Why risky Russia is still misunderstood

Emerging markets in Asia and Latin America continue to turn investors’ heads.  But the story of reform in ‘risky’ Russia may be getting missed, largely because it is still masked by misconceptions.

Year-to-date, Russia and eastern Europe are among the few emerging markets that has risen, however it is Brazil and China – both dogged by spiralling inflation - that continue to attract the bulk of investor flows.

There is a trio of benefits that could boost Russia’s appeal, though, namely its increased transparency at a political and corporate level as well as the country’s cheap – and untapped - labour force.

‘As is probably true elsewhere, the greatest upside is where the fewest people are looking,’ BlackRock’s Sam Vecht explained, arguing that like much of eastern Europe, misconceptions about Russia are widespread at a country, stock and sector level.

‘We think [Eastern Europe] as a story is not well understood.  It is misunderstood,' Vecht said. 'Earnings per share are strong at around 20% on average for the last 10 years.  20% is faster than emerging markets and faster than all the world.'

Compared to even the most popular emerging markets, Russia, Poland, Hungary and the Czech Republic are the only regions to have risen year-on-year.  Everywhere else is down, India particularly so.  To date, figures collated by MSCI show China has fallen 5.5%, India has slumped 15.6% and emerging Latin America is down 7.68%.  At the other end of the spectrum the Russia has risen 4.5% year-on-year, while the Czech Republic has shot up 18.8% and Poland is up 9.48%.  The differences in the emerging world are extreme, Vecht, who runs BlackRock's Frontier Markets and Eastern European Trusts, believes.

Can weak expansion thwart Russia's rise?

While Russia, along with a number of parts of eastern Europe has been on the rise, weak economic expansion could force a pause in its run.

The country's GDP is forecast to meet the 4l.5% year-on-year rise expected for quarter two, however against a backdrop of soaring oil prices, low single-digit expansion may disappoint investors.

Capital Economics' believes Russia is still vulnerable, as the fortunes of its economy remain hitched to the price of oil.  Over the near-term, strong retail sales growth, investment and the government's decision to start spending some of its oil profits will help keep the country on growth on track, and even help it accelerate further.  But any investor who scratches beneath the surface will find familiar problems persist.  'Most obviously, the economy remains leveraged on the price of oil.  The non-oil budget is now greater than 12% of GDP - compared with a pre-crisis target of 4.7% of GDP - and we estimate that an oil price of around $105 per barrel is needed to balance the books,' Capital explained.  'If the government does opt to spend at least some of its latest windfall (as seems likely) the public finances will simply become more vulnerable to shifts in oil prices.'

However Vecht says that when investors pile into a region they are largely buying its companies.  '[Investors] are buying companies not countries...eastern Europe is cheaper than other markets.  PEs are around 10 times, currencies are cheap and not overheating.' Vecht added.  'People are perhaps missing the story of reform.  Between 2005 and 2006eastern Europe was broadly in line with emerging markets but today it is discounted 30% to 40%.  I am not of the view that all of this will necessarily close, but if some of it does, you can see why the region will perform.'