A winning investment in Russia ETFs

BARING Asset Managers were probably the only people in England to find an upside to Russia winning the bid to host the 2018 World Cup last week. They believe that the win offers us a better case for investing in the emerging giant. Indeed, the improved infrastructure and reputation that comes with hosting the Cup will have an impact on the economy. But what is the best way for investors to expose themselves to this?

Single country funds have always been a tricky business. Investors know that they take a gamble when they put all their eggs in a one-country basket. But the temptation for exposure to an emerging market’s growth can sometimes be too much to resist. If you are drawn to Russia exchange-traded funds (ETF), it is extremely important to you know exactly what type of stocks you are tracking.

Much like many emerging market indices the mainstream MSCI Russia is heavily weighted in the energy sector (55.8 per cent, see chart). This means that you can be highly exposed to one company: the oil giant Gazprom makes up 26.78 per cent of the index. You only have to image what a BP-style crisis at Gazprom would do to your capital to think twice about investing.

But fear not, there are ways around such exposure. Providers such as iShares through its “capped” ETF ensure that you won’t rely on any one stock disproportionately since it caps each stock in your ETF at between 15-20 per cent of the index.

Alternatively, traders can track the RTS-2 index. Unlike the MSCI Russia it follows small and mid-cap stocks, giving significantly higher exposure to the telecommunications, banking and transportation sectors. These are precisely the industries that Douglas Helfer, the fund manager of the HSBC GIF Russia Equity fund, said this week were the best ways to access the domestic recovery.

Alan Rambaldini, Morningstar’s European ETF Analyst, suggests that these types of stocks can offer the investor a good deal: “Emerging markets small caps are often neglected and undervalued, so they do offer more potential by allowing the investor better access to middle class growth.”

But when the oil price has hit a 26-month high and is predicted to be in a structural bull market that will carry on into 2012, getting uncapped MSCI exposure to the oil industry suddenly doesn’t seem such a bad idea. Rambaldini however advises that investing straight into an Oil and Gas ETF would be a more sensible option because it provides a more diversified way to gain exposure to the increase.

Keen Russia investors will find that the ETFs available require them to understand precisely what degree of risk and exposure they are looking for. When that is resolved they may well find that they too will see the upside to Russia’s winning bid.