Russia Looks Rich and Cheap

Victor is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In my previous post I made the long term case for commodities.  In this post, we'll consider an indirect way to get exposure to them.  It's common knowledge that emerging market economies tend to be correlated with commodity prices.  That's because emerging markets are often dependent on the export of natural resources, making them "banana republics," if you will.  One notable exception is China, which is a both a leading commodities producer and importer.  In addition to being the exception to the rule, China also tends to get much of the emerging market spotlight.  People seem to forget that there are three other big names in the "BRIC" acronym, with the "R" standing for Russia.

Despite what some may think, Russia has much more to offer than just stiff vodka and camaraderie.  For example, Russia is rich with a wide range of natural resources, including timber, metals, coal, rare earth elements, and one of the world's largest natural gas reserves.    Russia is also one of the largest exporters of steel and aluminum.  In addition, and surprising to many, Russia is the world’s largest producer and exporter of oil.  Yes, that is correct--Russia produces and exports more oil than any country in the Middle East.   These facts correlate well with my secular outlook for commodities, but that is not the only reason why I like Russia right now.   

Compared to other emerging market countries, I think the Russian economy looks financially strong and healthy.   Figure 1 shows some key economic statistics for the BRIC countries as of the end of 2012.   Notice that Russia has the highest current account surplus and lowest levels of debt (relative to GDP) compared to Brazil, India, and China.  Brazil and India in particular have the highest Debt/GDP levels.  While Russia’s GDP growth is not “on fire” like China's, I think it is within a healthy and sustainable range.  Russian inflation and unemployment are a bit on the high side, but they are by no means the worst (unemployment is lower in Russia than in the US).  In addition, both measures have fallen significantly from their recent double digit levels, and they are both projected to continue improving according to the International Monetary Fund.

Figure 1


<img src="/media/images/user_15926/bricstats_large.png" />

With those things in mind, the fact that the Russian equity market is trading with a P/E multiple of 5x and a P/B of 0.68x makes it worth looking at, in my opinion.  Of course, emerging market equities tend to have lower valuations relative to developed markets due to their perceived risks.  Valuation swings, as measured by standard deviation, also tend to be more volatile.  That being said, it is hard to say that Russian equity market valuation is not low in absolute terms. Figure 2 shows a comparison of P/E and P/B  measures for BRIC equity markets.

Figure 2

<img src="/media/images/user_15926/bricval_large.png" />

Risks include the obvious.  As mentioned above, emerging market equities can be very volatile. That is especially true for a country like Russia that is heavily dependent on oil exports.  For unhedged investments, foreign exchange risk via the Ruble would also be a consideration.  Other common concerns regarding Russia are corruption and productivity issues.  Many regard Vladimir Putin to be more of a dictator than a president.  Political favors seem to run rampant, and heavy Russian state involvement in private industry is widely seen as a burden on innovation and efficiency.  Then again, these issues are not unique to Russia, and may even be considered common in emerging markets.  From that perspective, I think Russian equities still look relatively attractive.

Unless you have some expertise with picking Russian stocks, it is probably a good idea to cast a wide net and avoid concentration risk.  There are a number of different ETFs that will provide market wide exposure.  The Market Vectors Russia ETF (NYSEMKT: RSX) is the most popular and trades more than 3.7 million shares per day.  The iShares MSCI Russia Capped Index (NYSEMKT: ERUS) fund is another popular choice, and has volume of more than 380,000 shares per day. The SPDR S&P Russia (NYSEMKT: RBL) fund is the least popular based on volume, and trades only 25,000 shares per day.  While all three funds provide similar exposure, the SPDR fund provides the lowest expense ratio--a mere 0.59%. It is no surprise then that it has the highest YTD return (3.40%, versus 3.08 for Market Vectors and 3.13 for iShares).  In addition, although the SPDR fund has the lowest volume, the bid - ask spread is still very narrow and similar for all three.  That should be a reminder that when dealing with ETFs, volume and liquidity are not the same things.

The bottom line is that I think a rich natural resource base, strong financial position, and cheap valuation make the Russian equity market an attractive long term investment opportunity.  As always, I think positions should be taken in moderation as part of a properly diversified portfolio appropriate for your needs and objectives, and of course, only at your own risk. 

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