Investors looking for strong domestic growth opportunities like those witnessed in China could consider an allocation to Russian equities, according to Baring Asset Management’s Matthias Siller, who says there are a number of companies with the potential to become much bigger.
The Covid-19 crisis has hastened many of the pre-existing trends towards e-commerce and the digital transformation, and a lot of what is happening in western Europe is also happening in Russia.
Yet, because the internet infrastructure in Russia is homegrown, domestic companies have greater opportunity when compared with peers in western Europe, according to Matthias Siller (pictured), manager of the £89m Baring Emerging Europe trust. 
The manager said the situation in Russia is comparable to China where domestic companies dominate the internet infrastructure, noting: “local incumbents in Russia have been able to forge out a good market share”.
“What sets Russia apart, is that you’re not talking about the fringes of the internet or heavily competing areas of the internet like e-commerce, you’re talking about the whole thing,” said Siller.
And due to the fact that the internet has become hugely politically charged over the last couple of years, Siller believes it gives Russian internet names a competitive advantage.
He explained: “Over the last couple of years, you’ve had a very strong political move to make sure domestic infrastructure is being used and established, when it comes to data.
“To be successful in any form of internet in Russia, you will find yourself in a situation where you will have to store data on Russian soil. This will be a bit more difficult for some of the US names.
“That means the Russian domestic names will be the winners amongst the different sectors within the internet, e-commerce, e-banking, advertising and social networks.”
Indeed, some of the trust’s strongest contributors of performance in the last year have been e-commerce and internet stocks, namely Mail.Ru and Yandex, where the trust is overweight relative to the rest of the sector.
The manager highlighted Russian challenger bank Tinkoff as an example of a company that has mirrored the developments seen in western Europe.
The company was set up as a branchless operation initially focused on credit cards, and has since expanded into other financial services.
“Built from scratch, it doesn’t have any legacy or branch network and can therefore focus on the opportunities in the market, where it has been very successful in exploiting these opportunities,” explained the trust’s co-manager Maria Szczesna.
She said that Tinkoff is an example of a company where there is true and idiosyncratic development.
“It is the largest and most successful challenger bank in Europe in terms of user engagement and user numbers. It really stands out,” Siller added.
“Whether the likes of Monzo or Revolut will make economic sense, I would say Tinkoff leads them on many parameters but trades at a similar valuation in terms of their last capital-raising rounds.”
Baring Emerging Europe trust has around 2 per cent of the portfolio invested into Tinkoff, which currently yields a 2 per cent dividend.
“What is depicted as a relatively low yield, is quite attractive given it is a growth company, or trading at a valuation where the yield makes a mark,” said Siller.
“The relatively low valuation of Tinkoff, even with a conservative payout ratio, means you get some sort of yield pick-up from many of those growth companies in emerging Europe.”
He continued: “The fact that Tinkoff yields you 2 per cent doesn’t mean they pay out, it means they are cheap.
“They pay roughly a quarter of their profits, which means they can reinvest 75 per cent. On a peer-to-peer comparison a company like Tinkoff paying out 25 per cent of their profits would not equate to a 2 per cent yield.
“It’s just because you have the discount in emerging Europe that keeps valuations lower than all the other places.”
This allows the trust to generate an underlying yield without compromising on investing into growth companies, said Siller.
“Normally you have to choose,” he explained. “The overall yield generation of the portfolio does not necessarily indicate we are not investing into growth. It is an unlikely marriage between high yield generation and growth exposure in unique sectors from a European perspective.”
Beyond the ongoing digital revolution in Russia, one of the trust’s other strongest contributors to performance of the trust this year has been Russian gold miner Polyus. While Siller admits that he is by no means a ‘gold bug’, he praised the “unbelievable” growth profile of the company.
“It really stands out because it has this huge project, the largest manmade structure under construction that is an open pit,” he said.
Interpreting the initial geological data from the project, he estimated it would improve gold production by about one-third, “which is super attractive in an environment that will see growth in the gold price”.
He added: “That changes the entire characteristics of this huge project and therefore the entire company.”
Siller also pointed out that it is one of the cheapest gold producers globally, with the production of one ounce of gold costing Polyus slightly more than $1,000 all-in, including depreciation – i.e.: over the entire investment cycle.
“With gold closer to $2,000, therefore Polyus is actually one of the best placed companies in terms of gold production,” he noted. “If the gold price went down this year, Polyus wouldn’t have necessarily performed negatively.”
And due to its low production costs, said the manager, Polyus will probably be the last gold mine to shut down.
In addition, if the majority owner – the billionaire Kerimov family –sold some of its stake to allow more free float on the market, Siller said it would make Polyus more sought-after by global managers in their benchmark.
“This would make Polyus a household name from a portfolio management perspective,” he explained. “It already is, from an engineering perspective”.
“It’s the growth aspect that nobody is looking at,” the manager concluded. “That’s why we like Russian equities, much like Polyus – you have a lot of defensive characteristics at the same time as this growth option.”
Baring Emerging Europe has made a 74.91 per cent return versus the average peer in the IT European Emerging Markets sector’s 79.65 per cent return and the MSCI Emerging Markets Europe’s 48.25 per cent return over the same period.
Performance of the trust vs sector & benchmark over 5yrs
Source: FE Analytics
The trust is trading at a 12.3 per cent discount to net asset value (NAV), has a 5.5 per cent yield and is not geared, as at 15 September. It has ongoing charges of 1.49 per cent.