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Betting On Red: Building A Russian ETF Portfolio

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Mike Venuto, co-founder and chief investment officer of New York-based Toroso Investments.

Russia has been in the news in the past few years, and ETF investors owe it to themselves to take measure. We take a closer look at Russia—a big oil-producing country whose actions affect geopolitical stability, the price of oil and, if you believe it, even the 2016 U.S. presidential election.

Whether you’re long or short, to choose the right ETF for Russia exposure, you need to know what’s available. Let’s start by looking at ETF.com, which lists six ETFs that have exposure to Russia. In reality, only four of those require looking under the hood, because two of the six are triple-exposure funds built around the same index as the VanEck Vectors Russia ETF (RSX), the largest fund in the category.

Including RSX, the four Russia ETFs we’ll evaluate are:

Again, RSX is the largest and most liquid fund in the Russia category. It’s the go-to fund that most investors use. It has $2.8 billion in assets under management. It's also worth noting that between the two triple-exposure plays, a lot more is invested in the long version, which gives you an idea of what the market is thinking.

Overlap Analysis

Now that we know what’s available, let’s plug all this into Toroso’s software, which can analyze any security or ETF, and determines what overlaps with it. We run client portfolios through a similar process to arrive at workable and realistic approaches, but what we’re doing here is a bit different. (We have a 2.17% exposure to Russia in our Global Alpha SMA Strategy.)

Ticker

Fund

Overlap

Expense Ratio (bp)

ERUS

iShares MSCI Russia

43.9%

61

RBL

SPDR S&P Russia ETF

71.1%

59

RSXJ

VanEck Vectors Russia Small

0.0%

67

The first thing we notice is there’s overlap between RSX, RBL and ERUS. I built a grid to show us the overlaps. RSX overlaps RBL with 72% securities, and RSX has a 44% security overlap with ERUS. Notably, RSX has no overlap with the small-cap Russia fund, RSXJ. Quantifying such overlaps or lack of overlap helps us develop an initial idea of how to construct a portfolio.

P/B Ratios And Beyond

The next thing I do is drill into these exposures to uncover the differences between RSX—again, the biggest fund—and the three main choices: RBL, ERUS and RSXJ. In each comparison, RSX has the highest price-to-sales and price-to-earnings ratios, the second-highest price-to-cash flow, the highest price-to-book and the lowest yield.

Ticker

Fund

P/S

P/E

P/CF

P/BV

Yield

RSX

VanEck Vectors Russia ETF

1.1

8.5

5.2

1.1

4.1%

ERUS

iShares MSCI Russia

0.8

6.7

4.0

0.8

5.2%

RSXJ

VanEck Vectors Russia Small

0.6

8.1

5.7

1.0

5.6%

RBL

SPDR S&P Russia ETF

0.9

7.5

4.6

0.8

4.3%

These positive attributes might be the effect of the concentration of RSX. It has just 30 companies in its index, and those 30 companies are garnering most of the flows into the underlying shares that make up the RSX portfolio. Understanding these additional metrics, we know that at the very least, owning RSX as a tactical trade is a great way to get exposure to Russia.

That said, there might be a better long-term strategic choice for building a Russia-focused portfolio.

Concentrating On Concentration

Let’s look more closely at concentration, and start with RBL versus RSX. We can clearly see RBL is substantially more concentrated in fewer sectors, and we can see that concentration from a market-capitalization point of view of the underlying securities. In other words, RBL’s concentration is very much at the top among its biggest holdings.

From the fundamental standpoint, however, we are getting better fundamentals and a similar expense ratio.

2016

RBL

RSX

Prem/Disc.

Price-to-Earnings

8.7

9.6

-9.0%

Price-to-Sales

1.1

1.2

-12.5%

Price-to-Book Value

0.9

1.2

-27.9%

Yield

3.6%

3.5%

3.4%

Return on Equity

10.6%

13.4%

-21.5%

RBL

RSX

Difference

Expense Ratio

0.59

0.62

-0.3

The concentration story is similar to ERUS. The sectors are concentrated in energy. The fund has fewer sectors to be exposed to than does RSX, and ERUS constituents have higher market-caps than those in RSX.

Depositary Receipts vs. Local Shares

The ERUS portfolio gets even more interesting when we look at its underlying securities. The biggest difference between ERUS and RSX is that Gazprom appears twice in ERUS, and just once in RSX. You’ll also notice Lukoil is in ERUS, but absent from RSX.

ERUS

RSX

GAZPROM OAO

10.5%

SBERBANK-SPONSORED ADR

8.4%

LUKOIL OAO

9.7%

GAZPROM OAO-SPON ADR

7.7%

SBERBANK-SPONSORED ADR

7.2%

OIL COMPANY LUKOIL PJSC SPONSORED ADR

7.1%

GAZPROM OAO-SPON ADR

5.4%

NOVATEK OAO-SPONS GDR REG S

5.7%

TATNEFT-CLS

4.6%

MAGNIT OJSC-SPON GDR REGS

5.3%

NOVATEK OAO-SPONS GDR REG S

4.4%

ROSNEFT OJSC-REG S GDR

5.0%

MMC NORILSK NICKEL OJSC

4.0%

TATNEFT PJSC SPONSORED ADR

4.8%

ALROSA AO

3.8%

PUBLIC JOINT STOCK COMPANY MINING

4.7%

MAGNIT OJSC-SPON GDR REGS

3.7%

VTB BANK OJSC-GDR-REG S

4.5%

MOBILE TELESYSTEMS-SP ADR

3.5%

AK TRANSNEFT OAO-PREF

4.4%

The reason is that RSX is constructed using U.S.-listed global depositary receipts and American depositary receipts that contain Russian companies, whereas ERUS gets its exposure using ordinary shares that are exclusively listed locally in Russia. Local shares don’t necessarily lessen ERUS’ concentration, but the concentration in ERUS focused on locally listed firms helps minimize the extent to which ERUS is not being influenced by developments outside of Russia and in the rest of the ETF markets.

How To Invest In Russia

That said, I want to isolate some of these key fundamental parameters we’ve looked at to create a portfolio that, for long-term strategic holders, could be a great way to get exposure to Russia.

Here’s what we arrived at to achieve what we consider to be optimal Russia exposure:

  • 40% position in RSX

  • 30% holding in the small-cap ETF RSXJ

  • to get exposure to those ordinary Russia-listed shares, a 30% stake in ERUS

This portfolio is less concentrated than RSX, and, from a market-cap standpoint, we have achieved broad small-, mid- and large-cap exposure.

Also, regarding the underlying securities, we don't have any position in a single stock that is over 8%—even when we count Gazprom twice, but that’s in line with RSX. We also have a 53% overlap between the three Russia ETFs in our portfolio, capturing 100% of what’s in RSX.

We’ve also achieved superior fundamentals, all while delivering an approach with about the same cost as RSX.

2016

RSX/ERUS/RSXJ

RSX

Prem/Disc.

Price-to-Earnings

9.4

9.6

-2.2%

Price-to-Sales

0.9

1.2

-27.4%

Price-to-Book Value

1

1.2

-17.7%

Yield

4.1%

3.5%

18.1%

Return on Equity

11.2%

13.4%

-16.7%

Expense RAatio

63.2

62

1.2

Performance Expectations

In summary, ETFs provide some wonderful solutions to access the Russian equities. RSX is a solid choice for short-term or trading exposure, but I think as a strategic holding, this is a model that makes the most sense.

With that, good luck navigating Russia’s political environment and deciding which way to bet on Russia. I hope this analysis helps you find the right tools to invest with.

At the time of writing, Toroso had no positions in the above-mentioned ETFS. Toroso is affiliated with Global X Management Company. Toroso is a New York-based investment advisor focused on researching ETFs and other exchange-traded products, and designing asset allocation strategies, using ETFs that seek to perform well in various economic climates while emphasizing future objectives over past correlations. For more information about Toroso, call 646-465-5930, visit www.torosoinv.com or email info@torosoinv.com. For a list of relevant disclosures, please click here.

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