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Investment Trust Insider: JPM Russian Securities - a rocky but rewarding ride

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Investment Trust Insider: JPM Russian Securities - a rocky but rewarding ride

I had a look at JP Morgan Chinese last week. This week it is the turn of JP Morgan Russian Securities (JRS). It has the distinction of being the only Russian fund to outperform the MSCI Russia Index over the past year and appears to have an excellent long-term record, having returned almost twice as much as that index over the past decade, making investors five times their money.

The fund is a decent size, with a market cap of £282 million, and has been around since 1994, which makes it the oldest investment company specialising in Russia. It became an investment trust in 2002; prior to that it was an offshore fund.

At the moment, it is trading on a discount of 12.5%, having widened out a little over the course of this year. This is wider than the board’s desired maximum of 10% and the company has bought back a few shares recently.

It uses the MSCI Russia 10/40 index as its benchmark – one of a number of indices MSCI introduced to make it easier for investment managers that wanted to comply with the Ucits III rules on the concentration of portfolios. The 10/40 indices limit the largest stock in the index to 10% of the market cap of the index and limit the combined weights of all those stocks that comprise more than 5% of the normal index to 40%.

Russia’s three kings

Interestingly, there is quite a divergence between the MSCI Russia 10/40 index and the MSCI Russia index and that is because around half the MSCI Russia is composed of just three stocks – Gazprom, Lukoil and Sberbank – and the energy sector accounts for over half. If you compare the fund’s long-term performance with the 10/40 index, the fund has more or less matched its benchmark since launch.

In its last full accounting year, which ended 31 October 2011, JRS’s performance was very poor relative to its benchmark and this has dragged down the fund’s long-term figures.

The reason for this was a conscious decision by the investment manager to underweight the energy sector. This worked well for a while, but came unstuck when the oil price recovered in September 2011.

The board was rattled enough to consult shareholders on the best way forward and came up with a cut in the management fee from 1.5% to 1.2% and limits on divergence in sector weights between the portfolio and the benchmark and a limit on the maximum overweight in any one stock.

It also held a continuation vote in January this year. It passed this comfortably and the next is scheduled for 2017.

On the whole, I think the measures adopted were sensible but I think they should be careful not to make JRS too like the benchmark. JRS’s portfolio managers, Oleg Biryulyov and Vitaly Kazakov are stockpickers. They have been trying to construct a focused portfolio (around 40 names) of high quality growth stocks that will outperform the market as the Russian economy becomes more like a developed market.

If they believe, as they said in last year’s report and accounts, that many stocks in the energy sector do not have sufficient free cashflow to warrant inclusion in the portfolio, then in my opinion they should be free to exclude them. The managers have also highlighted the growth in popularity of ETFs, even in ETFs based on the MSCI Russia Index, which carry enormous stock specific and sector risk.

As more money flows into these products, markets become less efficient and truly active managers can exploit this.

Time to buy

At the moment, Russian stocks are trading at 1.5x book. The managers say this is usually a good time to be buying. The recent weakness in the oil price may push the market lower in the short term. However, even after the introduction of the portfolio limits, they are still almost 15% underweight the energy sector.

Of course, there is a big question mark over the pace (and maybe even the direction) of Russia’s shift to become more ‘normal’. The ruling party’s manipulation of the political system and enrichment of its members and allies is a major impediment to the process.

The managers hope for less central control, more privatisation, better property rights, more democracy, investment in infrastructure and the encouragement of private savings. They also recognise that energy prices have a huge influence not just on government revenues – Russia is the world’s largest oil producer and tax revenues from the energy sector made up half of state income in 2011 – but also the pace of reform.

If their desires are realised, investors in Russia will do very well, but this is always going to be a rocky ride.


James Carthew is a director of Sapient Research 

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