Investing in Russia

Right now, the Kremlin is struggling with political uncertainty, rampant corruption, weak productivity, and falling energy prices, all of which have hammered Russian economic growth and markets.

And can you believe it? The Russian economy is now smaller than Italy’s.

So why would anyone in their right mind invest in Russia right now?

Two reasons: When Russia’s stock market moves, it really moves, and it is the cheapest market in the world right now.

A Little Better

This may surprise you: Russia is the best-performing major stock market in the world for the period 2000–2013 when measured in U.S. dollars against the major market indices.

It is well ahead of not only all developed markets but also developing markets like China and Brazil.

And the Russian market is trading at about 4.5 times earnings, significantly below other emerging markets and at about 25% of the valuation of the S&P 500 index.

An American entrepreneur and investor I know who has made a bundle in basket-case countries like Russia and Argentina put it this way: “To make money, it doesn’t have to get great — it just needs to get a little bit better.”

But Russia is also a good example of the challenges facing investors trying to tap into emerging market opportunities. You have limited choices.

There are a few mutual funds, of course. Then there are four Russian companies that trade as ADRs: Mechel Steel, Mobile TeleSystems, Rostelecom, and Vimpel Communications.

There are an additional 37 Russian companies listed over the counter. These “pink sheet” listings represent a growing trend for even the largest companies like Gazprom and Lukoil, eager to avoid the high cost and regulatory burdens of the big boards.

Picking through this list to find the “pink sheet blue chips” takes patience, skill, and judgment. Be careful.

Then there are exchange-traded funds, or ETFs, that trade like stocks but represent a basket of Russian stocks.

The highest profile of these is the Van Eck’s Market Vectors Russia ETF (NYSE: RSX), with energy and basic material companies accounting for 68% of its assets. RSX has $4 billion in assets, and 95% of the companies in the basket have a market value greater than $5 billion.

While RSX is a decent proxy and presents good value after falling 26% so far in 2014, it is very top heavy.

I suggest you also look at many smaller Russian companies that offer the following advantages over the better-known giants:

Private ownership and control

Government ownership and support comes at a high price. Smaller private companies fly a bit under the radar. They also tend to be more nimble and have the opportunity to grow faster.

Broader and deeper play on growth turnaround

Even marginal market reforms have and will continue to create winners outside of energy and commodities. The tax revenue from higher commodity prices filters back into the domestic economy sort of like a perpetual stimulus program. Smaller-cap companies in a wide variety of industries are poised to capture this demand and turn it into profits for shareholders.

Less research coverage equals “discovery” potential

Like small caps all over the world, Russian small caps are largely unknown and are covered by analysts only sporadically.

While it is difficult to invest in these Russian bear cubs, Van Eck’s Russia Small Cap (NYSE: RSXJ) will get the job done.

RSJX offers good diversification with a 35% weighting in energy and materials, leaving more room for allocations to utilities (18%), industrials (15%), health care (8%), and other consumer sectors (18%).

Try a double-barreled shotgun approach with RSX and RSXJ to take advantage of a dirt-cheap and unloved Russia.

Until next time,

Carl Delfeld for Wealth Daily