The Russian index has sold off since the beginning of the year when Russia supported Ukrainian separatists’ annexation of the Crimean peninsula. The province then applied to become part of the Russian Federation and was annexed by Russia, prompting sanctions from the US and the European Union.
Apparent ongoing military support by Russia for the rebels has bought deeper sanctions against the country by the US and EU, which has been partly reciprocated, and has meant sentiment has stayed low for the market.
Since the beginning of the year the MSCI Russia has fallen as much as 25 per cent but it is currently down 15.48 per cent.
Performance of indices in 2014
Source: FE Analytics
By comparison the MSCI Emerging Markets index has bounced back from its recent sell–off at the beginning of the year and is up 8.99 per cent.
Titherington (pictured) says that despite the headwinds, there is almost no historical precedent for a strong bounce-back in emerging markets over the short term when the average dividend yield of an index is larger than the price to earnings ratio.“Today, the dividend yield on Russian equities is higher than the price to earnings ratio [P/E]. Russia is not an easy subject to talk about right now. It has been a difficult place for many years. However, what drives long-term returns as an equity investor is valuations,” he said.
“Everyone thinks that corporate governance is really bad in Russia but dividend yields and pay-out ratios have actually been going up. Corporate Russia is actually distributing more cash to shareholders today than it has ever done in the past.”
“What happens in emerging markets when you get a P/E below the dividend yield? Historically it has happened about 30 times. It has happened in Hungary, Indonesia, Turkey, Brazil and Russia. Every single time except one on a 12-month view you have made somewhere between 50 and 150 per cent.”
Titherington says in these examples the situation on the ground has looked equally bad or even worse than Russia’s current sanction constraints.
“Every single time it has looked really bad - coups in Thailand, presidents arrested, currency collapses - but only one occasions when you have lost money buying an emerging market when the dividend yield is higher than P/E and that is our dear old friend Argentina.”
“That happened because they both revalued the currency and imposed capital controls and defaulted on their debt.”
“So unless you think Russia is going to impose capital controls and default on its debt you have to think it is different this time and Russia is heading down a road like Iran - an international pariah rather than going through one of its typical cyclical issues.”
Over the past 15 years the MSCI Russia has suffered a marked correction of more than 25 per cent seven times and in each time it had rebounded more than 50 per cent within 12 months.
Performance of indices over 15yrs
Source: FE Analytics
According to FE Analytics, there are 18 actively managed funds with more 15 per cent exposure to Russian equities including Invesco Perpetual Emerging European [63.55 per cent], JPM New Europe [49.1 per cent], JPM Russia [81.6 per cent] and Schroder ISF Emerging Europe [47.84 per cent].
Jan Dehn, head of research at Ashmore, says the Ukraine/Russia stand-off was the primary worry for global equity markets but that has recently been displaced by concern of US monetary tightening as the Fed looks set to end its quantitative easing policy, after nine months of ‘tapering’.
“We think the more rational assessment of Russia/Ukraine is positive, but we do not expect the tightening of financial conditions in the US to become a major problem for emerging market countries.”
“Geo-political concerns have not gone away, but markets are becoming more rational about the situation in Russia-Ukraine and the Middle East, and shifting attention back to US markets, notably the dollar and US treasury yields.”
“It is unsurprising that geo-political concerns are fading a bit. It is the normal pattern for the complexities of geopolitical events initially to scare investors into selling all kinds of assets, even those with no direct connection whatsoever to the events in question, but then slowly for rationality to set in and eventually the risk is correctly priced.”
He expects to see further de-escalation of tension in the coming months, improving stock market sentiment.
“Russia’s fundamentals are strong and we see little risk from a credit perspective. We think a solution is close, because the costs to both sides have now reached a level where they begin to matter more than what is at stake in Ukraine.”
“Throughout this conflict both sides have been extending olive branches, but so far both sides in this mini-Cold War have failed to display the courage required to fix this relatively simple geo-political conflict. Minds are likely to become more focused as winter draws closer and once the Ukrainian elections are out of the way.”
