My Russian Value Trap

I bought into an ETF replicating the MSCI Russia Capped Index back in April 2014 on the basis of the Russian market’s low Cyclically Adjusted Price Earnings ratio (CAPE), which was around 5 at the time and the lowest in the world. (For more on the rationale of CAPE investing, see this post.) After three frustrating years and a lot of self-doubt, I sold out of my position for a very modest 4.11% pa compounded profit recently. I actually lost money on the USD-denominated position, but the savings grace was that I came out slightly ahead because of AUD’s depreciation over the investment period. This is a bad result nonetheless because I could have obtained 7.61% pa compounded if I had kept my money in the ASX200 index, which is my performance benchmark.

So what happened there?

In the value-investment community, there are (at least) two philosophies around buying cheap stocks that trade at below book value. One insists on there being an explicit trigger for the value to be unlocked in the not-too-distant future. The other school of thinking is that cheapness is its own trigger. I bought into the Russian index mostly on the latter thinking. I could not explicitly identify any trigger points, except for some vague notions that oil prices, from a low of ~$25 per barrel, would likely recover to ~$50 per barrel at some point, which I read from credible research is the sustainable break-even price for shale, and that the sanctions levelled against Russia’s politicians and oligarchs will be lifted eventually.

There were conflicting signals all along. Jim Rogers was widely quoted as being bullish on Russia at the time, and there were good contrarian signals like surveys that show people were reluctant to invest in the Russian market despite its obvious cheapness for no reason other than its widespread unpopularity. But there are warning signs too, of course. I read Bill Browder’s book Red Notice: How I Became Putin’s No 1 Enemy with great concern and the Russian government’s handling of the MH17 tragedy left a bitter taste in the mouth. Putin’s continued interference in Ukraine and Syria is also hard to decipher.

Perhaps I have simply run out of patience, but I think I ultimately liquidated the position for these reasons:

  1. It’s clear the majority owners of the Russian publicly listed companies — the oligarchs and the Russian government — likely never have the minority shareholders’ interests at heart and they are quite capable of extracting values from the listed companies using their privileged positions without needing the share prices to rise to reflect the companies’ true values. The enactment of legislation to force publicly listed Russian companies to pay (unsustainably) high dividends to alleviate the Russian government’s financial position and the subsequent action by some large companies to outright ignore the request speak volumes on the lack of corporate governance in Russia.
  2. The Russian government will likely continue to act in a way that advances its leaders’ interest even at the cost of further conflicts with the rest of the world. Even the honeymoon period between Trump and Putin didn’t last more than a few months before war of words broke out over Syria. This means economic sanctions on Russia will likely stay in place for a while longer and continue to put a dampener on the economy.
  3. Oil prices has now recovered to the $50 per barrel level but its effect on Russian oil companies like Gazprom appears muted so one of my main hypotheses in buying the Russian index, which is dominated by several oil companies, is wrong.

Russian stocks has been my value trap. It could still turn out to be a winner in the longer term if CAPE’s predictive power is proven in this instance, but I wouldn’t be holding my breathe and I think I wouldn’t be bothered even if I turned out to be wrong. There are more pleasant ways to make money.

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