Just weeks before Donald Trump was sworn in as US president, the billionaire Republican posted a series of comments on Twitter about Russia.
“Having a good relationship with Russia is a good thing,” he posted on the messaging platform. He added that the two countries, which had a fraught relationship under Barack Obama, the former president, could work together in the future to “solve pressing problems” around the world.
The tweet — one of a series of positive comments the new US president has made about the country and Vladimir Putin, its president, over the past year — was viewed by many investors as the latest signal that the geopolitical risks surrounding Russia are decreasing.
This fall in risk is one of the reasons investors have begun piling into the country after several years of scaling back on Russian stocks and bonds. In January, the Micex index of Russian stocks hit an all-time high.
Colin Croft, manager of the Jupiter Emerging European Opportunities fund, who increased his allocation to Russia to 58 per cent, up from 45 per cent 18 months ago, says: “There is a strong investment case for Russia.
“Donald Trump is the most pro-Russian US president in a long time, raising the chances sanctions [imposed in 2014] will be lifted — a great boost for sentiment.”
Christopher Bannon, a portfolio manager at Pictet, the Swiss fund house, adds: “[Mr Trump] seems quite willing to have a strong, positive relationship with the Russians.
“The geopolitical risk premium that had been attached to Russia has come down and that has been helpful for asset prices.”
The positive views on Russia are a big change from 2014. Investors ignored the country after it was hit with far-reaching sanctions over its military actions in Ukraine that eventually lead to the annexation of Crimea.
The sanctions, driven by the US and the EU, contributed to the collapse of the rouble, Russia’s currency. The fall in the price of oil from mid-2014 also hit the Russian economy hard, sending the country into recession.
But last year the Russian stock market rallied as the oil price stabilised and the country showed signs of returning to growth. A third of the 15 best-performing funds in the world in 2016 were specialist funds investing in Russia equities, according to Morningstar, the data provider.
Many general emerging market and European funds have increased their exposure to Russia over the past 18 months in order to take advantage of the strong stock market returns. In emerging market funds that hold Russian stocks, allocations to the country have jumped from 6.91 per cent at the end of 2014 to 9.61 per cent in December 2016, according to data from Morningstar.
Most funds are still underweight compared to the benchmark, but James Donald, head of emerging markets at Lazard Asset Management, and Patrice Lemonnier, head of emerging market equities at Amundi, Europe’s largest listed fund house, are both overweight Russia.
Lukas Schmitz, portfolio manager of the Emerging European fund at SW Mitchell Capital, who increased his allocation to Russia to 42 per cent, up from 24 per cent in 2015, says he expects Russian stocks to continue to do well this year.
“We should have a fairly good year because the Russian economy is normalising. Any better relationship with the US would be a plus,” he adds.
1%
Expected growth in Russia’s gross domestic product in 2017
In January, Moody’s, the international rating agency, forecast that Russia’s gross domestic product would grow 1 per cent in 2017 after two years of recession. Inflation is also expected to fall, after dropping to 5.8 per cent from 9.8 per cent over the course of 2016. This could lead to interest rate cuts.
Jan Dehn, head of research at Ashmore Group, the emerging market specialist, says: “The [Russian] central bank has been very hawkish and holding out against rate cuts, even as inflation has fallen. We expect multiple rate cuts in 2017.”
Fund managers are hoping a fall in inflation will drive up consumer spending. Mr Schmitz is favouring businesses that are exposed to the domestic economy for 2017 rather than commodity companies that were behind much of last year’s stock market rally in Russia.
“I don’t expect as much of an increase in oil or other commodities this year as we saw last year. But there is a case to be made that consumer-focused companies could do well this year,” he says.
Mr Schmitz and Mr Bannon have both added LSR, a Russian housebuilder, to their portfolios in the belief that as inflation comes down, interest rates should also fall and more credit should become available, leading to more house purchases. “There is a very strong risk reward there,” says Mr Bannon.
Mr Croft says he likes preference shares in Sberbank, a financial services company based in Moscow. “I am less enthusiastic about stocks like Surgutneftegaz [an oil and gas company], which is among the most negatively exposed to rouble strength due to its US-dollar cash pile.”
The growing strength of the rouble, where the value has increased by 27 per cent against the dollar over the past year, has attracted investors. Mr Dehn says: “The Russian currency has more upsides.”
Rob Drijkoningen, co-head of the emerging market debt team at Neuberger Berman, says the $255bn fund house has been increasing its exposure to Russian debt denominated in the local currency, but is selling off dollar-denominated debt.
But like many other western investors, Neuberger Berman did not buy any Russian debt last May when the country returned to international bond markets for the first time since sanctions were imposed. Many investors avoided the debt issue because of the sanctions, as well as concerns about whether the bonds would be eligible for settlement.
Such concerns are not the only issues troubling investors in Russia. The political climate remains volatile, particularly because of Russian activities in Ukraine and Syria, where it has been supportive of the Assad regime. A group of US senators put forward a bill for new sanctions on Russia in January.
Several fund managers also mentioned concerns about corporate governance in the companies they invest in. One fund manager says: “There are always corruption allegations and bribery allegations.”
There are fears that there is little chance of Russia’s stock market repeating its stellar performance of 2016. Others say that as investors pile in, it becomes harder to find interesting stocks.
Mr Lemonnier says: “One of the problems now is that a Russian overweight position is becoming much more consensual as a position among managers. The overweight is becoming a worrying factor despite positive macro indicators. If more and more people are in Russia, it could be difficult to find investments.”
Any fall in the oil price, meanwhile, would hurt economic growth, says Adrien Pichoud, chief economist at SYZ Asset Management, the Swiss fund house.
But others remain confident that the outlook for Russia is strong, particularly because of President Trump’s appointment of Rex Tillerson to become US secretary of state. Mr Tillerson has close links with Russia through his former work at ExxonMobil, the oil company, boosting hopes sanctions will be lifted.
Mr Dehn says: “Donald Trump seems to think Putin is a wonderful man and if this eventually translates into a reduction of US sanctions against Russia, then clearly this is positive.
“Relative to fundamentals, Russian stocks and local bond and currency valuations remain cheap. Sanctions relief, should it happen, would provide a further leg up. Compared with developed economies’ bond markets, Russian markets are both safer and pay far better.”
Additional reporting by Cat Rutter Pooley
