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Food for thought in Russia

The troubles in Egypt are a reminder to investors in emerging markets that economic and stockmarket risk can be exacerbated by political issues. The Egyptian stock exchange has been closed for days following the anti-government protests so owners of shares listed there do not even have the option of selling until it reopens.

Of course, Egypt is not one of the major emerging markets, rather a frontier investment proposition with a nascent, illiquid market. None- theless, political risk for those investing in emerging markets is nothing new and it is worth bearing in mind.

One of my favourite markets at the moment, Russia, carries a degree of political risk, which is one reason for the inexpensive valuations of many its shares.
There are a number of specialist funds that invest in Russia and I have been a particular fan of the Neptune Russia and Greater Russia fund since it launched but it is always interesting to meet other managers investing in the area. I was especially keen to meet with Hugo Bain and Peter Jarvis, managers of Pictet Russian equities, a fund that has closely matched the Neptune one in terms of performance.

Although not well known to UK investors, Pictet is one of Switzerland’s biggest private banks and put significant resources into the EMEA region with dedicated traders, a team of 17 analysts and an emerging market debt team. It has a proprietary system which looks to find undervalued companies where the share price does not fully reflect what the company owns. Around 120 companies are screened by this method, and they follow this up with consideration of regulation within the industry and by meeting key personnel to assess management quality.

There is also a focus on liquidity – essentially, how easy it is to trade the shares. The Russian market can be a real rollercoaster and the team have seen two 80 per shares falls from peak to trough, so they like to be ready to cut a position quickly if they need to. The portfolio tends to be relatively concentrated between 22 and 35 stocks and may also include shares of companies in the Ukraine, Kazakhstan and Georgia.

The Russian stockmarket is dominated by energy and commodity stocks and highly correlated to the price of oil, but perhaps not quite in the way you would expect. The Pictet team have identified that oil price rises have a relatively small effect on Russian energy stocks and shares in other sectors go up faster.

This is because a progressively higher amount of oil company profit is taken in tax as prices rise. Additionally, a buoyant oil price magnifies the trickledown effect on consumer spending, allowing retailers and other domestically orientated firms to flourish – so it is these areas that benefit more.

Among the biggest holdings in the fund are commodities stocks Norilsk Nickel, and Gazprom. Sberbank completes the top three but note the fourth-biggest stock is Magnit, a food retailer. The food market in Russia is still in its infancy and growing fast and consolidation has only just begun. So far, Magnit has 3,500 convenience stores and 60 hyper-stores but it is opening 500 convenience stores a year, which tend to be profitable after one year. This type of stock could prove a big beneficiary from the growth in the economy, especially if the company can move into a position of dominance.

The Russian stockmarket remains on a remarkably low price/earnings ratio of eight, a big discount to other emerging markets. Some of this discount is deserved due to political worries but I agree with the Pictet team it seems excessive. Given the vast reserves of oil and other commodities in Russia, I can see the Russian economy improving further. Russia is some way behind other emerging markets in creating a consumer culture, as is much of Eastern Europe, so if you can tolerate the risk, some exposure to a fund like this could prove worthwhile over the long term.

Mark Dampier is head of research at Hargreaves Lansdown

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