Where and How to Invest in Russia Today: Risks and opportunities
Investors love silence and tranquility. Today’s times, however, don’t offer much of either. Nevertheless, business life goes on. Irina Prokhorova, portfolio manager at Otkritie Asset Management Ltd. (“Open Investments”) tells where and how to invest in Russia today.
Which sectors of the Russian economy are particularly interesting for investment now, based on a long horizon?
These days, modern economies are hugely interrelated and dependent upon one another. And even though the world might have begun moving towards deglobalization, certain products will be impossible to forego. Trade will become more fragmented, leading to growth in prices and increased inefficiency, but volumes will remain more or less unchanged.
Russia, as the largest holder of the world’s natural resource reserves, naturally has particularly high resilience. While the list of resources produced in the country is long and each is critical for certain supply chains, the need for energy – to power industries, heat homes and provide fuel for vehicles – is universal and lies at the core of an economy. Years of negative rhetoric about oil and unrealistic expectations of a green transition have led to a lack of financial stimulus for producers worldwide to develop new fields. Even though energy demand usually falls during a recession, risks on the supply side, previously left unnoticed, can be fundamental to future price dynamics. Proximity to major shipping routes and fast growing consumer regions can leave Russia generally immune to punitive sanctions.
For risk-averse investors, food retail can be a good alternative. First of all, it’s a true defensive play, with no risk of business restrictions (sanctions, etc.). The Covid experience made households accustomed to shopping for groceries online, and even if a new wave were to come, it would not present a meaningful threat. Second of all, in an environment of falling disposable income, food spending is the last category people cut. Moreover, the highly fragmented food industry in Russia creates opportunities for top players to expand through M&A deals. A big scope for increasing operating efficiency is also present. Food retail is not as boring as some investors tend to think, especially considering the price levels.
Stocks of which Russian companies are preferable now, based on the long horizon?
While high LNG prices make gas less competitive in the long run and postpone gas transition, in the mid-term they will be highly beneficial for Novatek, the lowest-cost gas producer in the world. Lukoil and Tatneft are also names to watch. Highly efficient and consistent dividend payers, the companies might be the top choice in the Russian oil industry. The preferred shares of Surgutneftegas seem to have been oversold in light of the absence of clarity about the prospects for its dollar cash pile. Considering the probabilities of a variety of scenarios, the current discount can hardly be justified.
X5 Retail Group and Magnit are potential buys in food retail. The former has the biggest upside due to ownership rights being in the form of depositary receipts, and the company being registered abroad.
What risks need to be considered? What could negatively affect the stocks suggested?
Having said that oil and gas will remain in high demand over the years to come, there are some risks to mention. One is the EU’s embargo on Russian oil, which will come into full effect at the beginning of the next year. Also, not only do Europeans plan not to buy Russian oil, but the G7 wants to cap the price and make sure that the rest of the world follows this. At this point in time, it’s impossible to say whether this initiative will be a success or not. Much will depend on the severity of the secondary sanctions, which remains to be seen. However, the latest dynamics suggest that it’s more likely the production decline in Russia will be neither significant nor prolonged, and prices will not come down notably.
How should investments be distributed between the proposed sectors and shares? How much should be invested in which shares?
Individual recommendations should always take into account an investor’s risk profile and investment horizon. Generally speaking, investing in the Russian oil & gas industry at this point in time has a relatively low risk in comparison to many other investments. The sector remains vital for the Russian economy, and a potentially weaker ruble once capital flow restrictions are eased can bring additional positivity to the results. It’s wise not to eliminate oil & gas companies from the portfolio completely even if you are a very risk-averse investor. Again, generally speaking, it’s best to aim for sector diversification (and among companies as well), with a bigger portion allocated to oil & gas, and non-cyclical retail.
Are there any interesting financial instruments including these stocks?
The most popular way of having your money managed by a professional is through an open mutual fund. There are funds with strategies to anyone’s liking. Some are exchange-traded, and some provide investors with interim payments – a relatively new possibility, but timely for the Russian market. These may become especially popular, since during volatile times like today, people tend to value more having a regular tangible income, in the form of dividends and coupons. The way this type of fund is organized means that an investor is able to cash out payments without having to sell shares in the fund.