JPMorgan Russian Securities 14 September 2020

JPMorgan Russian Securities (JRS) aims to generate long-term total returns from investing in cash- generative businesses in Russia. Despite the fact the index is highly concentrated and volatile, managers Oleg Biryulyov and Habib Saikaly have managed to generate significant levels of alpha (2.5% annualised over the past five years, calculated on NAV performance) on top of the high returns from the Russian market in the period.

Over five years Russia has considerably outperformed the general emerging markets index, as we discuss in the Performance section. However, in 2020 Russia has lagged the broader benchmark as China has outperformed and a weak energy price has weighed on the oil- and gas-heavy RTS stock market. JRS has outperformed in this period too, but remains on a considerable discount of 11.7%, although we note this is close to the level it was trading at before the crisis.

Over the longer run, the Russian market has been boosted by improving corporate governance and a drive by the government to see state-owned enterprises pay out higher dividends. This has seen large companies like Gazprom, Lukoil and Sberbank pay out high dividends, and JRS’s dividend has more than doubled over the past five years – the yield is currently 5.1%. Both the management team and the board are convinced that we have seen a secular shift in culture, and that further dividend growth is to be expected. As a consequence, the trust’s objective has shifted to providing a total return rather than just capital growth.

Oleg and Habib’s work has led to a portfolio with some balancing exposures in technology and gold, but fundamentally we think JRS is a high-beta play on a global recovery. While the remainder of this year could see some stumbles as government support programmes run off, by 2021 we should be seeing the beginning of a sustained recovery which should boost demand for energy and thereby for the Russian stock market.

Russia entered this crisis with its public finances in good shape and with its corporate sector displaying much-improved corporate governance. We think this means the economy should be more resilient and the demand on public funds less onerous, all of which should boost the chances of recovery. Meanwhile, although dividends may be lower in the 2021 financial year thanks to the pandemic, we think the shift to a high-payout culture is permanent and a considerable part of JRS’s total return should continue to come from its high-dividend yield.

The Russian market is extremely concentrated, with three stocks on the index each worth more than 10% of the market capitalisation. We think this means that a closed-ended fund is the best vehicle to use to invest in the country, as UCITS funds cannot invest more than 10% in any single stock and are therefore forced to be permanently underweight to the largest stocks. We also note that JRS has substantially outperformed the managers’ open-ended Russia fund over the long run.