably isn’t the first place that springs to mind when somebody suggests diversifying your investment portfolio. As recently as a month ago, former Soviet leader Mikhail Gorbachev said relations between the United States and Russia were headed for a “new Cold War”—hardly encouraging an investment haven there.

But with respect to Mr. Gorbachev, does anyone expect Russia’s current woes to last 45 years, as was the case with the Cold War? Bigger forces are at play now, which even President Vladimir Putin cannot completely control—the world is far more connected than it was during that period. And most of the largest Russian companies are publicly listed in London and New York.

These public listings, together with a new generation of executive boards that have worked in Europe and the United States at other publicly listed companies, create an open-minded and progressive culture at firms that just wasn’t present even 15 years ago. Slowly, even the management culture in Russia is changing for the better.

Russia’s history is one of peaks and troughs. In 1998, for example, the country defaulted on its debts, causing an international maelstrom (particularly at American hedge fund LTCM—Long-Term Capital Management). However, it recovered reasonably quickly and by 2002 was already being spoken about as a fast-emerging BRIC nation by Goldman Sachs.

In the space of 10 years, Russia’s GDP grew year on year, stoking up government coffers, which invested (sometimes, but not always) in improving the country’s infrastructure. On the ground, in cities such as Moscow and St. Petersburg, the changes have been incredible—new highways and metro stations have sprung up everywhere.

Everyone who timed it right that time, whilst taking the necessary precautions, made a fortune. Private-equity firms such as the Hermitage Fund and the Sputnik Fund purchased millions of dollars’ worth of under-priced assets and waited for markets to recover. When markets recovered—as they tend to do—a “killing” was made.

So how quickly can we expect Russia to recover this time? It’s difficult to say as each occasion is somewhat different. The last time, Russia hadn’t really come to terms with a market economy, causing it to default on its debts. This time its travails are related to low oil prices, political sanctions and even perceived political volatility.

But now would be a good time to recall the words of Warren Buffett: “Be fearful when others are greedy and be greedy when others are fearful.” In other words, when asset prices start to fall well below the rolling average, start looking to make some purchases. The prices will rise again at some stage.

Where do you invest? If somebody knew the exact answer to that question, the chances are that he wouldn’t be writing an article about it. All of the usual rules that apply to investing apply to Russia as well, with the added note of caution that it is a developing market—and what’s more for now, at least, quite a volatile emerging market.

Likewise, you have to ask yourself if Russian assets will make a useful addition to your portfolio. Is too much of it already exposed to emerging markets? Are you looking for shorter-term returns than the mid- to longer-term horizon in which Russian assets might deliver? These are all questions to consider.

Use the information that is available on companies such as X5 Retail Group and SberBank, both of which are listed on foreign exchanges. X5 Retail Group is the largest Russian food-retail group, and Russia is the third biggest food-retail market in Europe, so it’s a stock that deserves attention based on its merits. SberBank is one of the largest 20 banks in the world by assets held. The problem, of course, is that most of its assets are in roubles, which took a massive slide only a few weeks ago but seem to have recovered. Now, in fact, might be a good time to look at SberBank with fresh eyes and see how it could benefit your portfolio.

The broad index fund for the RTS (Russian Trading System—Russia’s stock market) might also be worth a look. It fell dramatically in line with the rouble recently and is likely to fall again in the next year—mainly on momentum. But when stock markets fall too many times, they begin to look under-valued quite quickly. Take this into account when considering it.

Professor Aswath Damodaran of New York University also notes how he likes to look at stocks with virtually no exposure to the domestic economy— those whose business is all done abroad. That way, whatever happens with the Russian economy, these companies’ stocks are sheltered. Honestly, there do not appear at first glance to be many of these companies in Russia.

One also should always consider monopolies. There are several near-monopolies in Russia—the example of Russian Railways is a good one. You could say that airways represent a threat to this, but in a landmass of Russia’s size, train freight will always be required, and for this there is only one company.

These are just some of the suggestions you could take onboard. Having done some reading on the topic (and you would be silly not to if you are considering investing), you will no doubt see more emerge. Try to block out the sound bytes about the Cold War and World War III— sensationalism has no place in rational investing.

As a thought to finish with, consider this: the United States has been declared bankrupt four times (five times unofficially given the recent fiscal cliff). There are records of foreign investors from each of those separate periods writing off the United States and saying that as an investment, the United States would forever be a write-off.

Who knows what happened to those investors that wrote off the United States as an investment. Chances are that their descendants aren’t living on an endowment fund. The point is that every country—even the United States—has experienced economic hardships. But think in the mid- to long-term for investments; this is where the returns lie.

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