Are Russia ETFs Signaling More Trouble Ahead?

Zacks

Emerging market equities have been a laggard since the start of the year, underperforming domestic equities by a wide margin. Lower demand, Eurozone weakness and an appreciating dollar have been the key culprits in the slowdown in these developing nations.

The weakness in the emerging market is quite evident in the performance of broad-based products like Vanguard FTSE Emerging Markets ETF (VWO) and iShares MSCI Emerging Markets ETF (EEM) (Time to Buy Emerging Market ETFs?).

Both VWO and EEM have slumped in the period, tumbling close to 3.86% and 4.62%, respectively, in the time frame. Yet these losses pale in comparison to what some experienced in certain emerging nations, especially in the case of Russia.

Russia in Focus

The Russian markets have pretty much matched their broad-based funds in terms of movements, only with significantly more volatility. Investors should note that Russian stocks have a big chunk of their value so far this year.

Russia is the world’s top producer of crude oil and has the most natural gas of any country on the planet, ensuring that it will be a top player in this space for decades to come. However, investors should note that the oil sector has been underperforming lately.

In fact, the state run, largest natural gas extractor Gazprom, which is responsible for half of the Russian government’s revenue, has not been really successful in reducing the government’s deficit or improving the state’s pension system (Will There Be a WTO Boost for Russia ETFs?).

Also, consumer demand appears to be sliding, attributable to the weakness in the euro zone, which accounts for about half of Russian trade, thereby obstructing corporate investment and reducing demand for commodities.

However, Russia's industry showed a sharp improvement in March, recording a rise in output for the first time after December. Industrial production recorded growth of 2.6% year over year.

The growth was mainly driven by a much weaker base effect and strengthening output in all major sectors, with the fastest year-over-year growth in manufacturing. However, the outlook for industrial production appears to be somewhat uncertain.

Weak Projections

The economy ministry has reduced its 2013 economic growth forecast to 2.4% from 3.6% issued earlier in April. Additionally, core inflation remains a matter of concern for the economy. However, a low unemployment level along with high capacity utilization should provide a cushion in this uncertain environment.

Also, the ministry mentioned that the Russian economy would grow only 3.7% in 2014, down from an earlier outlook of 4.3%, and 4.1% in 2015 from 4.5% projected earlier. The economy expects weak exports, capital inflows, investment, industrial production and retail growth (Why Russia ETFs Are Not a Debt Crisis Safe Haven).

The ministry has also revised its investment growth forecast downwards to 6.6% from 7.3% in 2014 and to 7.2% from 7.9% in 2015, while industrial growth is expected to be 3.4% in both years, which is also a downward revision from an earlier forecast of 3.7% for both years.

The ministry does not foresee capital inflow in the economy in 2014, and expects just $10 billion in inflow in 2015, which is also a huge downward revision from an earlier estimated figure of $40 billion, in 2015.

Given the unsteady Russian economy, it could be a dicey time to invest in Russian ETFs. Though, for investors seeking to learn more about the space, and some of the key options in the market, the following three ETFs should be the starting point if you are brave enough to make a play on this beaten down economy:

iShares MSCI Russia Capped ETF (ERUS)

The entrant from iShares in the space is ERUS, a fund that follows the MSCI Russia 25/50 Index. This index produces a fund that holds 28 securities and has a heavy concentration in the top three companies that make up nearly 77% of total assets.

The fund manages an asset base of $206.8 million and trades at volume levels of 0.2 million shares a day (The Truth about Low Volume ETFs).

Additionally, energy firms make up nearly 51.9% of total assets in ERUS, while the next biggest sector, financials, occupies just 17.4% in comparison. ERUS, which charges investors 60 basis points a year for its services, slightly beat out its counterparts in the space over the past six months by losing "just" 11.7% in the period.

Market Vectors Russia Small-Cap ETF (RSXJ)

For investors looking for a small-cap play on the Russian economy, RSXJ represents a solid choice. The fund provides exposure to 26 companies that are either domiciled in Russia or generate a substantial portion of their revenues in the country. The fund manages an asset base of $12 million.

While its focus might be on pint-sized securities, the product still has a heavy focus on the energy sector as RSXJ puts 26.1% of its assets in energy firms, 19% in industrials, and 18.8% in materials (Go Green with These 3 Clean Energy ETFs).

The product charges investors a net expense ratio of 67 basis points a year but has had an extremely rough year-to-date period, losing 7.94% in the period. This level is slightly higher than its large-cap counterparts, but this could make the fund a star performer if the Russian economy rebounds in 2013.

Market Vectors Russia ETF (RSX)

For investors seeking the biggest and most liquid option in the Russia ETF world, look no further than RSX. The product trades about 5.5 million shares a day and holds $1.1 billion in assets, suggesting tight bid ask spreads for investors.

The fund invests its asset base in a portfolio of 48 securities and appears to be concentrated in the top ten holdings. The top ten holdings constitute 60.56% of the total asset base.

In terms of sector exposure, energy dominates, making up nearly two-fifths of the total portfolio. It is closely followed by the materials sector, which accounts for another quarter of the assets. RSX has a net expense ratio of 62 basis points a year and has slumped by 11.8% in the year-to-date period (Who says iShares ETFs are not cheap?).

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report >>

Read the analyst report on ERUS

Read the analyst report on RSX

Read the analyst report on RSXJ

Read the analyst report on VWO

Read the analyst report on EEM

Zacks Investment Research


 
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

More From Zacks.com
View Comments