An Insider from Russia Gives His Take on Investing There

MARKET ROUNDUP
Dow	-317.06 to 16,563.30
S&P 500	-39.40 to 1,930.67
Nasdaq	-93.13 to 4,369.77
10-YR Yield	+0.002 to 2.556%
Gold	-$13.20 to $1,281.70
Crude Oil	-$2.30 to $97.97

Mike Larson, is away today. Mark Najarian, the managing editor of Money and Markets, is filling in …

After the fall of the Soviet Union, Western companies and individuals made billions by investing in Russia. The abundance of commodities — oil, gas, metals, forestry — and a Wild West atmosphere made it, some said, impossible not to make money there in the 1990s and early 2000s. Get in, make billions, get out. Talk of uncertain laws and shareholder rights, corruption and crony capitalism went unheeded.

And, in fact, many did make their billions and get out. Others, without the knowledge to navigate the Russian business world, lost billions and got out.

Now, it’s a bit of Back to the Future with Russia and the West, with the signs of a new Cold War emerging. This week, the U.S. and Europe ramped up sanctions over Russia’s involvement in the Ukraine crisis. And, in the face of the shoot-down of the Malaysian airliner by suspected pro-Russian separatists, more, harsher sanctions could be on the way. But do they matter? Have they hit Russia’s economy and its markets? In that vein, some money managers are saying that, with any falling valuations, Russia would provide some bargain investments. Would it be unpatriotic for Americans to invest in what appears to be adversary No. 1 right now?

To get a better picture of how sanctions are working in Russia and what effect they’re having on investments there, I spoke to James Beadle, a former Russia fund manager who has also worked as an investment adviser for SocieteGenerale. James is now an independent investor with more than a decade of living and investing in Russia. He has appeared on CNBC discussing Russia and has been quoted regularly by news agencies; he consults on investing in Russia and has spoken at many major investment conferences.

Q: Overall, up to now, what effect are the sanctions having on foreign investment in Russia?

A: “The sanctions are certainly having a dramatic impact, although not perhaps as blatantly as you might expect. Rightly or wrongly, Russia has had a reputation as a difficult and less-safe investment location for many years now. As a result, it has long been out of favor, and those foreigners still present tend to have very thick skins, and long-term views — not least because they are in many cases “under water” or holding stocks below the price they paid to buy them. This means that there hasn’t been a huge volume of foreign money flooding out of the country as there could be if, say, Mexico or Brazil got into a similar situation.

“But as I say, the impact has been dramatic. It has come in the form of capital not allocated to Russia. In the last couple of years, the Russian economy has stalled sharply and foreign investment was well-recognized as the key factor needed to spur growth. The sanctions, more than anything before, have persuaded people to steer clear, as they dramatically undermine the potential for gains and the risks associated with moving capital in and out. In short, the sanctions are deteriorating Russia’s foreign investment profile.”

“It’s Back to the Future with Russia and the West, with the signs of a new Cold War.”

Q: How are the Russian markets responding?

A: “Given the relatively low profile of foreign investors, the impact on Russian markets has come mainly from the actions of Russian corporations and individuals. We can watch the Russian market — equities, bonds and currency — exhibiting volatile tendencies either down or up, depending on what headlines are breaking. Since the shooting down of MH17 in Ukraine, the overall trend has again been negative.

“This means that Russian assets are moving from being extremely low-priced to being even lower-priced, as the market begins to reflect fears that the economy will suffer more directly from sanctions and isolation. Investors expecting the sanctions to be fully implemented and Russia to remain fixated on its current policy route will likely want to stay clear of Russia-related assets. But those who think that economics have a chance to trump politics may want to think about starting to build positions.”

Sanctions are affecting the common people in Russia, including through higher inflation due to a weaker ruble.

Q: Are common Russians being hurt by the sanctions or are they just affecting the business community and the specific Russians targeted in the sanctions?

A: “At this stage, ordinary Russians are really only feeling the strain in two ways: one is through the media dialogue, where Ukraine is of course dominating the public discourse every day. The other is in the form of inflation. Russia’s economy is based on exports of commodities and the imports of all manner of consumer goods. As the ruble weakens, so the price of imported goods comes under pressure.

“This economic dynamic is beginning to cause inflation to return, the latest year-on-year price change was 7.75 percent. But other than this, the impacts on ordinary Russians are so far very limited. With commodity prices strengthening, Russia’s economy is ticking along better than might be expected.”

Q: Are there places for Westerners to invest in Russia now? Is it even possible for Westerners to invest there? Through what means would one invest — U.S.-listed Russian shares, perhaps, or ETFs? Or directly through the Russian stock market?

A: “It is certainly possible for Westerners to invest in Russia, both through international instruments and through domestic ones. To invest domestically, you would probably have to transfer money in, and open a local brokerage account, which is a rather complex and bureaucratic procedure. So many prefer to invest through ADRs in the U.S., and GDRs in London, Germany and elsewhere. There are also liquid ETFs, based on these depositary receipts.

“One notable feature of markets going through turmoil such as this is that prices tend to be driven by headline macro factors. This means that stock picking is of limited use. True, Russia is home to the world’s largest nickel company, and the dynamics of the global nickel market have driven that particular name up impressively this year. Alternatively, names that are owned by individuals targeted by sanctions have struggled more. But overall, stocks tend to move on headlines, making it safer and more logical to focus on ETFs and index strategies. The largest ETFs also have options on them, which provide a useful tool for risk management or enhanced returns.”

Q: What about the ruble? Are there investment possibilities there, maybe by shorting the currency?

A: “The ruble is theoretically fully convertible, but in reality is closely managed. It certainly is tradable, and there are non-deliverable futures that make shorting easy. But these are domestic instruments. Retail clients without access to truly global platforms or domestic exchanges will find the ruble hard to trade. They might find proxies that are useful though — perhaps other Eastern European currencies are interesting to sell if you think the conflict with Ukraine will worsen. Or currencies like the Mexican peso or Norwegian krone will benefit if the crisis pushes the price of oil up.”

Q: How good are protections for foreign investors?

A: “This is an interesting question, without any single simple answer. Many direct investors, including most global corporations, are well-entrenched in Russia, and more than happy with the growth they have experienced as Russia has evolved from a Soviet economy to a modern consumer culture. This, of course, does not mean that protections are good, as is normal with emerging-market investments, companies have to learn the local rules and risks and navigate through them. Missteps can be very costly.

“In stocks and bonds, the risk protections are also rather limited compared to those of more advanced economies. But they are gradually improving. Russia aspires to become a regional financial hub, and is implementing many best of class practices to achieve this goal. Overall though, the maxim remains true as ever: Buyer beware!”

***

So what do you think about sanctions? Should the U.S. and the West set even stricter sanctions, even if it means that our markets would also be hurt by the spillover of the sanctions? If sanctions drive down market valuations, would you ever consider investing in Russia if you knew you could make big profits but also knew that you’d be investing in an adversary of the U.S.?

Do profits supersede all other considerations? Many major investors had that choice earlier and decided to invest there; others stayed away. I’m interested in hearing your views — click here to participate.

OTHER DEVELOPMENTS OF THE DAY

Staying on a theme of international news, we can look to South America, Western Europe and Asia for three interesting items today.

 Crying for Argentina: Talks broke down between that country and U.S. creditors late last night, sending the country into default for the second time in 13 years. The South American country said it couldn’t accept the demands of hedge fund-led U.S. investors, calling them “vulture funds.” The country owes $1.5 billion to U.S. hedge funds. Paying them, the government said, would force Argentina to make similar payments to other bond holders.

Standard & Poor’s deemed the country to be in default on some of its obligations, a move that will lead to higher borrowing costs and put even more pressure on Argentina’s ailing economy. The country might also be forced to devalue its peso, leading many residents to snap up U.S. dollars as a form of protection. Analysts were split on the international implications, with some saying that it can be contained in Argentina, while others were citing contagion effects of similar crises in the past and warning that U.S. and European markets could be hit as well in the short term.

 French lessons: BNP Paribas SA, that country’s largest listed bank, reported a record loss for the second quarter, hit by fines related to pleading guilty to violating U.S. sanctions against Sudan, Iran and other countries. It said it had set provisions of $7.71 billion to help cover the $9 billion fine imposed by U.S. authorities. For the quarter, it said it had a net loss of about $6 billion. It had a net profit of about $2.46 billion in the year-ago quarter.

Commenting on the results, Chief Executive Jean-Laurent Bonnafé said: “The group has learned lessons from these past events and is implementing a major reinforcement of its internal control.”

 Over to Asia: Samsung Electronics Co. reported a lower-than-expected net profit for the second quarter and said uncertainty in its handset business could hit profits going forward. It said net profit fell 20 percent to $6.1 billion, the lowest since the second quarter of 2012. The company had earlier warned that the quarter would be weak, citing a lack of growth in its handset business as it struggled to compete in the low-priced smartphone business.

Remember, you can comment on these or any other items by  clicking here.

Best wishes,

Mark Najarian

P.S. Now available: The ULTIMATE Stock-Picking Tool. Capable of helping you consistently earn $3.40 for every $1 earned in the average S&P 500 stock!

(Mike Larson’s regular afternoon Money and Markets column will return Friday.)

Mark Najarian is managing editor of Money and Markets. He has served as an editor and reporter in Los Angeles, New York, London, Paris, Frankfurt and Moscow. He most recently was the Financial Services Editor for the EMEA region for Dow Jones Newswires and an editor for the Wall Street Journal, based in London.