There are three exchange traded funded funds offering exposure to Russian large-caps: The Market Vectors Russia ETF (NYSEArca: RSX), the oldest and largest of the trio; the SPDR S&P Russia ETF (NYSEArca: RBL) and the iShares MSCI Russia Capped ETF (NYSEArca: ERUS).
All three traded higher last month, which could be a sign that although growth is slowing in Russia, investors are finally finding it hard to resist some of the emerging world’s cheapest stocks. Russian equities historically trade at discounts to the broader emerging markets universe, but those discounts have become so steep that Russian stocks can be had for a song relative to their usual valuations. [A Look at the Cheapest Emerging Markets]
Last month, J.P. Morgan Asset Management said Russian stocks traded at four standard deviations below the EM average and its forward P/E of five is far cry from the 7.7 10-year average. Russia’s 0.7 price-to-book is about the 10-year average.
Increased oil output could make those valuations rise a bit. Last month, Russia, the world’s largest oil producer, pumped an average of 10.59 million barrels per day, a record for the post-Soviet era. Last month’s production increase was in part “due to Rosneft increasing production at the Vankor field in the Krasnoyarsk Region, according to RT.com.
While Russia still has a way to go to reach the Soviet-era record of 11.41 million barrels per day seen in 1988, last month’s output increase and the ensuing rise in Russia ETFs reminds investors just how correlated those funds are to Russia’s oil industry. [Russia ETF’s Lag BRIC Rivals]
The average weight to the energy sector among the three Russia ETFs is 48% with ERUS allocating 55.3% to Russian oil and gas names. Although RSX has the smallest energy sector weight of the trio (42%), it was able to muster a 1.3% gain last month due to the increased Russian output and a modest increase in Brent futures. The U.S. Brent Oil Fund (NYSEArca: BNO) rose 1.9% last month while the U.S. Oil Fund (NYSEArca: USO), which tracks near-month West Texas Intermediate futures, plunged 5.4%.
While few would argue that the energy sector weights held by Russia ETFs are excessive, there is a potential advantage there, even for dividend investors willing to take on increased volatility. Russia’s Finance Ministry is fighting to require the country’s state-controlled companies to boost the percentage of profits paid out in dividends to 35% by 2016 from the current level of 25%.
Importantly, the Finance Ministry wants Russian firms to reach 35% based on international, not local accounting rules.
Since Russia’s largest oil companies are state-run, the higher dividend push could benefit the aforementioned ETFs. An alternative is the WisdomTree Emerging Markets Equity Income Fund (NYSEArca: DEM). Russia is the largest country weight by nearly 300 basis points in DEM and the country is the fastest-growing dividend payer in the WisdomTree Emerging Markets Equity Income Index, DEM’s underlying index. [Emerging Markets ETFs Gaining Momentum]
Market Vectors Russia ETF
Tom Lydon’s clients own shares of DEM.