By Charles Bond, Invesco Asian and global emerging market equities fund manager
- Russia could be on the brink of war with Ukraine – We’d like to think that the economic arguments will be enough to prevent conflict, but the Kremlin’s desire to restore friendly buffer states on its borders may yet prove their priority.
- How are we exposed – The Invesco Emerging Markets Strategy has three Russian holdings that comprise approximately 4% of the strategy.
- Should we exit our Russian holdings – We are cautious about capitulating at the moment of maximum fear. During periods of greatest fear, investors get their biggest opportunities.
Investing by its nature involves taking risks. We’re all taught about the inverse correlation between risk and return, ‘nothing ventured, nothing gained’, even if the psychology of human behaviour can often make that relationship somewhat perplexing.
There have been countless examples of asset bubbles caused by irrational exuberance. This ultimately led to financial calamity for many of those involved, suggesting that risk is often heightened when greed is in abundance, rather than when investors are most fearful. We would argue that it’s often not the risks themselves that prove disastrous for investors, but how those risks are priced.
Take the example Cisco during the Dotcom bubble. In the 10 years following the year 2000, when the shares peaked at US$80 per share, Cisco grew revenue at an 8% CAGR and earnings per share at a 10% CAGR – a respectable rate. Yet, the shares were down around 70% over that period, and they trade at only US$56 today.
The fundamental risks to Cisco’s business in the first quarter of 2000 proved far, far less important to shareholders than the risk they were taking by paying such a high valuation. Cisco shares were trading on roughly 150x earnings in 2000 but trade on around 16x today.
We seek to minimise the main risk investors face – that of permanent loss of capital – by making sure we don’t overpay for stocks and by ensuring the companies we own shares in have strong balance sheets. We take this approach with companies wherever they’re listed, including in Russia.
Russia and geopolitics
It’s important to keep the context in mind – Russian equities have traded at a steep discount to emerging market peers for many years. There are a good reasons for this:
- Commodities. A predominance of commodity producers in the Russian market, which typically trade on lower multiples.
- Governance. Whether it’s fears about government expropriation (à la Yukos in 2003), or that a particular oligarch may get on the wrong side of the Kremlin – there is a governance deficit in Russia.
- Geopolitics. Russia’s foreign policy approach under Putin has become increasingly muscular, which has led to tensions with neighbours, including those in an expanded NATO. Following Russia’s annexation of Crimea, Western countries introduced a raft of sanctions, largely targeted at individuals close to the Russian President himself.
Given this context, we typically ascribe lower ‘fair’ valuation multiples for Russian stocks than we do for other countries in emerging markets. Effectively, we assume these risks will persist and so we price them into our estimates of what constitutes fair value. This means that we require higher returns from our Russian holdings than we do from holdings in other countries to account for these risks. We believe this fundamental approach to valuation helps reduce the risks associated with investing in Russia.