With gains of 31.58 per cent, Russia was comfortably the best performing major market in the first half of 2019, beating its closest competitor by more than 12 percentage points.
Yet the winding up of BlackRock Emerging Europe last year means the IT European Emerging Markets sector comprises just one trust – Baring Emerging Europe – with assets under management of only £107m.
Matthias Siller, the manager of the Barings trust, is surprised by the lack of interest in the region’s companies, considering the outstanding returns they have generated year to date.
“Normally there’s so much content on TV and on the net, I thought the best performing large cap stock in the world would be a talking point with people on Twitter,” he said.
“But the best performing large-cap stock is Gazprom and nobody talks about it, at least not in a positive way.
“This is so symptomatic. I think it is up 60 per cent year-to-date, it has a $100bn market cap and this is a stock that is truly liquid – it’s about 45 per cent free float.
“I thought people would talk about it, at least from a global emerging markets perspective. So, you see how hostile the environment is towards emerging Europe.”
One of the reasons there is so little interest in Russia is the delicate political situation, with the US and EU imposing sanctions following military intervention in Ukraine in 2014. It is estimated these have cost Russia between $100bn and $140bn so far, and while sanctions were lifted against three countries in January, the majority remain in place.
However, Siller believes this is more than priced in.
“In regard to the trade disputes, something can pop up somewhere every other day,” he said.
“And I’d say this political risk exposure in emerging Europe is at least known: the scope is unknown, but at least we do know that Russia is not good friends with the US. And this is leading to a situation where Russian equities are very cheap, or cheaper than they normally used to be.
“So you are rewarded as an investor for taking this risk. And as long as you diversify your overall risk, I don't think that this is necessarily negative for your portfolio.”
However, the manager said pointing to cheap P/E multiples is far too simplistic as a reason to invest.
“I’d take a step further and I would highlight the high yield the portfolio has been generating and more importantly, that the income of the portfolio has been increasing substantially.
“This is not so much a function of the earnings per share, it’s much more a function of ESG [environmental, social & governance], especially corporate governance.”
The manager said the region seems to have only recently stumbled across the benefits of returning cash to shareholders and, as a result, the income paid by his portfolio has almost doubled over the last five years.
Another benefit is that in a world where income is difficult to come by and a high yield is often accompanied by question marks over its sustainability, the opposite is true in the emerging European market – valuations and payout ratios are low but yields are high.
“Going forward, one of the main attraction points here will be uncorrelated EPS [earnings per share] growth, low correlated EPS growth, coupled with a high chance that ESG drivers will see corporate governance improve further and therefore there will be more efficient spending,” he added.
“More efficient spending means higher payout ratios and that will translate into DPS [dividend per share] that grows faster than EPS. Our base case is this is what will drive the portfolio forward in the next couple of years.”
One major issue with emerging Europe is the dominance of oil & gas – while Siller is 6 percentage points underweight compared with the market, the sector still accounts for about one-third of his portfolio.
However, even Russia is not entirely dependent on oil – for example, over the past five years while the price of the commodity has fallen by 40 per cent, the market is up by close to 80 per cent.
One sector that is growing in importance is tech, with co-manager Maria Szczesna pointing to Russian online bank Tinkoff, which has millions of customers even though it doesn’t have a single branch.
Meanwhile, Siller highlighted Polish computer game producer CD Projekt, maker of the Witcher series which has sold 30 million copies. The manager has high hope for its follow-up, too.
“It’s all about Cyberpunk 2077, this is a game that is going to be released in 2020,” he explained.
“It features Keanu Reeves, has a global fan base before it’s been released and will sell between 17 and 20 million copies in the first year.
“In other words, this is a computer game developer that has achieved global status and a strong following across all continents.
“This is outstanding, and also underscores our argument that a lot of the global scale development nowadays will happen from Warsaw, Poznan, Minsk and Kiev and you don’t necessarily have to work in Silicon Valley or London to achieve strong fellowship in Asia, for example.”
Data from FE Analytics shows Baring Emerging Europe has made 177.48 per cent since Siller became manager in January 2009, compared with gains of 124.22 per cent from its MSCI Emerging Markets Europe 10/40 benchmark.
Performance of trust vs benchmark under manager tenure
Source: FE Analytics
It is on a discount of 10.74 per cent compared with 11.83 and 12.54 per cent from its one- and three- year averages.
The trust has ongoing charges of 1.5 per cent and is yielding 4.09 per cent.