A new reason why Russia should not stay unloved

It has been a funny old year for Russia. The world’s best performing stock market in the first three months, it then experienced the biggest level of fund outflows it has witnessed for five years during late May. That flow was caused by the reduction in the oil price, a sector which still accounts for just over half of the Russian index.

Da Vinci CIS Opportunities Fund is a multi-strategy fund focused on Russia and the CIS. The fund invests in listed equity and debt instruments and derivatives. The fund targets absolute annual returns of 20% and its current size is $45 million. The fund was up 88% in 2009, 32% in 2010 and 9% year-to-date in 2011.

“There are old, but still good reasons for investors to love Russia: It is the cheapest big equity market in the world, (despite being the best market in the last 10 years) and it is politically stable in the medium term,” says fund adviser Dmitry Malykhin.

“A new reason Russia should not stay unloved is that it is by far the largest oil exporter outside the Mena region and the developed world. Increased demand for liquid natural gas and natural gas after the earthquake in Japan has made Russia the best gas play.”

The other plus mark for Russia he highlighted was the low level of public debt. Sovereign Russian debt trades at about 160 basis points over treasuries. The country is running a budget deficit at present, but has built up a cushion amounting to the world’s third largest foreign currency reserves as a rainy-day buffer lest oil price revenues decline.

In March this year, Russia’s finance minister Alexei Kudrin said that in order for the government to balance its budget, it needed crude oil at $115 per barrel. Today oil traded just below $100 per barrel.

“While Russia may show gains similar to its huge 700% run for the last 10 years, most developed markets may suffer just another “lost decade”. Investors who allocate just 5% to Russia will distinguish themselves considerably compared to those who don’t, providing all other things are equal,” he added.

‘Just give the country 5%’ is a statement we hear from a number of managers with geographical mandates in emerging markets, (and in Japan too, come to think of it). With a lot of countries making a similar case, allocators have a lot to choose from.

In the July edition of AsianInvestor we speak to a number of Russia fund managers who tell us why Russia has become an ‘unloved Bric’ and why they think that label will not stick.