Finding emerging markets that are trading at discounted valuations is not hard these days. China, India, South Korea and other emerging markets are trading at discounted valuations. And yes, per usual, so is Russia.
Russia, the world's largest oil producer, is home to some of the most profitable companies in the developing world, yet the market typically trades at a discount to the broader emerging markets universe. The "Russia is cheap" theme took on an added significance earlier this year when it became apparent that Russian stocks were not just cheap compared to China or Brazil, but also deeply discounted relative to Russia's own history of inexpensive equities.
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"Since mid-June, Russia has displayed some relatively strong performance compared to its emerging market peers. We believe this rally was underpinned by attractive Russian equity valuations, but we also note that the performance coincided with a recent rise in U.S. interest rates," said WisdomTree Research Director Jeremy Schwartz in a note.
Schwartz is correct in noting that Russia ETFs have been sturdy compared to other emerging markets funds. Among the major BRIC ETFs, only the iShares China Large-Cap ETF (NYSE:FXI) has outpaced the Market Vectors Russia ETF (NYSE:RSX) year-to-date and over the past three months.
"The recent rally in Russian equities is testimony to the ability of its local markets to thrive in an environment of rising U.S. bond yields," said Schwartz. "With an encouraging second-quarter gross domestic product out of the U.S. and a sanguine July Federal Open Market Committee (FOMC) outlook, markets are widely anticipating tapering to occur as early as the fourth quarter this year. While policy rates will remain accommodative for a longer period, steady improvements in the U.S. economy may result in a further increase in treasury yields."
One potential bright spot for Russia, at least for patient investors with longer-term time frames, is the country's growing dividend footprint. While there have been struggles on the road to President Vladimir Putin's plan to force state-controlled companies to pay 25 percent of net income in dividends, Russia is the fastest-growing and second-largest dividend payer overall in the WisdomTree Emerging Markets Equity Income Index.
That is the underlying index for the $4.8 billion WisdomTree Emerging Markets Equity Income Fund (NYSE:DEM). DEM has an almost 19 percent allocation to Russia, more than triple that of the iShares MSCI Emerging Markets ETF (NYSE:EEM).
The newly minted WisdomTree Emerging Markets Dividend Growth Fund (NASDAQ:DGRE) also features a healthy Russia allocation of nearly 11.4 percent, well above the average weight to the country found among established, diversified emerging markets ETFs.
"The EM block has experienced outflows, partly due to the narrowing yield gap between the U.S. and the rest of the emerging markets. The closing of this gap renders the EM block less compelling from a yield perspective. However, we feel that Russia is well positioned to withstand the storm, as it is less reliant on external funding and thus better able to keep its monetary policy loose (i.e., low interest rates), while other EM nations tighten their monetary policywhich can slow down their economiesin order to attract foreign flows," said Schwartz.
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Disclosure: Author is long DEM.
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