US institutional investors drive recovery of Russian market

Nov 06, 2019
Russian issuers advised to target investors in the US and Europe

US institutional investors are driving the recovery in the Russian stock market, according to new research.

Over the first six months of the year, US funds increased their holdings in Russian stocks substantially and now account for 54 percent of all foreign institutional investment, finds a study by Investor Update, conducted in partnership with Moscow Exchange.

The surge in overseas investment, also strongly supported by UK and Scandinavian investors, has pushed the MOEX index of Russia’s biggest companies up 15 percent this year, with the benchmark hitting a series of record highs.

At the end of June, US institutional investors held $43.9 bn in Russian stocks, up from $35.3 bn at the close of 2018, finds the study. Over the same period, UK and Scandinavian institutions upped their holdings to $16.5 bn and $8.1 bn, respectively. 

Growth investors are the ‘dominant force behind this year’s market performance’, while  index investors have played a ‘supporting’ role and will be compelled to allocate more capital to Russia as valuations increase, notes the report.

Impact of sanctions

The Investor Update report looks at institutional investment in Russia over the last eight years, considering the impact of rounds of sanctions on inflows and outflows. It finds that while sanctions have led to substantial pullbacks of foreign investment, money has quickly returned to the market when conditions improved. 

In 2014 the US and the European Union imposed sanctions related to the war in Ukraine. This led foreign institutions to cut their holdings of Russian companies by 50 percent in 2014 and a further 7 percent in 2015, says the report.

But in 2016, with market sentiment improving, institutions rushed back to the Russian market. Overall foreign institutional investment rose by 66 percent in 2016 and 11 percent in 2017.

New sanctions in 2018 – prompted by allegations of Russian interference in the US presidential elections and the poisoning of an ex-spy living in the UK – caused another sell-off, with foreign institutional investment falling by around $10 bn. 

It didn’t take long, however, for overseas investors to become net buyers again: 2019 has witnessed a ‘mini Tsunami’ of inflows, says the report, demonstrating that ‘sanctions have had a very short-term impact on international institutional investment into Russia’.

US, UK and Scandinavian investors are the largest overseas players in the Russian market. Since 2011, when the data in the study begins, they have comprised at least 74 percent of all foreign institutional investment in Russia. Having played a key role in this year’s market rally, these regions now account for around 84 percent of institutional investment. 

‘If I were a Russian issuer thinking about which markets to target for new investors, I would very much go to the US, the UK and the Nordic region because these are not only the largest investors, but they’ve also returned more quickly,’ says Patrick Mitchell, managing partner at Investor Update.

For Mitchell, one of the most encouraging signs of the current recovery is that institutions are investing in a wide variety of Russian companies. ‘It’s not just investing in Gazprom, Rosneft and Lukoil – it’s investing across the board,’ he says.

Special characteristics

There are three main reasons why the Russian market is performing so well in 2019, according to Michael Chojnacki, CEO of corporate access platform Closir, which focuses on emerging market companies. 

‘This was partly driven by an increase in commodity prices this year: given that many Russian listed companies in the index are linked to commodities exports, this has had a positive effect,’ he explains. ‘Secondly, dividend yields in the Russian market are very high compared with other emerging markets. Thirdly, there is a general perception that corporate governance has improved.’ 

Chojnacki adds, however, that sanctions and the ‘Russia discount’ still weigh on the market. ‘This partly explains the low valuations,’ he says. ‘Russia trades on a forward P/E ratio of just 6.2, compared with an emerging market average of about 14.5.’

Vladimir Zaluzhsky, head of IR and communications at Severstal, the Russian steel and mining company, says the risk of sanctions continues to worry investors, especially in the US, and he has seen a drop in US investment. 

‘I would say that yes, [US] investors are still there, but their number has shrunk,’ he says. ‘Those that left are mostly global funds that have a choice, while Russia-dedicated and emerging market funds are still around, thank God!’ 

Zaluzsky says the long-term picture should be helped by the high dividends on offer in the Russian market. ‘Interest rates in Europe and the US are declining further and this will force global funds to look for high yields, which are well represented by Russian dividend payers,’ he says.

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