When a tearful Vladimir Putin accepted the Russian presidency in early March, his political opponents, who had endorsed the view that his victory was fraudulently won, were confident that the protests that began after a disputed parliamentary election in December were not a flash in the pan.
Russia and Russians were angry, they said, fed up of the allegedly undemocratic ways in which their politics have been run. They wanted change, they would fight for change, and they would continue to protest until they got the changes they sought.
Today, the anti-Putin protests are still raging. As in other countries—Tunisia and Egypt, to name a couple—the Internet is playing a keen role in spurring an angry population (or parts of it, anyway) to participate in protests across the country.
Is Russia another Arab Spring in the making? Despite the serious political awakening that the Russian population is experiencing, most pundits and analysts have said no. But there’s no denying that political risk has become the No. 1 concern for anyone investing in Russia, undoubtedly leading some to cut back on their exposure to one of the largest emerging markets in the world.
At the same time, though, the allure of Russia is undeniable. This is a huge, vast nation with boundless growth prospects. Most importantly, it has a wealth of natural resources: That alone is enough to keep many investors committed and going back for more.
How do investors view Russia from here on? Politics aside, what do they consider the greatest challenges to investing in Russia? What are the greatest investment opportunities, and where do they lie? What sort of reforms would they want to see enacted to ensure stability in the long term?
Investment Advisor interviewed several Russia experts to get a sense of how they’re answering these questions and how they’re navigating the rough waters between politics, corruption, oil and other opportunities.
Tom Wilson, head of EMEA equities, Schroders:
“Compared to other emerging markets, particularly Asia and Latin America, Russia is starkly cheap.”
Tom Wilson, head of EMEA equities at Schroders in London, is overweight Russia for the company’s $500 million Emerging Europe fund (SEMVX).
Granted, Russia makes up 60% of the Emerging European index, but that aside, what’s driving the overweight at Schroders is simply valuation: the fact that Russia appears cheap compared to the rest of emerging Europe.
“The current market multiple is 5.2 times price to earnings—notably cheap compared to other emerging markets, particularly Asia and Latin America,” Wilson says.
That’s too good to be true, but difficult to pass up for investors like Wilson. To boot, he believes that “Russia is also attractive from an economic perspective. The economy is well-supported by current crude prices, which have positively surprised investors in 2012. The demand picture in the United States has been somewhat weak, but limited spare capacity at [the Organization of Petroleum Exporting Countries] and geopolitical events in Iran, Nigeria and Sudan have been supportive.”
Easing geopolitical tension and higher Saudi Arabian oil supply might reduce crude prices somewhat, but Wilson is nevertheless comfortable where things stand.
“My expectation is that we see oil prices average $110 per barrel in 2012,” he says.
At the beginning of this year, Wilson and his team had counted on 3.5% GDP growth for Russia. But if crude oil prices remain at their current level of $125 per barrel, “there is a clear upside to that figure,” he says. “If crude prices are sustained at current levels, then it is positive for Russia both fiscally and in terms of the current account. It is therefore positive for both the currency and domestic liquidity, and supportive of both corporate and consumer confidence. It is also positive for the government debt metrics, already notably low compared to other countries, with gross public debt to GDP at only 10%.”
As a region, emerging Europe is currently out of favor from an allocation perspective given its links to the eurozone. Valuations are attractive across the region, but for Wilson, Russia stands out compared to both the emerging European region and particularly compared to global emerging market peers, as it is relatively cheap in almost all industrial sectors, except consumer staples.
Wilson likes a large number of Russian equities, particularly consumption-driven stocks. Media and food retail are two areas he likes, and he has a positive outlook on financials as well, while he finds oil and gas notably cheap. Contrary to other investors, though, Wilson is cautious on metals and mining, mainly because of the slowdown in demand from China.
When it comes to Russian politics, Wilson is less bearish than other investors. After the December parliamentary election and the questions about its legitimacy, there was a material sell-off in Russian equities (which made the market even more attractively valued), and protests in the streets of Moscow and St. Petersburg dominated the headlines.
“The big question before Christmas was whether the protests would gain momentum and whether we’d have another Arab-Spring-type situation, but we took the view that we wouldn’t and that the protests would not run out of control,” he says. “The government addressed them in a pragmatic fashion. Furthermore, even though Putin’s poll performance has been falling, he retains a high degree of popular support. The key question now is how the government responds to the concerns of the protestors. We have seen positive reform rhetoric on this front, but implementation will be key during the next presidential term.”
The protests—which came mainly from the middle class—can be viewed as a testament to Russia’s increasing political maturity, whereby the middle class has achieved relative prosperity and is increasingly concerned with issues like rule of law, civil liberties and freedom of expression. Nevertheless, the protests did and will continue to highlight corruption in Russia—a concern for Russians as well as for foreign investors.
Richard Segal, Emerging Markets Credit Strategist, Jefferies:
“Russia’s oil and natural gas reserves are its greatest asset, but could be the country’s undoing.”
It goes without saying that investors will be attracted to any large market, no matter the challenges and risks it presents, if it is rich in natural resources.
This has been and continues to be the case for Russia, says Richard Segal, an emerging markets credit strategist at Jefferies International in London. Russia’s oil and natural gas reserves are its greatest asset, but Segal—who has been covering Russia for many years—believes that this same wealth could also turn out to be the country’s undoing. Russia, in his opinion, is far too oil- and gas-dependent, and that dependence seems only to be increasing. If ever the oil price trend were to reverse itself and head downward, things would become tough for Russia.
“Unfortunately, even if the country diversifies away from oil, it tends to be toward metals or other natural resources in general,” Segal says. “It’s been hard also in Russia to build industries that can compete with oil and natural gas for a number of reasons. Geographically, it’s a huge country to manage, which makes diversification even tougher. Really, there’s little incentive to diversify because whenever oil prices have been low, the government has gone into an effective crisis management mode and manages to keep things stable.”
Diversification efforts—or lack thereof—aside, Russia doesn’t have what the other BRICs have in terms of being able to produce consumer goods. It hasn’t proven to be much of a service industry nation either, and it is affected by several inherent challenges, namely a falling population, a difficult geography and high levels of governance risk.
That said, there is no need to panic in the near term about the potential negative impact too much dependence on oil could have on the Russian economy. The price of oil appears to be constant and oil reserves will last a long time, Segal says. Besides oil, Russia is extremely rich in many other natural resources.
Russia is also close to Europe and China, which means it benefits from a strong demand for both oil and other natural resources from several quarters.