Russia’s ruble-denominated Moscow Interbank Currency Exchange (MICEX) index is on a roll, clocking up a new all-time high every few weeks as Russia’s equity market comes back to life.
The MICEX index was up 23% year to date as of December 6, while its sister index, the dollar-denominated Russia Trading System (RTS), was doing even better, up a massive 41%, making it the best performing index in the world. Think what you want about Russia, there is good money to be made in Russian equities at the moment.
And this performance has been enough to whet the appetite of foreign investors. The hall at the Waldorf Astoria hotel in New York was packed for a Moscow Exchange promotional event in the middle of November. Fund managers and investment bankers came out to hear the MOEX pitch. The star guest was former finance minister and co-head of the presidential council Alexei Kudrin, who highlighted the solid macro-fundamentals and the government’s commitment to implementing a realistic reform plan to put the country back on a growth path. And he had a good story to sell. For example, in 2014 many analysts were predicting Russia would run out of money; this November gross international reserves were up on the year by some $30bn to $400bn – the equivalent of 18 months of import cover.
That is not to say a lot still needs to be done before the old enthusiasm for Russian assets comes back or the economy starts growing as fast as it did during the boom years. However, the recession has refocused the government like never before on the need to carry out its privatisation programme and make a start on deep structural reforms.
The fund managers at the Waldorf were not passive bystanders, but to a large extent they are responsible for the indices outperforming this year. Foreign investors have always played an important role in Russia’s equity capital market, accounting for about half of all the traded shares by value, and they are helping to drive the MICEX index up now. Despite the fraught east-west politics of the last two years, it has been US investors who have played one of the largest roles in pushing up valuations. Washington and Brussels may not have forgiven Russia for annexing Crimea, but the markets have.
“American investors started piling into Russian equities on Moscow Exchange long before the results of the US election. In fact, American investors are one of the fastest growing subsets, having increased their holdings from around 41% of total foreign ownership in 2013 to 52% in the first nine months of 2016,” Evgeny Fetisov, chief financial officer of MOEX and member of the executive board, told bne IntelliNews in an exclusive interview, referring to US holdings in both global and American depository receipts, as well as locally traded shares in Moscow.
The MICEX Index is one of the best performing in the world this year, but its rise is not exactly a boom. The RTS also passed through the psychologically important 1,000 market to hit 1064 on December 3 – its highest level for a year and half.
But to put this in perspective, the RTS index is still about half its all-time high of 2487.92 on May 19, 2008 when oil was at $122.8 per barrel. The dollar equivalent value of Russian stocks still have a long way to go to recapture all the value they have lost since the Great Recession began.
The trend is your friend
The big gap between where the RTS used to be and where it is now is one of the main appeals of Russian equities at the moment. The recent rise of oil prices following a production cut deal with the Opec oil-producing countries at the end of November, which includes a 300,000 barrel a day cut to Russian production, has given the market a boost.
But rising oil prices have only poured oil on a fire that was already ablaze. Probably the most important change is the slow cooling off of tensions between Washington and Moscow. Donald Trump’s victory has led to optimism that relations between Russia and the US could improve dramatically – and the MOEX New York event was poignantly held just a few blocks from Trump Tower, which was crawling with Secret Service as dignitaries came and went, interviewing for the top jobs in the new administration. A recent poll found that half of Russians expect relations with the US to improve now.
Because Russia lacks any domestic institutional investors to speak of, the performance of the market is largely driven by short-term sentiment and the local investment banks think there is at least a 10-15% upside to prices at the moment. The Russian stock market remains fundamentally attractive judging by relative yield versus bonds, historical valuation and peer comparison, and dividend yield, Gazprombank analysts said in a note recently.
“The spread between the implied yield of the Russian stock market (E/P 16.1%) and the Russian risk-free bond yield (UST10 yield + CDS Russia = 3.7%), or the equity-risk premium (ERP), remains above its ten-year average (12.4% vs. 10.1%),” Gazprombank said in a note recently.
But more fundamentally it has been Russia’s ability to weather the sanctions storm and the building economic momentum that should turn into a return to economic growth in 2017. Russia remains a massive consumer market and is littered with natural resources that make it one of the most attractive markets in the world – even if you are only interested in the domestic market action.
“[The inflow of US investors] tells us that American investors are interested foremost in performance, not politics,” said Fetisov. “Over the past few years, foreign investors have consistently accounted for more than 50% of the sizeable ECM transactions on Moscow Exchange.”
Here, too, some progress has already been made. A 10% stake in the state-owned diamond monopolist Alrosa was sold earlier this year, raising RUB52bn ($835mn) for the budget. The subsequent sale of oil company Bashneft to state-owned oil behemoth Rosneft and a mooted sale of 19.5% of Rosneft to itself have been more controversial, but Kudrin promised investors in New York that there is a substantial privatisation agenda for 2017 and it will be carried out.
At the same time the Russian economy is looking increasingly robust. The Markit services PMI grew strongly in November and some industrial sectors like manufacturing have already returned to growth. At the macroeconomic level, sovereign debt remains small and inflation has fallen under 6% for the first time since the Soviet Union collapsed.
“Looking forward, I am confident that the ‘Russian discount’ will narrow. We will likely see interest rate cuts from the central bank in 2017, and this will bring about a better macro environment, which will ultimately provide additional support for both equities and bonds,” said Fetisov
Another side effect of the crisis has been to make the owners of companies reassess their stock, which has become a source of capital for expansion and M&A activity. The Russian dividend story has been a winner for several years now and owners have been investing in the value of their shares by paying generous dividends. Likewise, the state has turned to dividends as a way of generating more cash for the budget; state-owned enterprises (SOE) already have to pay 25% of their profits as dividends and there is talk of increasing this to 50%. The upshot is corporate governance in general has improved dramatically.
“We are activist investors,” Matthias Westman, co-founder and chairman of Prosperity Capital Management, told the audience in New York. “In the 1990s we used to lose all our cases, but in the noughties we have started winning them all.”
MOEX is a darling
All this has been made easier by the financial market reforms already completed about four years ago, which hooked Moscow up to the international financial system for both bond and equity trading.
“We've made major investments into modernizing Russia’s financial markets infrastructure and promoting Moscow as an international financial centre,” said Fetisov. “Over the past several years, long-awaited infrastructure reforms were implemented including the central securities depository and unified central counterparty; international central securities depositories began servicing equity and bond markets clients, and the equity market was transferred to the T+2 settlement cycle. These changes have made trading on Moscow Exchange incredibly convenient and resulted in growth of trading volumes.”
With a large part of the exchange’s IT investment already in place, MOEX has been practising what it preaches and increased its own dividend payments to investors in its stock up to a very generous 55% of its profit.
“The bulk of our capex in 2015-2016 has gone towards the capital of our clearing house and investments into our new data centre, and this will be key in supporting our growth and reliability in the coming years,” Fetisov added.
Indeed, the exchange is an investors’ darling in its own right. Its diversified business includes investing and trading in equities, bonds, forex, commodities and derivatives, which contribute a steady income irrespective of which way the stock market is moving. Each of the equity, bond and forex markets has seen very stable trading volumes on the order of $500mn-700mn a day for equities and bonds in the first ten months of this year, and $19.3bn for the forex market. The derivatives market has also grown. MOEX now has 91 derivative products including 62 futures on the most liquid names, which have an average daily turnover of $7bn and 44% is foreign investors.
“I believe Moscow Exchange has a lot of room to grow, in ruble terms. An important strategic task for us is to further diversify trading on Moscow Exchange. We have about 250 corporate names trading on the Exchange, but there is a very high concentration of trading in those top 25 names,” said Fetisov.