ETFs: from Russia with love

Russia ETFs have been pulling in new investors keen to play the rising oil price and materials theme. Yet choice is limited and returns can be volatile, as Paul Burgin reports

Investors have been keen to exploit Russian stock indices via ETFs, with funds tracking the country gaining traction over the last six months. Inflows picked up in October of last year as the price of oil broke out of the $70 to $80 range in which it had been languishing.

European investor inflows amounted to €126m in October. They dropped back to €44m in November, before climbing to €143m the following month. In January this year, they crossed the €200m barrier.

BlackRock data suggests strong interest in the emerging market. Global inflows to Russia ETFs were $585m in January, a quarter of the total for the previous year and more than the total in 2009.

Ben Johnson, director of European ETF research at Morningstar, says: “We have witnessed some really heavy inflows in recent months. Investors are looking for pure exposure to energy.”

The Russian stock market and indices that track it are dominated by oil, other energy and basic materials stocks. Johnson says the giant gas firm Gazprom and oil company Lukoil make up over 41% of the MSCI Russia index, while almost three quarters are linked to energy or materials.

Oil prices continue to climb as investors and traders fret about events in the Middle East. That has been good news for Russian energy firms exporting their products to Europe and beyond. It is also good news for the wider Russian economy as state coffers fill with extra roubles.

Rising stocks
Russian stock prices and ETFs have reaped the rewards. Over one year, returns have ranged from 14.87% for the db x-trackers MSCI Capped index product to 23.50% for the Lyxor ETF Russia fund. Over six months, all returns have been over 20%.

Morningstar counts nine distinct products tracking Russian stocks, comprising a mix of narrow, capped and broader index-based products that are primarily synthetically replicated. Varied index construction allows investors to concentrate or diversify their exposure to energy.

The EasyETF Russian Titans 10 product has concentrations of 73.16% in energy and 22.61% in materials. The remaining 4.23% of the portfolio is in financials, according to EasyETF’s latest figures.

The ComStage ETF MSCI Russia 30% capped product is 57.3% weighted to energy, with Gazprom accounting for just over one quarter of the whole index. Johnson says that given a handful of selected stocks dominate free indices, the use of caps by ComStage and db x-trackers has no dramatic effect on overall sector exposures.
Liquidity in Russian markets can be an issue. Johnson says investors should be wary that ETF products are large enough to allow investors to exit when they need.

He says the Lyxor Russia Titans 10 product has an AUM of €1bn. After that, asset size falls away. The db x-trackers product has around €470m, while RBS Market Access Daxglobal Russia has assets of just €72m. Recent trading volumes hovered around the €500,000 mark. Johnson warns: “Liquidity is roughly proportional to the size of the fund.”

There are plenty of other issues to trip up investors in Russia. Political risk and opacity should always be front of mind, just as they are with direct investment and joint ventures in the country.