Russia Is The Worst Performing Emerging Market Of The Year; Will It Regain Its Lost ‘Energy’? 1

Russia has had a difficult YTD 2017 as it relates to equity performance. Among MSCI country indices for emerging markets, Russia is by far the worst performer this year. The index has declined 8.6% in YTD 2017 until May 18. Meanwhile, the MSCI Russia ADR/GDR index is down 9.7% in the same period.

This is quite a bit of fortune reversal for an index which had returned 49% in 2016, and was the third best performing emerging market country index of last year behind Brazil and Peru.

ETF performance and flows

Among ETFs investing in large and mid-cap Russian stocks traded on US exchanges, the three most prominent ones are:

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  • VanEck Vectors Russia ETF (RSX)
  • iShares MSCI Russia Capped ETF (ERUS); and
  • SPDR S&P Russia ETF (RBL)

The RSX, which witnesses the largest volume of trade among the three ETFs, has been driven down largely by the energy sector. Among holdings from the sector, the American Depository Receipt (ADR) of Gazprom (OGZPY) has been the biggest decliner in YTD 2017, followed by the Global Depository Receipt (GDR) of Rosneft Oil Company and ADR of LUKOIL (LUKOY).

On the other hand, the two holdings from the information technology sector – Yandex N.V. (YNDX) and Mail.Ru Group (MLRYY) – have done the most to reduce the drag on the fund.

Though ETFs investing in Russia and traded on US exchanges have attracted inflows in the past one year, in YTD 2017, they have witnessed outflows to the tune of $160 million according to Bloomberg data.

While ERUS and RBL have attracted net inflows, RSX has seen outflows amounting to $205 million in the year so far.

View on Russian equities

Russian equities are relatively cheap at present. However, Russia is closely correlated to the energy sector. This is true for both the economy and equity performance. Hence, the three ETFs mentioned above have energy as their largest invested sector. The RSX has the smallest exposure to stocks from the sector among the three, accounting for 37.9% of the assets. Meanwhile, 43.1% of the RBL and 50.2% of the ERUS’s assets are invested in the sector.

Energy has been the worst sectoral performer in the MSCI World, ACWI, and Emerging Market indices in 2017 so far. That explains the reason for the poor performance by the aforementioned three ETFs.

An extension of the crude oil production cut effected last year in an upcoming Organization of Petroleum Exporting Countries (OPEC) meeting is not expected to be beneficial to Russian downstream energy companies and detrimental to upstream companies. This is because even after taking into account agreed production cuts from last year, the energy sector is still the worst performer among 11 sectors.

The inexpensive valuations are quite attractive, but may yield handsome returns only in the medium-to-long term due to the heavy influence of energy stocks. Investors with a short-term horizon may need to look on a stock specific level for attractive investments. However, medium-to-long-term investors can find broad value in one of the cheapest major emerging markets.

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