The past year-and-a-half has been remarkable for
Russian equities. In 2005 they returned about 70%, as measured by Morgan Stanley Capital International. By mid-June this year
they had jumped another 24%. Over the same period, the S&P 500 rose a meager 4%.
Russia’s dramatic outperformance
is partly a result of global demand for commodities. “Very few other countries have as much of a concentration in natural-resource-related
stocks, and we all know what’s been happening with natural-resource companies for the last few years,” says Christopher
Sturdy, who heads the depositary receipts unit at The Bank of New York.
By “natural resources” he means
oil and gas. The world’s largest pumper of natural gas is Russia’s state-run Gazprom, which has a valuation of
some $200 billion. But there’s more where that came from. “There’s been substantial speculation that the
Russian market has tremendous upside,” observes Sturdy, “and it may still be undervalued.”
Among
the Russia bulls is Newgate Capital Management, a Greenwich, Connecticut-based hedge fund that specializes in emerging markets.
Recently, Newgate told clients that developing economies are “home to nearly 75% of the world’s natural resources”
and pointed out that strong demand for those resources—especially petroleum—promises continued growth and keeps
investors coming back for more.
For many investors the best way to buy Russian stocks is through depositary receipts
(DRs). Because they are traded on the New York Stock Exchange, Nasdaq, the London Stock Exchange (LSE) and other markets,
they have to meet appropriate listing requirements, so they save investors the trouble and expense of having to deal with
currency exchange rates, international settlement concerns, unforeseen taxes and other possible cross-border issues.
While
DRs may offer simplicity, convenience and cost-effectiveness for investors, to BNY they represent a great deal of business.
The bank handles roughly two-thirds of the world’s DR offerings. Of that, Russian DRs comprise “a growing though
not yet dominant part,” says Sturdy.
In all, there are some 126 Russian DR issues, with some companies having
more than one available. Their total market value exceeds $100 billion, making Russia one of the largest DR issuers in the
developing world. Most Russian DRs are listed in London, not New York, though some are on both. The perceived wisdom, Sturdy
explains, is that there’s a substantial differential between American and British markets in the valuations they put
on different sectors. The UK is considered the place for trading shares related to natural resources like oil, while the US
is deemed better for the capital-raising intentions of telecom and technology companies. “I’m not sure what the
story is behind that,” concedes Sturdy.
Another possible explanation for why the primary Russian DR market is
in London, not the US, is that London is closer to where most of the Russian DR investors are based. “As far as we’re
able to determine, most Russian DR investment comes out of Europe,” says Gregory Roath, vice president at B NY’s
London offices. Roath says it is unclear whether this is a cause or an effect. Furthermore, big US-based institutional investors
tend to transact London-listed Russian DRs through a satellite office in London, further blurring the distinction between
US and non-US investors.
Whatever the underlying reasons for Russian companies’ preference for the London exchange,
the impact of this choice can be dramatic. Last year there were nearly 300,000 trades of Russian DRs via the London Stock
Exchange alone, or 60% of its DR transactions, representing almost $80 billion. These figures are a significant jump from
2004’s, when Russian DR transactions on the LSE numbered 255,000, with a total turnover value of $64 billion.
BRIC Block
The insatiable appetite for Russian DRs, as well as those
from similarly large markets in Brazil, India and China, has led to the collective shorthand term BRIC. BRIC shares are so
popular that many market-trackers are benchmarking them separately from other emerging market offerings. In June BNY launched
its own BRIC index for American investors. Rebalanced quarterly, reflecting the volatility of the sector, the benchmark is
made up of 74 DRs. Surprisingly, only six of them are Russian, and the aggregate valuation of those Russian DRs is just $20
billion; the other 68 issues in the index amount to $310 billion.
Russia’s small slice of the index pie is due
partly to its small presence on US exchanges. Chinese, Brazilian and Indian companies have a bigger presence on US markets.
Brazil and India in particular “have accessed American capital markets with DRs for many years, especially in the telecom
sector,” explains Sturdy. Relative newcomer China has “a preponderance of technology companies, many of which
IPOed in the US,” he adds.
Still, the expectation of high demand for Russian equities is fueling an ongoing market
for Russian IPOs and secondary offerings. In late July, Rosneft, another large Russian energy group, floated its first DR,
hoping to raise $14 billion. That appears to have been too optimistic. Its first day of restricted trading on the LSE raised
$10.4 billion, making it Russia's largest-ever IPO. But in unrestricted trading a few days later, the IPO received an even
colder reception, perhaps on valuation concerns, slipping a penny from the original asking price of $7.55 a share. Its largest
buyer was Gazprombank, a unit of fellow Russian energy giant Gazprom, which ponied up some $2.5 billion.
Other factors
are having an impact on demand for Russian shares. In January a $125 billion Russian trade surplus sparked a drop in the country’s
sovereign bond yields, making those bonds only about as attractive as US treasuries. Frustrated investors, in search of higher
returns, turned to Russian stocks. Then, in April, restrictions on Gazprom were lifted to allow more foreign investors; they
could at last purchase the 49% of the company that isn’t government-owned. The share price shot up, though later it
pulled back. Nevertheless, from the start of 2006 through mid-June Gazprom DRs advanced 30%. “Since the cap was lifted,
we’ve issued several hundred million DR shares of Gazprom,” reports Roath. “That alone has certainly contributed
to the explosion in the number of DRs outstanding.”
Understanding
the Market
Casual observers of the Russian market may wonder at its complexity. For starters, most Russian
stocks are quoted in US dollars—even on the primary Russian stock exchange, the RTS (Russian Trading System). The reason
most often cited for this anomaly is that when the RTS opened, the volatility of the Russian ruble made it easier to track
prices and value using dollars. Russia’s other exchange, the Moscow Interbank Currency Exchange, or MICEX, uses rubles
exclusively. Some stocks are traded on both simultaneously.
As Western investors become more comfortable betting on
companies in emerging markets, a never-ending slew of newcomers to Russian DRs are ponying up. At the same time, satisfied
investors are coming back to expand their Russian exposure. “In time we’ll see more Russian companies coming to
American capital markets,” predicts Sturdy. Other major oil and gas companies—especially those based in Europe,
such as Britain’s BP Group, France’s Total, Repsol of Spain and Statoil of Norway, but also China’s CNOOC
(China National Offshore Oil Corp.)—do trade in the US, he points out. “In a sense, Russian energy companies are
bucking the trend.”
Russia also boasts a number of homegrown high-tech companies that have not yet addressed
Western capital markets, says Sturdy, calling it “one of the most technologically savvy and highly educated engineering
communities in the world.” He expects Russian technology companies to follow their Chinese counterparts and offer ADRs,
though when he cannot say.
What does seem certain, however, is that the flow of Russian DRs in general will continue
to grow.
· Ben Mattlin
