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Putin investment first

The victory of Vladimir Putin at the Russian presidential elections has gone some way to address the political uncertainty which has been manging over the Russian market.

The presidential inauguration is due to take place in early May and the new president will have two weeks to propose a new PM to the Duma. It is possible that key cabinet appointments and a policy platform will begin to emerge in the meantime.

Russian equities trade on a significant valuation discount to their own history and to other emerging markets, owing in part to the political risks.

When measured relative to its broad peer group, the MSCI Global Emerging Market index (currently trading on 10.4 times), Russia’s discount is nearly 50 per cent (compared with an average of 25 per cent) to the MSCI GEM index over the past 10 years.

While the election result was expected and to some extent has been priced in (at the start of March, equities were up by 26 per cent for the year), we believe the market is positioned to rally further. The political dynamic in Russia may be undergoing significant change as the urban middle class seeks a policy voice but this may take years to play its course.

Putin’s campaign was structured to address many of the issues raised, particularly reducing corruption, and the market will look for evidence that real policy reform will be implemented. Proposed structural reform, if implemented properly, should improve the longterm growth outlook for the Russian economy.

In his manifesto, Putin set out economic policy priorities, including privatisation, ratification of WTO membership and other measures to improve the business climate and attract investment.

We view it likely that these issues will stay at the top of his agenda in the run-up to and following the inauguration. We would view progress in these areas as positive for the equity market. Major state-run energy companies could benefit more from a shake-up of the status quo, particularly if management in these companies is passed to more market-friendly individuals.

We also believe Putin will assemble a market-friendly cabinet and may drive personnel changes at the top of key state-run companies. This could mark an improving trend in perceived corporate governance.

Such actions would also help to reduce the perception of risk and push Russian equities higher as, in the short term at least, falling political risk should be positive for the whole stockmarket.

Energy should remain a key driver of the economy. As the world’s biggest producer and exporter of oil, the commodity’s importance to Russia cannot be underestimated but there are opportunities in the financial sector too, a direct play on Russia’s recovering economy.

With high net interest margins, high capital adequacy and loan growth expected to be 20 per cent for the sector in 2012, coupled with low valuations, relative to emerging market peers, we believe good investment opportunities in the sector can also be found.

But the market will undoubtedly remain sensitive to ongoing developments as no region, including Russia, can be viewed in isolation of factors beyond its borders.

Russian equities will continue to be influenced by a range of external factors, including the eurozone debt crisis, global growth, geopolitics and, of course, commodity prices. It is likely that Russia will remain a highbeta market for some time, meaning that any deterioration or improvements in these external factors would be likely affect Russian equities disproportionately.

Ed Conroy is co-manager of the HSBC GIF Russia equity fund


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