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Moscow feels chill of sanctions threat

It may have been a mild winter by Russian standards, but it has been a chilling few months for investors in the country. The annexation of Crimea prompted huge net capital outflows – an estimated $50.6bn in the first three months of the year. The stock market, the Micex, fell more than 16 per cent in early March.

Although the index has regained most of the value lost in the spring, investor concerns about the lasting impact of Moscow’s revisionist foreign policy are unabated.

The Micex is heavily concentrated on a handful of companies – Gazprom alone accounts for around one-fifth of the index – meaning investment in a Micex tracker is essentially a play on volatile energy and commodity prices.

A key attraction for long-term investors is Russia’s growing middle class. The likes of supermarket group Magnit are well placed to tap into its demand for goods and services.

Domestic growth is slowing, however. The International Monetary Fund downgraded its forecast for 2014 growth to just 0.2 per cent. The prospect of deeper economic sanctions against Russian business threatens to compromise growth further. The appeal of Russian shares therefore lies primarily in their cheapness.

. . .

The road ahead

The ongoing situation in Ukraine has highlighted one of the significant problems when considering Russian equities: politics, writes Ben Yearsley. Contrary to international law, Crimea is now part of Russia, and tensions have shifted to eastern Ukraine.

From an investment perspective, the past few months have been tumultuous. At the start of the Ukrainian crisis the stock market and the rouble fell sharply. The former fell initially around 10 per cent and has drifted a bit lower since. This left the Micex index trading on a price/earnings multiple of five and a dividend yield of 4.8 per cent.

Although this is remarkably cheap, it seems there is no catalyst for a sustained rerating in the short term. Politics rather than fundamentals is still driving returns. When there is calm in Ukraine, the market responds positively; when there is increased violence it slips back.

Yet the Russian market has a deeper structural problem. If investors have little faith in the rule of law, it doesn’t matter how cheap the market is – they simply won’t invest. This is not a situation that will change overnight.

In my view, when buying Russian equities you are doing so for the long term. In the meantime, from the yield on offer you are effectively being paid for the risk that the Ukraine crisis escalates.

The weaker currency is helping Russian exporters, including mining and energy companies, so earnings could grow. This could mean decent income prospects for brave investors.

Ben Yearsley is head of investment research at Charles Stanley Direct

Investing in ... Russia

What is the fund?

Jupiter’s Emerging European Opportunities Fund invests in central and eastern European equities with almost half its capital is invested in Russia. The £165m fund invests in some 40 stocks across a spread of sectors, predominantly financials and oil and gas.

Why should I buy it?

The fund invests in several promising Russian companies, such as Sberbank and Magnit, which are well positioned to gain from structural economic growth. Through diversification of holdings across other economies, including Poland and Turkey, investors’ exposure to political risks in Russia is mitigated.

Why shouldn’t I buy it?

In the year to the end of March, the fund lost 20 per cent of its value as a result of political turbulence in Russia. While returns over the five years to March 31 were 39 per cent, this is significantly below its benchmark, the MSCI Emerging Markets Europe index, which posted growth of 85 per cent.

Copyright The Financial Times Limited 2017. All rights reserved.

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