Which Russian investments paid out the most in 2018?

Which Russian investments paid out the most in 2018?
What was the most profitable Russian investment in 2018?
By Ben Aris in Berlin January 9, 2019

Russian daily Vedomosti has calculated which investments paid out the most in 2018 and the winner was the stocks and bonds of Russian conglomerate AFK Sistema that returned 128% and 55% respectively, Vedomosti reported on January 8.

The reason for the outsized returns was the end of a corporate fight between the company and Russia’s state-owned oil major Rosneft, which took over Sistema’s regional oil company Bashneft.

Rosneft CEO Igor Sechin claimed that Sistema has drained Bashneft, a one time investors’ darling, of cash and effectively asked Sistema to come up with all the money that Rosneft paid for the asset during a renationalisation. The case ended up in court, which froze all Sistema’s assets in lieu of damages. The war between the two companies, which was very damaging for Russia’s investment image, came to an end in December 2017 when Sistema agreed to pay $1.7bn in damages to Rosneft and Sistema’s securities spent 2018 recovering from crisis-induced lows.

Ruble

The ruble proved to be another good bet for the exchange rate savvy population. The domestic currency swung widely over the year on the back of several rounds of sanction threats and the seesawing of the oil price. But Russians have long since learned to hedge their bets by using foreign exchange deposit accounts and are also very sensitive to the interest rates paid on these accounts with domestic banks that also went through some sizeable fluctuations.

As the US Federal Reserve bank started on its tightening cycle the dollar appreciated strongly over the ruble in 2018, up by 20% on the year, while the euro was up 14% and the Japanese yen by 22%.

Converting rubles to dollars and putting them on deposit earns extra income from the interest rates paid that started 2018 at 8.55% at the biggest Russian banks on ruble accounts, 2.5% on dollars and 1.2% in euros. As a result dollar deposits returned Russian investors 23% on the year in ruble terms while the euro returned 15.4% — something that will not be lost on most of the Russian population.

The outlook for 2019 for FX deposits is pretty similar as after a brief dip in the middle of the year the Central Bank of Russia’s (CBR’s) decision to hike rates in September is driving deposits rates up again on ruble accounts and the Fed is expected to continue tightening. Interest rates on dollar accounts at the leading Russian banks are already up to 3.5% as 2019 got started, but the rates have only increased 1% for euros.

The outlook for the ruble is very confused with the uncertainty of new “crushing” US sanctions hanging like the sword of Damocles over the currency. The majority of analysts are expecting the ruble to weaken in 2019, although the spread cited by Vedomosti is very wide, ranging from RUB66 to RUB75 to the dollar.

Bank deposits have long been Russians’ favourite investment vehicle for their life savings but the big difference now is thanks to the fall of inflation to record post-Soviet lows interest rates are now real. Whereas only a few years ago FX bank deposits were simply a way to protect savings against the ravages of double digit inflation, now they have become very profitable investments in their own right, which ironically is stymieing the development of a retail investment industry as few investments can match deposits for their returns or their predictability.

Bonds

Bonds also gave decent returns. Although the price of the vast majority of Russian bonds fell, investors were still in the black thanks to coupon payments. The aggregate income of the Cbonds ruble bond index portfolio (IFX-Cbonds) for the year was a modest 4.2% against 12.2% in 2017, although some names, like Sistema, did much better.

On average, the annual return on investment in the state treasury bills, the OFZs where most foreign investors are parked, was 3.7%. Returns were higher in other classes of bond where foreigners have less exposure, including reliable sub-federal bonds, which were up 7.5% and liquid corporate securities (6.4-10%). 

Vedomosti cited analysts saying that investments into the debt market this year are attractive but they recommend only buying reliable bonds, with a rating not lower than BBB-BB and a maturity of up to three years.

Stocks

Stocks have not been an obvious investment since the silent crisis started in 2013 when the petro-economic model for the Russian economy was exhausted in 2013 and things got worse in the “silent crisis” of 2014-2016. However, for the opportunist there have been some excellent returns to be made. The market returned 52% in 2016 simply it bounced back from a big sell off in 2014 on the back of the fears of war following Russia’s annexation of Crimea that year.

Since then the leading dollar denominated Russia Trading System (RTS) has been range bound at about 1000, but as bne IntelliNews has reported, if the price of oil is still valid as a factor on Russian stocks (and it is less important than it was in the boom years in the noughties) then the market in dollar terms was the most undervalued it has been for years in the third quarter of 2018 – the RTS is some was 400 points below where it should be according to the traditional relationship between the price of oil and the index. However, since the price of oil fell back from over $80 to an average of $54 in December, the RTS is now where it should be according to the oil price and ended the year at 1,074, down from 1,238 in January, a fall of 8.8% over the year.

The RTS’s sister index, the ruble denominated Moscow Interbank Currency Exchange (MICEX) index, did a lot better, adding 9.4% on the year, but in dollar terms lost ground due to the fall of the ruble against the dollar.

While the indices have not really changed the story is very different at a corporate level and some names stand out. Sistema returned a spectacular 128% y/y over 2018, but this was a special case. However, the crisis of 2014-2016 and the subsequent slowdown has been driving a massive consolidation in many sectors as the big and strong swallow the weak and poor and these leading companies have used their financial resources to grab more market share by aggressively going after new customers. The upshot is at a microeconomic level earnings and profits for some companies have been very strong. And as Kirill Chuyko, the head of research at BCS Global Markets, pointed out in a recent bne IntelliNews podcast, owners at these companies are now paying out the highest dividend yields in the world. That means the shares of some individual names have soared. Russian equities are a stock pickers’ game and it’s not for the faint of heart.

In 2018 the best performing of the liquid shares were almost exclusively the raw material exporters that are benefiting from the low wages thanks to a devaluation in 2014 against high commodity prices. Rosneft, for example, earned more profit in the first quarter of 2018 than it did in all of 2017. The best performing stocks in 2018 included indepdent gas producer Novatek (+ 62%), regional oil company Tatneft (+ 48%), and the oil production arm of the state’s gas monopoly Gazprom Neft (+ 47%). 

In the coming year, Vedomosti cited analysts that recommend inexperienced investors to stay away from stocks, as with the looming sanctions the main goal for 2019 is to get through what is expected to be a volatile year without losses. For most people that means staying in cash and parking the money in a dollar or euro account.

For the braver, analysts came up with similar recommendations to previous years. Amongst the most popular ideas for 2019 is what has turned into an old chestnut for veteran investors: the preferred shares of Surgutneftegaz. Apart from the low wage/high oil price equation that has made all raw material producers profitable, Surgutneftegaz has built up a massive $40bn cash pile and two-thirds of its expected 18.6% dividend payout is from profits on investing this cash, with the rest from actually producing oil. Investing in Surgutneftegaz is actually the same investment as depositing cash in a bank in dollars, plus a bit of extra profit from the oil business.

However, some say the oil story is over and expect prices to fall this year. BCS Broker Sergei Gaivoronsky told the Russian paper to avoid oil exporters this year and recommends instead to switch to metallurgy such as aluminium producer UC Rusal and gold miner Polyus Gold.

 

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