The Winter Olympics in Sochi are just a year away, and Russia has a lot riding on the event. President Vladimir Putin, who has taken a personal interest in the 2014 games, wants people to see the country as powerful and prosperous, and not the closed-for-business, human-rights-violating country that many think it is.
Global investors, too, hope the Games showcase a more open and tolerant Russia. For years, money has shunned the country, mostly because of uncertainty. There’s always a threat of nationalization, a sudden tax hike, arbitrary executive prosecutions and weird policies such as forbidding Americans from adopting Russian orphans.
Those fears, paradoxically, have made the country incredibly attractive from a value perspective. The Russian stock market is currently trading at around 5.5 times earnings, barely half the price-to-earnings ratio of other emerging markets. “It seems logical that a market trading that cheaply doesn’t have a lot of downside,” says Michael O’Flynn, the Massachusetts-based managing director and global head of business development for UFG Asset Management. A decade ago, Russia was trading at a 50% premium to its Brazil, one of its BRIC peers; today it trades at a 50% discount.
That discount could easily diminish. For starters, the events that most spooked investors are fading from memory. The state takeover of Yukos, a massively successful oil company, happened a decade ago. Former CEO Mikhail Khodorkovsky may be out of prison by Olympic time.
Russia’s middle class is growing too—and the country’s GDP per capita is about US$18,000, much higher than that of other emerging markets. There’s also been talk of privatizing government assets, which “foreign investors should be applauding,” Elena Shaftan, manager of the Jupiter Emerging European Opportunities Fund, wrote in a recent report.
There are already signs that foreign capital is returning to Russia. Its market is up 5% year-to-date, at least partly due to optimism for a global recovery. Alexander Young, a global equity strategist with S&P Capital IQ, points out that Russia’s market is especially volatile, meaning “when there’s a big risk rally, Russia is often strong on the upside.”
For Canadian investors who have money to spare—Young suggests allocating only a sliver of any portfolio to the country—there are plenty of cheap companies to buy. Both Young and O’Flynn advise thinking twice about buying into Russia’s energy sector, which makes up about two-thirds of its market. Canadians have so much exposure to energy already, we don’t need more.
Instead, look to the consumer sectors and other industries with direct exposure to Russia’s growing middle class. Less aggressive retail investors should consider buying an emerging market ETF that has some exposure to Russia. EGShare’s Emerging Markets Core ETF (NYSEArca: EMCR) could be a useful one, says Young. It holds 8.7% of its assets in Russia, and the fund’s top three sectors are consumer-focused.
It’s unclear what Russia’s future holds, but there’s potential upside in the short term. If the country can pull off a stellar Olympics and prove that it’s serious about political and financial reform, then there’s a good chance that investors will finally give the nation another look.