Questioning Russia’s Market Status

ETF Trends

Last Friday, the Market Vectors Russia ETF (RSX) gained 3.6% on volume that was more than triple the daily average ahead of Sunday’s referendum on whether Crimea will remain part of Ukraine or become part of the Russian Federation.

Even with last Friday’s ebullience, Russia ETFs have been punished over the past month with RSX losing 17.1% over that time while the rival iShares MSCI Russia Capped ETF (ERUS) is off almost 19%. [Crimea Occupation Punishes Russia ETFs]

Now, at least one analyst is questioning Russia’s status as an emerging market. Deutsche Bank strategist John-Paul Smith argues “Russia deserves a frontier market status, or a class of its own,” reports Shuli Ren for Barron’s. Smith has been underweight Russian stocks for over three years, according to Barron’s.

Smith highlights risks involved with investing Russia beyond geopolitical concerns, namely extreme wealth held by a small number of oligarchs and the high representation of state-run companies. The strategist notes President Vladimir Putin has companies such as Gazprom and banks like VTB and Sberbank for political gain. Those names were among the most adversely affected when Russian stocks plunge earlier this month on news of the invasion of Ukraine. [No Love for Russia ETFs]

Smith also argues that Russian consumer stocks are underrepresented on the benchmark Micex, a scenario that translates to U.S.-listed ETFs. For example, the energy and financial services sectors combine for over half of RSX’s weight, but staples and discretionary names combine for just 7.3% of the largest Russia ETF, according to Market Vectors data.

Still, a demotion to frontier markets status for Russia does not appear likely. At least not in the near-term. Although Russia is the “R” in the famous BRIC acronym, the country is not a major part of many diversified emerging markets ETFs. For example, Russia is merely the sixth-largest country weight at 6.4% in the Vanguard FTSE Emerging Markets ETF (VWO) , the largest emerging markets ETF.

The WisdomTree Emerging Markets Equity Income Fund (DEM) features an 18.1% weight to Russia, one of the largest allocations to the country among diversified emerging markets ETFs. However, that is by virtue of Russia being one of the largest dividend payers in the developing world, one positive to Putin’s heavy-handed approach to dealing with his country’s state-controlled enterprises. [Emerging Markets Dividends are Rising]

Four Russian stocks, including two oil and gas names, are found among DEM’s top-10 holdings.

WisdomTree Emerging Markets Equity Income Fund

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Tom Lydon’s clients own shares of DEM.

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