Growing investor confidence in the Russia as its historically high inflation rate continues to fall, and as its economy leaves recession behind it, has received dramatic confirmation with the news that for the first time Russia has overtaken India as the preferred investment option of emerging market investors.
This confirmation comes from the most authoritative possible source, an article in the Financial Times, which in recent years has been intensely critical of Russia.
Russia has taken over from India as the largest overweight position for emerging market equity funds.The article points out correctly that foreign investor interest in Russia starts from a very low base, and that Russia has overtaken India as much because of India's recent loss of attractiveness as Russia's rise in attractiveness.
The move comes despite the imposition of ever-tighter sanctions on Moscow, still low oil prices and an economy now pulling out of bitter recession but still assailed by real, inflation-adjusted interest rates of 5.2 per cent.
In contrast, India has long been a darling of foreign investors licking their lips at the prospect of the world's second-most populous country growing at a punchy rate, assisted by the reformist zeal of Prime Minister Narendra Modi.
"Russia is now the largest overweight position among emerging market managers for the first time since our records began in 2011, surpassing longstanding EM favourite India," said Steven Holden, founder of Copley Fund Research, who compiled the data and confessed to "surprise" at Russia's newfound popularity.
The average EM equity fund is now overweight Russia by 1.46 percentage points, surpassing the 1.4 percentage-point figure for India, where fund managers had an average overweight position of 4.4 per cent in early 2015, according to Copley's numbers, as shown in the first chart.
The data are based on the holdings of 126 funds with combined assets of $300bn. Of these funds, 72.8 per cent are now overweight Russia, compared with only 60 per cent with an outsize position in India....
However the article also makes it clear that the rise in investor interest in Russia is ultimately driven by Russia's increasingly strong fundamentals...
Mr Jain is among a group of investors with a genuine fervour for Russia now, which is striking given that he was "ultra bearish for 15 years", while CIO of Switzerland's Vontobel Asset Management, where he ran as much as $32bn. Yet now his GQG Partners Emerging Markets Equity fund has an exposure of 10.2 per cent to Russia, more than three times its index weight.Readers of RussiaFeed and of The Duran will already be familiar with much of this. By way of example, here is a recent article I wrote for The Duran on the subject of Russia's advances in oil drilling technology (one of the subjects touched on in the Financial Times article by Rajiv Jain), whilst the rapid advance of Russian agriculture, in part as a consequence of Russia's counter-sanctions (a subject also touched on by Rajiv Jain) was recently discussed by me on RussiaFeed here.
"I was publicly critical of investing in Russia. I have covered Russia for 25 years and this is the most I have had," he said.
Nicholas Field, EM strategist at Schroders and co-manager of the group's Global Emerging Market Opportunities fund, is another convert, with a punchier weighting of 14.2 per cent.
"A lot of the headlines one reads about Russia are about geopolitics and relations with the US and so on, but when you look at the economy you do see some things that are interesting to investors," he said.
Mr Jain's thesis is that the sanctions imposed on Russia by the US and EU, as well as the slide in oil prices, have been largely beneficial to foreign investors because they have forced Russian companies to de-lever and cut costs.
India is very expensive. It has gone from very cheap to one of the most expensive markets. More specifically, he says Russian oil companies have been forced to develop complex drilling technology in-house, potentially helping them in the long term, while some domestic agricultural companies, such as cheesemakers, have benefited from reduced foreign competition amid Russian counter-sanctions on European food imports.
"Sanctions have been positive for the Russian corporate world. [Companies] were forced to get their act together and there was a massive cost-cutting effort," said Mr Jain. "Because of this cost-cutting, operating profits are higher than people estimate. Corporate earnings have begun to recover after a long slump. You have to follow the corporate profits."
He even sees positives in the travails of Otkritie and B&N Bank, two private banks that have been bailed out by the central bank and nationalised in recent weeks after running into financial difficulties.
About 4.2 per cent of Mr Jain's fund is invested in Sberbank, Russia's largest bank. He said: "The banking industry has seen massive consolidation. Now three banks control 70 per cent of the assets. "Sberbank is very well run, on six times earnings. How many banks make 20 per cent ROE [return on equity] in the middle of a recession? The position they have wouldn't be allowed in many countries, and now there is tremendous credit growth and NPLs [non-performing loans] are coming off."
Overall, he sees room for further top-line revenue growth, margin expansion and a market re-rating, given that Moscow currently trades on a price/earnings ratio of just 7.8 and has a chunky dividend yield of 4.7 per cent.
As for the growing strength of the Russian financial and banking system - historically the Achilles heel of Russia's post-Soviet economy - I have discussed it many times and in many places (see for example here and here).
What is finally happening is that the international investment community - and the Financial Times - are finally catching up with the truth of all of this.
Given the enormous amount of negative "noise" from which Russia suffers and the Financial Times' longstanding hostility to the country and its government, the article about international investors coming to Russia nonetheless and entirely unsurprisingly comes with a sting in its tail. The growing interest in Russia is supposedly not because its long term economic prospects are good. It is only because of Russia's recovery from recession:
Mr Field's optimism is fuelled by the country's economic recovery, which he expects to continue until at least the middle of 2018. "Demand has been suppressed so the recovery should continue for a while. Inflation has dropped to 3.3 per cent, which is pretty unheard of in Russia. In the next 12-24 months there is room for quite a few interest rate cuts and that can certainly boost the economy. The one thing that can upset that is another major move in the oil price," said Mr Field.We are likely to hear numerous such comments over the next few months as Russia's renewed economic growth becomes impossible to deny even by those who previously said it would never happen.
Nevertheless, he is not a long-term bull. "We don't think long-term structural trend growth is very high, so as much as people are buying into Russia now it's not because it has a glorious 10 or 20 years ahead, it's because it's recovering."
Such comments are actually meaningless. In what sense is an economy's successful recovery from recession a reason for doubting its future growth?
Putting that aside, the article itself provides abundant examples of the 'structural reasons' why strong growth in the future is likely. To repeat again the comments which appear in the article from Rajiv Jain:
.......Russian oil companies have been forced to develop complex drilling technology in-house, potentially helping them in the long term, while some domestic agricultural companies, such as cheesemakers, have benefited from reduced foreign competition amid Russian counter-sanctions on European food imports.What is cost-cutting, greater efficiency, development of new products and new technologies, high operating profits and (within the banking system) successful industry consolidation if not evidence of the economy successfully addressing its structural problems, thereby ensuring its successful long term growth in the future? No doubt there is much more still to do, but why go on pretending that nothing is happening when it obviously is?
"Sanctions have been positive for the Russian corporate world. [Companies] were forced to get their act together and there was a massive cost-cutting effort," said Mr Jain. "Because of this cost-cutting, operating profits are higher than people estimate. Corporate earnings have begun to recover after a long slump. You have to follow the corporate profits."
He even sees positives in the travails of Otkritie and B&N Bank, two private banks that have been bailed out by the central bank and nationalised in recent weeks after running into financial difficulties.
About 4.2 per cent of Mr Jain's fund is invested in Sberbank, Russia's largest bank. He said: "The banking industry has seen massive consolidation. Now three banks control 70 per cent of the assets. "Sberbank is very well run, on six times earnings. How many banks make 20 per cent ROE [return on equity] in the middle of a recession? The position they have wouldn't be allowed in many countries, and now there is tremendous credit growth and NPLs [non-performing loans] are coming off."
One of the perennial problems discussion of Russia's economy faces is that its Western critics insist on having it both ways. They are forced to concede that the Russian economy has successfully adapted to the harsh post-2014 economic conditions in which it found itself (low oil prices and Western sanctions) and is now recovering from a recession that most of them thought would break it, but at the same time they refuse to admit that this successful adaption of the Russian economy to these same harsh economic conditions in any way undermines their deeply critical even at times apocalyptic picture of it.
In reality an economy that could adapt so quickly and so successfully to the challenges it faced in 2014 cannot be the inefficient, corrupt, badly managed, 'kleptocratic' and underdeveloped 'Zaire with snow' economy imagined by its Western critics.
The article in the Financial Times shows that increasing numbers of fund managers, including some like Rajiv Jain and Nicholas Field who had previously bought into this dark picture, are starting to see the truth of this.
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