Simple Advice On Russia: When Everyone Is Fearful, Be Brave

(The Forbes) – Warren Buffet is known for advising investors on the value of being brave when everyone else is fearful. Russia fits the advice to a T. Global investors are paying attention, though admittedly are only tiptoeing into Russian equities from here. This year’s CFA Institute survey of global asset managers put Russia at No. 4 for best places to invest.

In Los Angeles on April 29, at the Miliken Institute’s annual conference, Russia took center stage. The takeaway: we know there are problems, but Russia is a value investors goldmine. After being the worst emerging market in 2014 thanks to its adventures in Ukraine, Russia is on its way back. The ruble is stable. Everyone loves central bank governor Elvira Nabiullina, who very well be voted as the best central banker in the world this year. And the Russian stock market has beat the MSCI Emerging Markets Index year-to-date in dollar terms. It’s even beat China, which is now undergoing a mini-QE stimulus program.

Of course, nobody knows where Russia goes from here. A bomb can go off in Ukraine. Putin will be blamed. Europe and the U.S. will talk upping the ante on sanctions, some of which are supposed to expire this summer.

Assuming all things stay as they are, is it too late to get in on the Russia recovery? Or is it premature to think an anti-Russia West and an anti-West Russia story line won’t go haywire after a few months of relative calm?

I’ve been talking to European and Russian based fund managers about investor sentiment there all winter. When the Miliken Institute did their Russia panel, I was particularly curious about what successful investor David Bonderman had to say. Luckily, there is YouTube.

“When you look at companies in Russia you see that most of them are doing quite well. Which is a harbinger of some stability going forward,” said Bonderman, founding partner at hedge fund TPG. ”Our biggest investment is in the food retailing business. People are still eating. Their may be some economic downturns but the sanctions that the Russians put on — preventing the import of certain European and American (food) goods — have actually boosted margins. So what we’ve seen there is that business has been booming,” he said. You can see the entire panel below.

Watching the panel was a bit Twilight Zone-ish. Can someone in the U.S. actually have something rational to say about Russia? I mean, isn’t Vladimir Putin going to blow us all to kingdom come?

After nearly two decades of a Cold War truce, Russia became the West’s villain again last March. Political turmoil in Ukraine led to the ouster of pro-Russia president Viktor Yanukovych. Kyiv’s new leadership quickly went westward-ho, led by their new captain, Arseniy “Yats” Yatsenyuk. Russia annexed Crimea, a Ukraine peninsula that is home to Russia’s Black Sea fleet. Months later, Russians moved to help separatists in industrial hubs along the border in East Ukraine, where ethnic Russians and Chechens fought the Ukrainian military side by side. Sanctions were slapped on Russian companies in July, and again in September.

But here’s what’s been happening since. Foreign direct investment, which was negative at the start of the year, is rebounding to a little over 2% of GDP. That puts it right about where it was in 2011, and better than the 2008-09 financial crisis.

Despite the bad news, and a general lack of consumer confidence at the start of the year, retail sales were 2.2 trillion rubles in March, up 91% from the same month when Crimea made headlines, and double February sales.

Russia investment horror stories are not hard to find. Investment firms like Hermitage Capital have lost fortunes in Russia. Some foreign investors have been kicked out of the country on spy charges, and a handful would not invest one red cent in that economy ever again. Businesses like Yukos Oil were ransacked, swallowed up by state competitors; their CEOs arrested and upon release, exiled. These are the stories the Western media love about Russia. We know them. We read them every day. Putin’s wrath makes great drama. He’s the last real-life James Bond villain.

Russia is not to be taken lightly. This is a tough country. You don’t run afoul of the government there, just as you wouldn’t in the world’s second most important economy: China. Google found this out once. It’s finding it out in Russia now too. (Though, it is only fair to say Google is also feeling the wrath of anti-trust lawyers in Europe. But that would go against the narrative.)

Believe it or not, despite those horror stories, Russia is not the worst country for doing business. It’s been improving. According to the World Bank’s ease of doing business index, Russia’s overall ease is better than China and Brazil — but on other measures worse than Rwanda of all places. It is actually easier to start a business in Russia than it is in the U.S., according to the World Bank’s calculations. Contract enforcement is on par with the U.S.

Where Russia fails, of course, is protecting minority shareholder rights. That’s why investors try to ignore state owned enterprises, as Bonderman points out with this retail stock picks.

American investors have not followed Bonderman to Moscow. But European pension funds and long term capital management has.

I spoke with David Herne, a European fund manager who has been living in Moscow since the 1990s. He’s been on the board of Russian companies like Aeroflot, the first ever foreigner to sit on that airline’s board of directors, and now runs a $600 million asset management firm called SPRING.

We spoke while he was being chauffeured home in a Volkswagen Taureg.

“Investor sentiment right now among the locals is really negative…or maybe resigned is the better word,” he says. “Russians are always most negative about their own country, which creates the low prices in Russia. They are very skeptical about the economy and think the Iron Curtain will come down again. But foreigners…they are all over the place. You have some contrarians who think Russia is cheap enough to buy.”

Herne says he sees light at the end of the tunnel.

“At the end of the day, every investor is after returns. Look at the market this year. I think people will pay attention to that, and remember why Russia is doing well. It is an under levered nation, it has solid infrastructure, unlike India or Brazil. It has a smart population with a 100% literacy rate,” he says, practically whispering. Naysayers would tell you that an FSB officer was in the backseat with a loaded Makarov in his lap. Alas, Herne is just not the excitable type. Hell, he hasn’t even been to Club Fantomas yet! Before getting dropped off at his apartment, he tells me: “You may not like Putin…but the government is stable and you can count on that.”

His two favorite stocks: natural gas producer Novatek and Sberbank. Novatek is up 13% year-to-date in rubles. Sberbank is up 40%.

Low oil prices are forcing Russia to change. High oil prices have made them sick with so-called Dutch disease, where rich oil countries do nothing else but drill, baby, drill. Today, investors are diversifying and expanding. Everyone is expecting a 4% decline in GDP this year. From the investors I’ve spoken with, there is some risk to the upside.

Arent Thijsen manages around $250 million at T&E Inmaxxa near Amsterdam. The Netherlands is one of the two most important markets for Russia. Germany is right beside it. The long money there knows Russia well and understands the risks. They also know how to ignore the propaganda, which surely comes at them full force from Russia, Europe and — can you believe it? — the U.S.

“A lot of my clients are afraid, of course, because they see the news. It’s not that 30% of our fund is in Russia. You’re looking at maybe five to 10%, and even that is a very large amount,” Thijsen tells me, adding that local Rabobank is brave. They have a strong bias for Russia these days.

“We are looking for companies that are under-valued and will be revalued higher sooner rather than later. These are all private and they pay high dividend yields. I’m not going to ignore Alrosa Diamonds (+91% in 12 mos); M.Video (+68.6% YTD); Severstal (+135% in 12) and Dixy (+49% in 12) in food retail,” he says. “I don’t think you can. They all have nice market share in a large economy. Severstal has a 12% dividend yield.”

Sure, it is in rubles. But if you believe oil is going to $60 and $70 over the next two years, rather than $40 and $35, then the ruble will strengthen.

Back in the 1990s, during the fall of communism, a handful of foreign investors got very rich. Triple digit return rich. That might not happen now, but high double digits is and will continue to happen in the Russian stock market.

“Most people realize that the opportunity is too huge to ignore,” Martin Charmoy tells me. Charmoy is the director of Prosperity Capital, a $2.4 billion London-based firm managing institutional money in Russia and some ex-Soviet states. “You can buy private companies at multiples of three, four or five. Russia is almost nothing in the MSCI All Country World Index, so for large institutions that can only do All Country World allocation, they won’t spend a lot of time looking at Russia. But all the people we talk to see the long term. There’s the basic trade of ‘oil up buy Russia, oil down sell Russia.’ The best approach is to buy and hold for the next three to five years,” he says, fresh off a trip to the U.A.E. to tout Russian equities.

“I can tell you that a lot of people are being brave. It is more a question of getting allocation approved by their investment committees than anything else,” says Charmoy. “People will come back because it is difficult in this environment to get returns even if equity markets have done well this year and last year thanks to QE.”

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Source: The Forbes | Author: Kenneth Rapoza

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