Investing in Russia during the last 15 years has not been for the faint-hearted. Russian share prices have undergone two enormous rallies, followed by precipitous falls, since the mid-1990s. Nevertheless, the country continues to attract overseas investor interest and the main indices have doubled since the beginning of 2009, making Russia the world’s best-performing equity market this year. How does that leave valuations, and what options are available to European ETF investors seeking exposure to this key emerging market?

To give a feel for the rollercoaster ride of the past, here are some of the levels recorded by the dollar-denominated RTS equity index during the market peaks and booms, together with today’s index reading.

Fortunes have been made in Russia’s equity market during this period, and many have then been lost. Though the most recent (2008/09) bear market did not match the savagery of that of 1997/98 − investors lost only four-fifths of their money rather than nearly 95% − the latest slump happened in the space of only eight months. Investors and regulators alike seemed caught up in the panic, with trading on Moscow’s RTS and MICEX exchanges halted on more than 10 days in September and October last year.

In 2009, the recovery in the price of oil, the key source of earnings for the Russian economy, has helped sentiment and prices to recover. Meanwhile, for those who thought that Russia’s oligarchs had taken a lethal blow late last year, London’s Times newspaper reported two days ago that Oleg Deripaska, majority shareholder of Russian aluminium giant Rusal, is preparing for a flotation in Hong Kong later this year which will value the group he controls at US$30 billion. Less than a year ago Deripaska was forced to seek an emergency loan from a Russian state-owned bank to avoid defaulting on his loans to Western bank creditors.

While Russia has often been seen as the poor relation in many investors’ BRIC portfolios – with many overweighting China, Brazil and India at the country’s expense – the economy’s forecast GDP decline of 8.5% this year hasn’t prevented share prices from recovering strongly. With the Kremlin assuming a US$50 oil price in its budget, the government has some leeway in its spending plans, and Russia’s finance minister recently reminded investors that the country survived a 50% fall in GDP in the 1990s, making the current 10% decline feel relatively manageable.

That the country has indeed done better this time around is no doubt partly due to a series of macroeconomic reforms undertaken after the 1998 government default and banking collapse – notably, the introduction of a 13% flat-rate tax on personal income, reductions in capital gains taxes and the reform of VAT, all of which led to a surge in state revenues.

Many investors perceive the Russian market to be something of a one-trick pony. Oil and gas revenues constituted 87% of all the country's export earnings in 2008. According to Wiktor Bielski of VTB Capital in a recent Euromoney interview, this concentration of earnings should not necessarily be seen as a weak point. Environmental concerns in the rest of the world mean increasing supply-side bottlenecks in raw materials production, says Bielski, meaning that Russia, with its laxer operating constraints, is well-placed to benefit.

Concerns remain, however, about the economy’s prospects in view of lingering bad debts in the banking system and the broader corporate sector. If the oil price remains relatively high then government resources may be able to support a transition towards renewed growth, analysts at investment bank UralSib said in a recent report. If not, they argue, the outlook remains very uncertain.

Options For European ETF Investors

Investors in Europe who wish to track Russian equity markets via an ETF currently have five funds to choose from, shown in the table below. The latest addition to the range, from EasyETF, was launched only last week. Data are taken from the latest Deutsche Bank ETF liquidity trends report.

All the funds in the table use synthetic (swap-based) replication to track their indices. Funds offered by Lyxor (which has the largest emerging market equity range of the European providers) and db x-trackers are the two largest, although only the latter is listed in the UK.

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