Transcript: Where To Invest In Russia

Published in Investing on 4 April 2011

David Kuo talks to Marina Akopian from HEXAM Capital.

You can listen to or download this podcast here.

 

Narrator:

This podcast is brought to you by Motley Fool Dividend Edge, the home of high-yield investing.

David:

This is Money Talk, the weekly investing podcast from the Motley Fool. I am David Kuo, and in previous podcasts we have looked at investing in two of the four BRIC countries. We have looked at how to invest in China, and how to get exposure to the Indian market. Today we are going to look at the R in BRIC, or Russia. Some people would say you have to be insane to invest in Russia; others probably say investing in Russia is the crème de la Kremlin. Let us find out which is true from my guest today, who is Marina Akopian from HEXAM Capital. Welcome to Money Talk, Marina.

Marina:

Thank you very much for having me here, and giving me an opportunity to talk about Russia, which is one of our most favourite markets at the moment.

David:

I love your accent! – is it a Russian accent?

Marina:

It is a Russian accent. I came to London from Moscow in 1996, and clearly I haven't managed to lose it!

David:

Don't ever lose it – that is a beautiful accent. So tell me a little bit about HEXAM Capital. How did it start, why did it start, and why do you call it HEXAM?

Marina:

HEXAM Capital was started by a former Barings global emerging markets team in 2006. It started as a boutique, concentrating purely on global emerging markets. All of the partners, there are four partners at HEXAM, have always been doing global emerging markets equities throughout their career, and we have decided to create a new asset management boutique that will concentrate on global emerging markets, will be capacity-constrained, and will be driven first and foremost by interests of the investors.

David:

So when you talk about emerging markets, which ones are you referring to in particular?

Marina:

We look at all global emerging markets, which are all the markets that have a listed equity, and markets that do not fall into the developed markets indices. Just to give you an example, we have selective investments in countries like Kazakhstan, which is a former Soviet Union republic; we have investments in countries like Zambia; we have investments in the mainstream global emerging markets like BRICs. So as long as it's possible to invest in these markets, the stocks are liquid, we have met with the management and the stock is listed on a recognised exchange, we would consider it as an investment opportunity.

David:

So do you find there is a huge appetite for people to look at emerging markets? – because it's just like a new frontier for them.

Marina:

We have found certainly, over the last five years that HEXAM has been in existence, that the appetite for global emerging markets has risen considerably. There probably is a slight difference between investors in Europe and in the US. We currently have two billion dollars assets under management at HEXAM, which has grown from about 40 million dollars seed capital when we started in 2006, and the growth has been mainly through large institutional pension funds from the US, some of them from Europe, that have been continuously increasing allocation to global emerging markets. We believe that the crisis of 2008 certainly has showed that an opportunity for growth, non-artificially manufactured growth like sub-prime mortgages was, only can come from emerging markets, purely because of the fundamental reasons, like demographics and balance sheet. A lot of emerging markets at the moment have much better, stronger balance sheets than developed markets.

David:

So let's have a look at Russia in particular. I think I'm right in saying that the Russian economy is growing at around 4%, and yet you have two other big emerging markets such as India and China that are growing at 8% and almost 10% respectively. So why is the Russia economy growing so slowly?

Marina:

Russia has been lagging behind other BRIC markets in terms of growth, but Russia is still an interesting investment opportunity, even despite inferior GDP growth to other BRIC markets. Growth really comes from three factors: labour, capital accumulation and productivity. The reason that Russia is growing slower than China is due to the lack of the growth in labour force, and that relates to demographics. 

Clearly if you look at the population of Russia, which is 143 million, and if you compare that to the population of China and India, the reasons are becoming pretty obvious. So the higher population growth in India and China makes it possible to grow their GDP much higher than Russia. But Russia can compensate for that via higher productivity and investment growth, and that's why the current government has been calling for reforms to boost competition and develop financial markets and pension system to raise the economy's capability to accumulate capital.

David:

So can Russia ever grow at the same rate as India and China?

Marina:

Absolutely. This is not something that is not possible. Russia has absolutely everything it takes to growth 8, 9 or even 10%. The problem is a lack of productivity. For example, if you compare Russia to the United States, labour productivity in Russia is just 33% of the average in the United States. If you look at the productivity in the agriculture, it's just 10% of the level on the United States. So there is massive, massive inferiority in labour productivity. There is a potential for improvement, and it has been improving, and we believe that once the reforms come through, Russia will be able to increase its GDP growth even with a much smaller population.

David:

But I find it a bit strange, Marina, that a country like Russia that is growing at say 4% has a very high rate of inflation. The rate of inflation in Russia is almost 9%. You would normally equate a fast-growing economy with a high rate of inflation, but this is an economy that's only growing at 4%, and yet inflation is running at 9%. So what is causing the inflation in Russia?

Marina:

At the moment, if you look at why inflation has been so high over the past 12 months, you probably remember a severe drought that Russia experienced over the summer months last year, and a lot of fire that has affected food supply, etc. There was a significant growth in the money supply, which at the moment stands about 30% year-on-year. There are also factors that are structurally causing inflation in Russia. It has regulated tariff increases that are quite significant and sizeable, and another big structural problem is a lack of competition in Russia, especially at the regional level. So there is a lot of potential to basically hike prices whichever way they want.

But a very quick point to your previous question, if I just may add, is why we still think why Russia is attractive to especially foreign direct investments, like Pepsi-Cola acquired one of the largest Russian news producers ...

David:

Wim-Bill-Dann?

Marina:

... Wim-Bill-Dann last year, is the fact on a Gini Coefficient, which is basically the level of standard of living of people, Russia is actually not far behind the US and UK, and is way ahead of countries like Brazil and China on GDP per capital level as well – Russia is way ahead of China and Brazil and India. So the purchasing power of the Russian consumer is very high and especially for companies in the consumer sector, banking sector, Russia represents a very attractive investment opportunity. 

That's why, when you purely look on the top down level and you look at the GDP growth, and you take your investment decision based on the GDP growth, it's very misleading. The growth structure is actually growing much faster on the micro level, if you look at the EPS growth for certain companies, especially in the consumer sector.

David:

But Russia is trying to put a lid on inflation by raising interest rates. Interest rates in Russia are now almost 8%. How is this affecting businesses in Russia? Is it increasing the cost of capital for Russian businesses?

Marina:

Absolutely. It's reflected in the high cost of debt for Russian companies, and the rouble risk-free rate at the moment is, as you said, 8%, 7.5, and it does affect it negatively in terms of higher cost of capital. But if you look at the growth in earnings, these companies can compensate for these high interest rates. Another important point to make is that some of the Russian companies that certainly we look at have very low or no debt level at all. So the cost of capital is high, but you have to differentiate between companies – Russian companies are not very indebted.

David:

Now, my impression of Russia is that it is really just a play on commodities. How do you counter that argument that I might just as well go and buy an oil tracker? – because if you have a look at an oil tracker, and you superimpose that on the Russian stock market, it is almost identical. So how do you counter that argument that it isn't a play on things like oil and commodities, diamonds and the rest of those commodity-type of investments?

Marina:

It's very hard to counter that, and I'm not going to, because it will simply be untrue. Russia is at the moment incredibly dependent on the oil and gas prices, very dependent on other commodity prices. Clearly, if there is a sharp downward movement in, let's say, oil price, the Russian budget will be affected and as a result the money available to other industries in Russia will also be affected.

But there are two points to make. Russia is now in a much better state than it has ever been in terms of cushions that have been created over the past several years of higher oil prices. As of yesterday, the Russian foreign exchange reserves reached 500 billion US dollars, still one of the highest FX reserves in the world. The budget, if the oil price stays at the same level, will be balanced by the end of the year.

So there are two aspects to this. First of all, of course, Russia is very dependent on oil and gas, and I wouldn't deny that, as I said, if there is a downward movement in oil price, we will see a sharp correction in the Russian market, etc. But if you look at the Russian market wider, we actually think that it's probably better to play Russia not through the oil and gas sector. It's more interesting to play Russia, for example, through the banking sector. There are stocks that you can buy in Russia – for example, the largest Russian bank, called Sberbank, that is now coming up with a GDR programme, so if you do not have access to local Russian custody, you will be able to buy it on the London stock exchange in the near future.

Why banks are very interesting for us? – the consumer in Russia is not nearly as leveraged as it is in the West. So if you look, for example, at the mortgages to GDP ratio, it's only below 3%.

David:

So do people not borrow money to buy houses in Russia?

Marina:

First of all, the inheritance from the former Soviet Union, when every single citizen of Soviet Union was entitled to free accommodation, basically free flat or free house that was provided by the government. So of course, the majority of the housing that is still in existence has been left debt-free, mortgage-free, and purely ownership to the Russian people. So the demand for mortgages hasn't been nearly as high as it was, for example, for other emerging markets. But clearly, as the population grows and as the wealth of the population increases, and people would like to create their own families and leave the family home, they will need mortgages. 

There is double-digit growth in mortgage rate now in Russia, so we see a significant upside and opportunity for banking stocks in Russia, with mortgages and loans growing very fast. Again, if you look at the consumer debt in Russia, it's less than 10% of GDP. It's times and times less than it is in the UK, and that is to do with the fact that there is no culture of borrowing. Russians until recently did not like to borrow, didn't feel comfortable to go to the bank and get a loan. So this changes, and we see, as I said, a big upside for the Russian companies.

David:

OK, we'll take a quick break there, Marina. I just need to dab a bit of powder on my nose in readiness for a photograph with you afterwards, and when we come back, we're going to have a look at political risks.

Narrator:

Have you ever wanted to learn more about dividend investing? Hi, I'm Todd Wenning, lead advisor from Motley Fool Dividend Edge, here with a special offer for Money Talk podcast listeners. Right now at Dividend Edge, we're investing a real money, £20,000 portfolio in dividend-paying shares, with the goal of generating superior share income. In addition to the share tips, we also provide you with research reports and ongoing coverage of the shares we've recommended. So, if you'd like to improve your knowledge of dividend investing, visit www.dividendedge.fool.co.uk today to learn more. Thanks for your time, and Fool on!

David:

Welcome back to Money Talk. Now, can we have a look at political risks now, Marina? – because, as far as a lot of investors are concerned, you cannot separate political risks when you invest in Russia, and lots of people cannot help but recall pictures of people like Khodorkovsky and Yukos. So how can people be absolutely certain that the business they are invested in won't be interfered with by the Russian government?

Marina:

I think first of all, people have to remember where Russia is coming from, and what a phenomenal change the country went through from the early Nineties. You had a complete change of system from a communist command economy to a market economy. Until Putin came to power, Russia basically was in a total anarchy where you had President Yeltsin that was not really managing the economy and politics in a good way. Also, one has to remember how the accumulation of private capital happened in Russia. There were a load of criminal practices, and the privatisation did not happen in any way or form which could be called legitimate. I don't think anybody can doubt it now, or argue against that. 

What happened in Russia subsequently, and Yukos, etc, has been explained as a necessary evil to basically put things right and make oligarchs pay taxes. I think, without going into a discussion about what happened to Yukos and what happened to Khodorkovsky, and just purely being a pragmatic investor, looking at Russia there has been no Yukos since Yukos, and it's been quite a long time. 

Second of all, we believe that there is no reason for Russian government or Russian authorities to upset investors. Why is that? – well, first of all, Russia does want to get accession to the WTO, and if this happens it will be an additional positive indicator for investors that Russia will be more likely to adhere to rules of the good business practices than before. Second of all, there is going to be a massive investment programme starting from the Olympics in Sochi in 2014. There is going to be a World Cup. So there will be a lot of investment that Russia will need.

David:

I'm sorry you mentioned the World Cup, because there are lots of people over here who will be very upset that we didn't get the World Cup here in the UK. But congratulations for getting the World Cup in Russia.

Marina:

I'm not a football fan, so I cannot possibly comment. All I can say is, as an investor into Russian market, I think it's clearly a very positive sign, and our shareholders, investors in our funds rather, should also be very pleased with that. So I guess there are two ways of looking at that.

David:

I am a football fan, and my club would not have existed had it not been for a Russian oligarch.

Marina:

Well, here we go, so I think everything is relative. But I think the fact is that there is no objective reason for the Russian government to upset investors, or go and take assets away from the companies that we invest in. Having said that, we never become complacent. We never are complacent about any market that we invest in, and Russia clearly is not an exception. So we watch very carefully the legal side of things that's happening Russia, the laws that are being passed, and any sort of incidents that possibly cannot happen there, we watch very carefully, as well as meeting with the management of all the companies we invest in. 

So far, none of the companies that we have invested in or met with have sounded any alarm that there is any risk to their businesses. So I think certainly, with an outlook for the next 12 to 18 months, investors can be pretty confident that their assets are going to be safe.

David:

Now, you mentioned earlier on about the pragmatic investor. I am a pragmatic investor, and I look at Russia and I think there is going to be this growing middle-class consumers over there. Are there any easy ways of tapping into these consumers and what they would actually like to buy as they become wealthier?

Marina:

Yes, absolutely. There is a growing number of stocks that you can buy in Russia that give you this exposure to the Russian consumer. I have mentioned earlier Russian banks, and there is Sberbank and Bank VTB. VTB is already listed on the London stock exchange through the GDR programme. There is also Wim-Bill-Dann, which we've discussed, but it's now being bought out by Pepsi, but before that it was a very good stock to hold. 

There are companies like Magnet, which is one of the largest Russian retailers. There is also another retailer called Nvidia which is consumer electronics retailer, and consumer electronics in Russia is still a very unpenetrated sector with double-digit growth rates. If you are a little bit more adventurous, you can go for the real estate.

David:

That's me, yeah.

Marina:

You can go for the Russian real estate.

David:

OK. Now, people who are listening to this podcast will also be very aware – you mentioned GDRs, the global depository receipts. There are lots of Russian companies looking to list on the London stock market now. I'll just reel off a few names: one of them is Euroset, which I think is a telecom company; another one is Nomos Bank; another one is Rosagro, which is an agricultural company. Now, these will be joining another company called Petropavlosk, which was formerly Peter Hambro, the gold miner?

Marina:

Yes, that's right.

David:

So with all these companies listing on the UK stock market, why would I want to give my money to a fund manager to invest in Russian shares? Is that a tough question?

Marina:

You mean rather than investing yourself?

David:

In myself, in Russian companies here in the UK.

Marina:

Right. I think it all depends on clearly your risk appetite. There is nothing that prohibits you from doing that. At HEXAM, for example, we have taken the view of not running single country funds, precisely for that reason. For example, if you run a Russia fund, purely Russia fund, you'll put all your eggs in the same basket. It doesn't really matter at the moment. We're talking if you are investing yourself, or you're just putting money into the fund. So from that point of view, it depends on how your risk/return profile works for you. We are not advocates of investing in single country funds – that's why I wouldn't advocate you buying shares yourself, for one reason. 

At HEXAM, for example, we run very concentrated global emerging markets funds, and if we feel strongly about Russia, we are very happy to take a significant overweight against the index, and Russia will be in the company of other good markets that we feel very strongly about. At the moment, they are Brazil, China and Turkey and Russia – they are the four major markets that, apart from other smaller markets, but these are the four major markets that we invest in.

So the only thing that I would say, if for example you do decide that you want to have purely Russian investment, it's better though to go through a fund, because the managers that invest in this market, most of them, would do their homework for you in terms of meeting with the management, doing a lot of analysis, and some of them have been in these markets for a long time. So I guess again it's up to how adventurous you feel as an investor. I wouldn't be against you investing into the shares of the Russian companies, but I guess, as a fund manager, I have to advocate an investment into the regulated fund.

David:

OK. I'm going to ask you to look into your crystal ball now. This is my last question, and that is: what do you think is the outlook for the Russian stock market in 2011? I know it's a tough question, but just have a look in your crystal ball and tell me what you see.

Marina:

Well so far, and we're now in March, Russia has done very well. Year to date, it's one of the better performing markets globally. We do not see a reason for Russia not to continue its outperformance for the rest of the year, and if you look at the factors that we usually look at, which are growth, liquidity, currency management and valuation, Russia scores well on all of them. It's still trading at a massive discount to the rest of the other global emerging markets. 

We believe that commodity prices and oil will stay high this year, for a number of reasons, which for the sake of time I'm not going to go into. In terms of the liquidity, we believe that although inflation is high, Russia is going to manage to keep the inflation lid on, and it's not going to run away too high. Russian ruble, we think it's going to be stable. We don't see any dramatic movement in the FX rate. Certainly politically, we think Russia is enjoying one of the most benign periods of political stability and investor-friendly climate. So all these reasons, I don't see why Russia shouldn't perform very well.

David:

So the outlook is good?

Marina:

Very good.

David:

OK, well thank you very much, Marina, for coming in today. It's been an absolute delight talking to you.

Marina:

Thank you very much for having me here.

David:

You're more than welcome to come in again. Can you talk about Brazil next time?

Marina:

I've just come back from Brazil, so yes, I certainly can.

David:

We'll get you to come in and talk about Brazil. Now, I end each podcast with a quote. Today's quote comes from Winston Churchill, who said: "Russia is a riddle wrapped in a mystery inside an enigma." 

So thank you very much, Marina, for coming in to solve the Russian puzzle for us. This has been Money Talk, I have been David Kuo, and my guest has been Marina Akopian from HEXAM Capital. If you have a comment about today's show, please post it on the Money Talk web page, which you can find at fool.co.uk/podcast. Until next week, dasvidania!

Share & subscribe

Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

 

There are no comments yet - why not be the first?

Join the conversation

Please take note - some tags have changed.

Line breaks are converted automatically.

You may use the following tags in your post: [b]bolded text[/b], [i]italicised text[/i]. All other tags will be removed from your post.

If you want to add a link, please ensure you type it as http://www.fool.co.uk as opposed to www.fool.co.uk.

Hello stranger

To add your own comment, please login.

Not yet registered? Register now.