Chris 'Not an Economist' Doss The Russia Journal ------------------ The Guardian (UK) 4 April 2002 Investment A Russian revolution While lacklustre western stock markets continue to bump along the bottom, the eastern bloc is making excited fund managers sit up and take notice. Patrick Collinson explains why
If there is one golden rule in investing, it's that last year's super-soaraway stock market will be this year's dud. So it's rather perplexing that the Russian market, easily the world leader in 2001 with a 77% gain, is still steaming ahead and has already notched up an increase of 48% so far this year.
The second most successful market in 2001, Korea, also continues to power ahead, up 33% so far this year. Hungary is up 22%, the Czech Republic is up 18% and Thailand is ahead 28%. These sparkling figures contrast sharply with the slothful major markets of the world: Wall Street's S&P500 is down 5%, the FTSE100 has barely moved, while Frankfurt's Xetra Dax index is static, too. Little surprise, then, that after years in the wilderness, emerging markets fund managers are beginning to make their voices heard again. Jupiter, one of the biggest unit trust players for small investors in Britain, now has an emerging Europe fund on the launch pad, while Foreign & Colonial has Russia as its top tip for this year.
But memories are short. Only four years ago, Russia defaulted on its bonds, and the stock market collapsed. The robber-barons were in charge, the economy was sinking fast and there were fears that shares held by foreigners might be confiscated.
At one point, the entire market capitalisation of Russia - with oil and gas companies holding bigger reserves than BP and Shell - was less than that of Boots the Chemist.
Today, we are told, it's all very different. The iron fist of President Putin has brought some control over the mobsters, and the Russian economy is growing again at around 4-5% - twice the levels common in western Europe.
The key for investors, though, is that their money is safe, and that the company accounts aren't some Enron-style fiction. Dr Ghadir Abu Leil-Cooper, manager of Baring eastern Europe fund, believes that accounting standards are being transformed.
She gives oil companies Lukoil and Yukos as examples. "We are seeing far more in the way of internationally acceptable accounting standards, with Lukoil and Yukos both giving us US GAAP-standard accounts.
"Quoted companies now understand that if they don't produce international standard (IS) accounts, they won't find support from foreign investors and will trade on a much lower multiple of earnings."
There are moves, led by the banks, to force all big Russian companies to adopt IS accounts. But the target date of 2006 may be somewhat ambitious; even the banks have yet to approach reporting standards common in the West. Sperbank is the only Russian bank that produces IS accounts.
But the UK investment managers focus is not on accounts, but the soaring oil price. Oil companies make up 63% of the Moscow market capitalisation, and the recent spike in the oil prices inspired by latest Middle East crisis has sent stocks soaring. But Barings thinks that even without super-charged returns from the oil price, the market is still good value. It currently trades on 7.5 times earnings - compared to market p/es in London and Wall Street typically in the region of 25-30.
Barings's eastern Europe fund, registered in Dublin, has given investors a 34% return over the past year and 50% over three years. Among UK-registered unit trusts, Credit Suisse European Frontiers is currently enjoying the best figures, up 36% over the past year and 45% in the past six months alone.
Like other eastern Europe funds, it is now dominated by Russia. The Moscow stock market makes up 46% of the MSCI Eastern Europe index, and this will move up to 56% when the index is rebased in June. Next biggest is Poland, which makes up 14% of the index, followed by Hungary, 12%, and the Czech Republic at 8%. The Balkan countries - Romania, Bulgaria, Serbia, Croatia - are barely on the investment radar screen.
So anyone buying an "emerging Europe" fund is essentially buying a Russia fund. Neil Gregson, manager of Credit Suisse European Frontiers, says: "Since Putin came to power nearly everything has improved for investors: he has tackled reform of the judicial and legal systems, and weeded out the robber barons. The situation has been supported by the rising oil price plus a fresh wave of investor interest from the US.
"Of course, there is a long way to go, but share valuations are still very low. One issue is that there is not a lot of 'breadth' in the stock market, which is dominated by oil and gas. If you look at Gazprom, it has a lot of restructuring to do, but it is sitting on no less than 25% of the world's gas reserves."
The resource companies make up 63% of the Moscow market capitalisation. Telecoms and utilities make up most of the rest. The expansion potential for telecoms in Russia is massive - only Moscow and St Petersburg currently have mobile coverage, which has still to be rolled out over the rest of the country. But the price of telecom stocks already reflect that potential.
Gregson's two biggest holdings are also Lukoil and Yukos. Elsewhere, he goes for the Hungarian market, where he has a significant holding in OTP Bank. "I like Hungary. There's not a lot of stocks to choose from, but I thought that the Polish market had performed too strongly, and transferred money to Hungary instead."
He believes the country will meet the criteria that the EU sets for entry, followed by the Czech Republic.
But Russia, he believes, will remain as the main investment game for the rest of 2002. The booming market is bringing forth a glut of new share and bond issuance. "We're beginning to see Western bankers come out of the woodwork. There is a mushrooming of interest in Russia," says Gregson.
But for now the spectre of the Russian default in 1998 will continue to haunt small investors. The market remains hugely risky, and even the most gung-ho financial adviser will advise clients to keep only a tiny proportion of their money in Russian shares. After all, the Credit Suisse fund may be up 36% over the past year, but it is still trading below its launch price in August 2000.