In investment terms, Russia has famously been described as Saudi Arabia with snow. That is, of course, a considerable oversimplification but the importance of the oil and gas sector to the Russian economy and market is undeniable.Gazprom alone accounts for almost 44 per cent of the Russia equity market, as represented by the Russia ROS index. It is Russia’s biggest company, supplying almost all the gas needs of Central Europe, Eastern Europe and the former Soviet Union. Factor in Lukoil and Surgutneft, the nation’s second and third-biggest oil producers respectively, and those three stocks alone represent almost three-quarters of the value of the Russia equity market by capitalisation. Clearly, no matter how well the other 27 companies in the ROS index do, the overall performance of the Russian equity market tends to be heavily influenced by the performance of these three very big oil and gas companies. In turn, the profitability and share price performance of these companies depends to at least some extent on prevailing commodity prices. Given the near-quadrupling of the oil price since 2001, it should be no surprise to see the remarkable performance of the Russian equity market over the past five years. The Russia ROS index has returned a cumulative 557 per cent in US dollar terms over that period compared with 138 per cent from the MSCI Emerging Markets index and just 19 per cent from the MSCI World index, both in US dollar terms. It is not just an oil and gas story, though. Russia is also one of the world’s biggest producers of nickel, copper and iron as well as precious metals such as platinum and has benefited from strong demand from Asia and from China in particular in recent years. With such a rich resource base, many investors view exposure to the Russian equity market as a good way of participating in both global growth and Chinese demand for commodities. Given the strength of world equity markets and of the Russian equity market in particular in the early months of this year, some volatility was to be expected and so the weakness experienced in May and again in June was not wholly surprising. But the extent of the correction was unexpected and certainly did not reflect the strong fundamentals that continue to underpin the Russian equity market. We believe these favourable fundamentals are largely intact and that the recent sharp fall has been more a result of external global factors than a deteriorating economic environment. Gross domestic product grew faster than expected in the first quarter of the year at an annual rate of 5.5 per cent in spite of the very cold winter. Meanwhile, industrial production growth was an impressive 10.6 per cent on May compared with a year earlier while investment rose by 14.2 per cent over the same period. We believe the Russian market should stabilise and show strength again once investors have a clearer picture of the US interest rate cycle and global liquidity conditions in general. Energy prices have remained high and we do not think the commodity cycle is over yet. We are particularly upbeat on the prospects for the energy sector within Russia, favouring Lukoil for the potential we believe the company has for exceeding earnings estimates and the attractive valuations the company is trading on. There is, of course, also more to the Russian market than the very biggest oil producers and we have been finding investment opportunities among a number of banks in the financial sector and also in a number of companies operating in the consumer discretionary sector. Within the banking sector, we particularly like Sberbank, for example. It is the biggest bank in Central and Eastern Europe and a key beneficiary of Russia’s economic growth.
Ghadir Abu Leil-Cooper is head of emerging European equities at Baring Asset Management