In today's difficult global environment, affected by sub-prime issues in the US, Russia could be an island of relative stability given its current account and budget surpluses, low level of debt, high corporate profitability and undemanding valuations. Add to it strong corporate earnings and abundant domestic liquidity, and we believe it is likely to be one of the more exciting markets in the coming months
Market review
Emerging markets in general have shown considerable strength this year compared to Western markets, which have suffered in the wake of the US sub-prime crisis. Most notably, China and India have powered through the recent market turmoil. Russia, which is the largest market in Eastern Europe, has lagged behind early in the year due to a combination of investor nervousness ahead of the forthcoming elections and low expectations for corporate earnings and economic growth that prevailed at the beginning of the year.
However, data released over recent months suggest that the market may have underestimated Russia's potential. Strong oil prices have increased earnings for oil and gas producers, but this is only part of the picture - steel companies and telecoms providers have also delivered much better financial results than the market expected, with earnings growth running at more than 50% in the first half of the year. This comes on the back of much faster economic growth in Russia, which was close to 8% in the first half - significantly higher than the 5%-6% that was expected at the beginning of the year.
Performance
The fund has gained almost 36% over the past 12 months, a very healthy gain, but slightly short of its benchmark. An underweight stance in Poland and Turkey and an overweight position in Russia, which now makes up over 60% of the portfolio, limited relative returns, has also meant that our portfolio was less exposed to volatility. Our Russian holdings have fared well in recent months, but a sharp fall in the US dollar, in which most leading Russian shares are priced, has offset some of these gains.
Outlook
We believe the headwinds that were temporarily holding back Russia's stock market have now largely abated. Expectations for economic growth and corporate earnings have been revised upwards, and visibility of post-election political stability has improved following Putin's recent announcement that he will continue to play an important and active role after his presidential term ends in March 2008.
Russia is attractively valued compared to other emerging markets - while its economic growth rate is not far behind that of China, Russia's stock market is some 60% cheaper. Russian companies are achieving a return on capital close to that seen in Latin America, while at the same time the country has low levels of public and corporate debt, acting as a stabilising factor amid the current turmoil in global credit markets.
All of this would suggest that conditions appear right for more buoyant trading ahead in Russia. In Central Europe, higher rates of investment and strengthening consumer demand are driving economic growth rates well above those seen in Western Europe, allowing local companies to deliver superior earnings growth.
