JPMorgan Russian Securities 26 February 2020

JPMorgan Russian Securities (JRS) aims to generate long-term total returns from investing in cash- generative businesses in Russia. Managers Oleg Biryulyov and Habib Saikaly aim to identify national champions which can grow through exposure to international markets; and to avoid those areas of the market with poor corporate governance.

In recent years the performance of the trust has been extremely strong in absolute terms. Over five years the Russian market has made impressive gains, massively outperforming the MSCI Emerging Markets index. This has been helped by the recovery in the oil price after its collapse in 2014, as well as pressure from sanctions proving to have a limited effect. Investors who hold only generalist funds are likely to have seen very limited benefit from this rally, as the market has shrunk to just 4% of the Emerging Markets index. JRS has outperformed the Russian market over that period (to 20 January 2020), as we discuss in the Performance section. In the managers’ view, as corporates and households have de-levered substantially, they should have the ability to spend and keep up the momentum in the economy.

Despite its strong run, the managers observe that the Russian equity market still remains extremely cheap relative to peers. The forward P/E of the MSCI Russia index is 6.7, just over half that of the MSCI Emerging Markets index at 12.8. Meanwhile JRS is on an 11.2% discount, wider than the average of 9.1% in the AIC Global Emerging Markets sector.

The yield on JRS’s shares is 4.6%, having been boosted in recent years by the Russian government’s demand that companies increase their payouts to shareholders. This is motivated partly by the fact that the Russian state is a shareholder in many of the largest companies in the market, and partly by a desire to counteract foreign shareholders’ concerns about investing in Russia. Both the management team and the board are convinced we have seen a secular shift in culture and 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.

We think the risks of investing in Russia have subsided in recent years. The conflict in the Ukraine has frozen over, while the US political debate has moved on from the allegations of Russian interference in its elections. Meanwhile, the trade war with China has come to dominate headlines and has arguably much more significant consequences for investors than the sanctions on Russia, which have had limited effect. The shift in corporate culture in Russia could be even more significant in the medium term. A growing recognition of the importance of keeping minority investors happy should lead to better corporate governance, at least in some areas of the market. Russia is now one of a number of countries which recognise that global competition for capital means better governance is required – we would also put Japan and Korea on this list.

Although JRS’ discount has come in slightly in recent months, we do not think the limited move fully reflects this de-risking or the increased attractiveness of an investment in the country. In particular, the dividend story seems to have longer to run: JRS’s portfolio has a running yield of over 7.9%, and the managers tell us they expect further growth in payouts in 2020. The fact that the JPMorgan Global Emerging Markets Income team is overweight Russia tells us that this message represents more than merely managers talking their own book.

The Russian market is extremely concentrated, with three stocks on the RTS index each worth more than 10% of the total 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. They are therefore forced to either be permanently underweight the largest stocks, or to shift their benchmark to a 10/40 index, which ultimately amounts to the same thing. We note that JRS has substantially outperformed the managers’ open-ended Russia fund over the long run; and that the board’s current package of discount control measures should provide an element of protection to the rating should sentiment turn. As such the discount of over 11% remains attractive.