The Russian market is “significantly undervalued” with several key economic indicators becoming more supportive of stronger economic growth, according to Neptune Investment Management’s Robin Geffen.
The Neptune founder (pictured), who manages the £210.9m Neptune Russia & Greater Russia fund, said there are several reasons for optimism over the economy following previous challenges. 
James Dowey, Neptune’s chief economist & CIO, said that the short-term picture was encouraging for both the economy and the market.
He said: “The basic story is that Russia has recently emerged from recession. The approximate cause for that recession was a dramatic hiking of interest rates by the central bank in order to head-off two major risks to the economy that were present in 2015.
“The first was a bout of capital flight as the oil price sank and geopolitical problems caused a loss of confidence in Russian investments.
“A second risk was quite a sharp bout of inflation cause by depreciation of currency associated with that capital flight.”
Dowey said the Central Bank of Russia (CBR) had acted very strongly by hiking interest rates to around 17 per cent to head-off both risks “that are now receding into the rear-view mirror”.
“We can see inflation had risen to 17.5 per cent in 2015 and it is now back down to 4.1 per cent: effectively at the CBR’s 4 per cent target,” he noted.
“Inflation expectations have come down almost one-for-one with actual inflation which we find as a very significant data point.”
The Neptune chief economist said the Russian rouble had shown signs of stabilising, as had capital flows; credit default swap spreads have also moved back to normal territory.
He added: “Our basic case is that with these risks having receded the CBR is in a position to relax monetary policy quite significantly from here.
“They’ve done so only marginally so far. They’ve behaved very cautiously and quite commendably but we see lots of scope for rate cuts ahead and we believe this will boost growth strongly.”
Dowey said current consensus expectations for growth in Russia are at 1.2 per cent in 2017 and 1.5 per cent in 2018. However, Neptune is forecasting growth of 1.5 per cent this year and 2.5 per cent in 2018.
“This is not predicated on any help in improvements from the geopolitical situation: we’re not looking for any help from those unpredictable and noisy drivers, whatsoever,” he said. “This is all about basic economics and the impact of improving economic growth on profitability of stocks we invest in.”
Geffen added: “The Russian market is below the level when [Donald] Trump was elected, the famous ‘Trump bump’ is now gone.
“What we’re arguing for is an economic-led recovery; a recovery driven by GDP growth in this year and next year.”
Performance of MSCI Russia over 1yr
Source: FE Analytics
Geffen also noted that valuations are at very low levels, not just compared to developed markets, but other emerging markets as well.
He said: “Russia trades at a discount to other emerging markets of 50 per cent: an extraordinary discount and one you have to go back some time to find a similar level.”
Geffen said there are also compelling yields on offer in the Russian market with the prospects for a further boost in pay-out ratios as the market recovers.
The fund manager noted that the less foreign investment into the market had also allowed highly profitable oligopolies to develop.
“A lack of international capital flowing in to Russia has allowed oligopolies to develop in a number of areas of the market and create superior returns,” he said. “You’re able to find private companies with very high levels of management, proven execution and companies that have gone through very tough times and learned to survive in them.”
One example of a stock favoured by the management team is oil & gas company Novatek, which has increased free cashflow and invested in new projects to boost profits.
“Novatek is our preferred stock in the oil & gas space,” said deputy fund manager Thomas Smith. “I think it really stands out from peers in the sector, purely due to quality of management and the alignment of managers with minority shareholders.
“They have consistently generated very high returns. The story over the past couple of years has been about the Yamal LNG [liquid natural gas] project, that is approaching completion now.
“At the end of Q1 the project was 81 per cent completed… it is due to start up in the second half of this year and that has been a key driver behind free cashflow generation.”
Smith said Novatek was completely different to sector giants Gazprom and Rosneft, where management is not incentivised to generate value for minority shareholders.
Geffen added: “We deliberately do not hold overvalued state-owned oil companies. They have a very specific objective of helping employment in Russia.
“They tend to have high levels of staff and tend to fulfil a social objective in places where they are drilling, they might own schools, chicken farms: things you don’t expect them to own.”
The three crown-rated Neptune Russia and Greater Russia fund has delivered a return of 19.63 per cent over the past three years, compared with a gain of 13.87 per cent in the benchmark MSCI Russia Large Cap index.
Performance of fund vs benchmark over 3yrs
Source: FE Analytics
The fund has an ongoing charge figure (OCF) of 1.1 per cent.