In 2020, Russians will rediscover capitalism.
That doesn’t mean it becomes a Western democracy. It means locals will return to investing in the stock market, relying less on old fixed income and real estate. From a top-down perspective, Russia will continue its tortoise pace towards private business expansion and a shrinking of a state that’s gotten too large thanks in part to numerous failed private banks taken over by the state in recent years. Sky scrapers and luxury residences are still being erected in Moscow’s financial district despite five years of sanctions.
Minority shareholders matter more than ever now. Even state owned companies are spreading the wealth, returning profits to shareholders in the form of hefty dividends.
But the main trend that will continue apace into 2020 for Russia is the fact that the locals have become more trusting of the stock market. They’re investing, and holding for longer periods. Long term for a Russian investor is about a year. As a result of this change, Russia’s financial services industry may have are more solid and tangible foundation on which to grow into the new year.
“Russian retail flow into stocks is more than it’s ever been,” says Vladimir Potopov, CEO of VTB Capital Investments.
Potopov estimates that around 7,500 new clients a day have come to the Russian stock market in 2019. If he’s right, that would mean close to two million newcomers dipping into Russian equities.
VTB Capital Investments started the year off with 1.6 trillion rubles under management. It now has 300 billion rubles more at just under 2 trillion (around $32 billion).
“Low interest rates and improved client experience is what’s driving the market now. It’s really helping to change the whole industry in Russia,” he says, busily rummaging through his phone for messages about a large, secondary stock offering VTB had just taken part in. Russia spent 2019 in a quiet bull market despite lackluster economic growth of around 1%. “We are in the middle of a transformational growth spurt for the entire financial services industry here,” Potopov says.
Approximately one-third of all money invested in Russian securities are now invested in equities. In the U.S., it is at least double that.
“If global recession risk comes off and assuming you have no major external shocks, then Russia will do fine,” says Denis Rodionov, head of research at Spring Capital, a Russia-focused investment manager and one of the largest independent investment specialists in the country led by California-raised David Herne in Moscow. “People won’t be scared about Russia risk in that environment,” he says.
Rodionov likes Russian real estate because of high dividend yield between 9% and 10% in rubles. He also likes tech giant Mail.ru Group, owners of social media company Vkontakte and partners in a joint venture with China’s AliExpress, Russia’s leading online retailer.
“Russia has done very well for us,” says Gerardo Zamorano, fund manager for Brandes Investment Partners in San Diego. He runs the Brandes Emerging Markets Value fund. It’s overweight Russia. “We exited some securities this year that we have held for years, specifically in the oil and gas sector after talks about higher dividends. It just led to incredibly good performance of some of those companies so we cashed in,” he said, adding that they are still buyers of Russia.
International investors showed more interest in the Russian markets this year, but the stock market was the stand out.
The VanEck Russia exchange traded funds are even outperforming China, the most talked about, high-flying market of 2019. Their Russia Small Cap (RSXJ) and the VanEck Vectors Russia (RSX) funds are both up more than 35% year-to-date.
Over the last five years, investments in those two funds have returned 61% for RSX, loaded with the sanctioned entities of Sberbank and Gazprom, for example, and 76% for RSXJ, which is more loaded with private firms like private equity company Sistema and real estate developer LSR Group.
Russia is the cheapest emerging market thanks to political risk. It has a price-to-earnings multiple of around 5.6. China is more than twice that even with both sanctions and trade war risk. Brazil is three times that. India, four times.
“Russian equities have huge upside potential,” says Potopov. He estimates another 70% gain over the next three years thanks to falling interest rates, stable oil prices, and a relatively weak ruble exchange rate.
This year ended with global investors taking a second look at value stocks. The disparity in price between growth and value was near an all-time high for most of the year. Global fund managers shifted into value around August. Russia benefited from fresh inflow from the foreign value funds adding to the inflows into its stock market all year.
Companies that were priced out-of-this-world, like Mail.ru Group (PE over 100x earnings), got hammered and did not participate in the bull market. Plus, for the local retail investors who are now treating stocks like a bond, Mail.ru doesn’t pay dividends.
The global outlook is improving. That bodes well for Russia in 2020.
“People were getting overly pessimistic in the second half about a recession, about Brexit and maybe even U.S. labor markets being overheated,” says George Mussalli, chief investment officer and head of equity research for PanAgora Asset Management, a 30 year old quant fund firm based in Boston with around $44 billion in assets under management. Recession fears kept investors mostly in safe haven bonds and brand name global growth stocks like Apple (up 40% year-to-date) and Taiwan Semiconductor (up 51% YTD).
Once that risk subsided, investment firms trimmed their expensive growth stocks and some of them starting looking for something that wasn’t already priced to perfection. The value factor got more attention.
“I think we are going to see profits accelerate next year and if you’re looking for value there’s more of it to be had outside of the U.S.,” Mussalli says. “We’ll take Russia. I think it’ll be a decent year.”