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Most Foreign Capital Flowing Into Russia Stock Market Is American

This article is more than 4 years old.

Sanctions against some of their most important companies, and the constant barrage of anti-Russia rhetoric in U.S. headlines have failed to deter American investors from pumping billions into the Moscow stock market.

North American investors, led fully by Wall Street, account for over half of the foreign capital flowing into Russian stocks, according to the Moscow Exchange. By comparison, Russia’s next door neighbors in Europe account for only 26%.

“Our weight in Russia has not materially changed and if anything it has increased slightly,” says Lu Yu, a fund manager for Allianz Global Investors in San Diego. She says they have a “large overweight” position in Russia stocks, including shares of Norilsk Nickel and Lukoil. Norilsk is up 46% year-to-date. Lukoil is up 26.3%. “These two private companies have weathered the sanctions storm much better than other state-owned companies,” she says.

As of the second quarter of 2019, the most recent number for stats shared by the Moscow Exchange, U.S. fund managers like Allianz put $79.3 billion of American investment capital into Russian publicly traded companies, an increase of 58% since 2015. The RTS Index has a market cap of around $170 billion.

“The idea that foreign investors have abandoned the Russian market is entirely unfounded,” says Maxim Lapin, CFO of the Moscow Exchange. “Foreign investors – and prominently U.S. investors – hold a sizable portion of the Russian free float.”

Active investors have been able to avoid sanctioned companies like Gazprom and Sberbank, and buy shares in companies like tech giant Yandex or consumer-driven names like Magnit, a grocery store chain with around 20,000 stores nationwide and over 300,000 employees.

Russian stocks, as measured by the VanEck Russia (RSX) exchange traded fund, are up 23.4% year-to-date while the S&P 500 is up 19.9% and the iShares MSCI Emerging Markets Index (EEM) is up 8.45%.

“Europeans are overweight Russia; Americans are overweight Russia. If you look at the benchmark, Russia accounts for maybe 4% of emerging markets equity but these guys hold much more than that,” says Charles Robertson, global chief economist for Renaissance Capital in London. “You don't have to invest in sanctioned companies,” he says of the sanctioned sectors of the Russian economy.

The U.S. slapped sanctions on Russia primarily due to Russia’s involvement in an eastern Ukraine separatist movement.

Like India and China, Russia is also investment grade with a BBB rating by Fitch. Unlike Brazil, Russia has spending under control and has $124.14 billion in a Finnish-style National Wealth Fund. That was 7% of Russian GDP at the start of the year.

They also have double that in central bank international currency reserves.

Besides equity investors, bond investors like Russia.

“I find myself almost laughing to think that Russia is a safe haven,” Eric Jayaweera, senior portfolio manager for Emso Asset Management said during a recent panel discussion at a Moscow Exchange event held at The Roosevelt Hotel in New York.

They have a twin surplus, a conservative finance ministry that could actually be a little more liberal with its spending because Russia’s debt to GDP ratio is just around 20%. Brazil’s for example is close to 80%.

“Plus, you’re in a world in Europe where a third of government bonds are zero or negative. There is no yield there,” says Jayaweera. “Russia is a low risk place as far as we are concerned and you can go to ruble debt if you want to take on more risk and do even better with interest payments. The last two months I think there has been about seven or eight Russian corporations issuing euro bonds, like Serversal and Russian Railways come to mind,” he says. “The fear of sanctions have disappeared. I think its pretty remarkable.”

Yield also comes in the form of dividends for equity investors. Russian dividend yields are over 7%, more than twice the yield of the MSCI Emerging Markets Index.

“For bonds, we are bullish until mid-2020,” says Slav Smolyaninov, chief strategist for BCS Global Markets, the largest broker in Russia. “When we sell the Russian case to American, European or Asian investors, the 1% GDP growth isn’t what excites anybody,” he says. “That 7% yield is a better reason to buy. The ultimate global investor is the American retirement fund and they are invested in every part of the world. Russia is still part of the world,” he says, tongue-in-cheek.

So long as Europe interest rates remain depressed, Russian securities look like “safe havens” even as many political leaders there – and here – continue to blame Russia for all sorts of domestic upheavals.

“This may be the peak (for Russia), but with yields all around her looking a bit flat, investors will still be showing positive interest,” says Lapin.

A slowdown in Europe could hurt economic fundamentals in Russia, especially if that translates into weaker oil and gas demand, a staple Russian export to the EU.

Russia will be faced with an increasingly difficult external environment, too, if China’s economy retreats. Russia has been increasingly looking to China for business and investing partnerships, though much of this has been in the obvious commodity sectors.

Even so, Russia has the fiscal and monetary wiggle room to deal with these external factors, unlike Europe, says Robertson from RenCap.

Russia needs a hefty dose of supply side economics: productivity growth, better demographics, and capital infusion outside of speculative capital in securities.

Demographics aren’t working in Russia’s favor, so they need productivity growth and capital formation into job creating industries with potential for export. Taxation is not high, and expected to come down once the VAT tax expires next year, though that is not a guarantee.

Russia’s economy has had much of the same problems since 1992. Investors are still waiting for many of them to be addressed, including privatizing state assets. It looks like they’ll keep waiting.

Nevertheless, they’ve waited just as long for China’s market to become more open to foreign investors. Over the last five years, Russia has returned around 7% annualized to investors. Within the big four emerging market nations, that’s only beat by China. The MSCI China is up 20.7% since 2014, and investors there are now faced with a trade war and sanctions, making Russia look pretty good so long as Washington’s angst is aimed at Beijing and not Moscow.

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