Page 77 - IFR Opportunities in Russian capital markets

CHAPTER03
ifrintelligence reports/Opportunities in: Russian Capital Markets
Figure 3.15: RTS index, Jan 2005 - Mar 2007
2,100 1,900 1,700 1,500 1,300 1,100
900 700 500
Jan 05
–30%, 25d May 06
–12%, 14d Sep 06
–12%, 5d Feb 07
Source: Bloomberg, UBS
Jul 05
–11%, 9d Mar 06
–15%, 13d Oct 05
Jan 06
Jul 06
Jan 07
Eric Kraus, the manager of the Nikitsky Fund blames the speculative nature of investment into Russia for driving some of the volatility.
"The experience of May 2006 and [previous sell-offs] has taught us that even though fundamentals were first rate, and the risks to the overall story low, technical issues can drag down asset prices in violent ways", says Kraus. "Specifically, the fact that the marginal buyer is often now a hedge fund, and hedge funds with no appetite for performance volatility (for fear of seeing outflows from fund-of-funds/investors unwilling to countenance it), means lots of ‘stop-lossers’ about. With real money accounts often finding less inflows or even outflows when things turn down, and often fully, or close to fully invested before the storm breaks, there are few marginal buyers to meet the loss-stopping sellers. This breeds more selling and more violent price falls. Saying when this will stop from a fundamental perspective is mixing apples and oranges."
Both these sell-offs show that the link between the RTS and the GEMs has become more important; during the China-induced sell-off oil rose from US$55/bbl to over US$60 for the first time that year, which shored up the index and cushioned the fall, but did not send the index upwards as fast as it would have done two years earlier. Analysts were quick to dub this link "the butterfly effect" – where a sell-off in one GEM affects all the stock markets of all big emerging markets the same day.
The value of Chinese equities is similar to the total in Russia, or just over US$1trn, or less than 3% of the total value of global equities. But what it has done is allowed US economic concerns and the fear of a sudden unwinding of the yen carry trade to take centre stage again.
These sell-offs have introduced an element of volatility into the market as it is not clear where the GEM markets, and Russia in particular, will go in the short to medium term. The benign conditions that supported the catch-up of most of Putin's term of office have come to an end, but investors are now asking if domestic growth is strong enough to power through a global economic slowdown, if it comes, or whether a recession in the US would take the edge off high commodity prices and suck the liquidity out of emerging markets which would sell-off as a result. The answer to this question will only be provided over the next year.
However, the Russian growth story will continue and the braver investors will attempt to weather this recent bout of nerves that hits the Russian market periodically. Alfa Bank recommends the following sectors as defence plays to park money until the picture becomes clearer.
Sector strengths
Electricity
Momentum is continuing in industry reforms, and a sizeable part of the equity to be raised will come either from strategic investors or domestic sources. UES is still the best proxy for these changes, but it is also one of the most liquid blue chips and therefore will not buck a major sell- off. Moscow City and Moscow United Distribution are the cheapest in P/E terms, while OGK-5 and UES both have good upside based on DCF target price.
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