Thomas Smith

Why we’re underweight energy in our Russia fund

Thomas Smith

Russia has made huge strides in recent years away from a reliance on the price of oil. Here, Thomas Smith explains why the team is underweight energy in the Liontrust Russia Fund and where they are finding valuable opportunities.

Thomas Smith: Why we’re underweight energy in our Russia fund

Russia’s recent huge strides are largely a result of the introduction of the Budget Rule – legislation designed to keep budget expenditures within a limit – but also due to actions taken by the Central Bank.

The Budget Rule has materially reduced the impact the oil price has on the economy and, by sterilising the surplus revenues, has sharply reduced the ruble correlation with the oil price. Therefore, revenues generated from oil sales above the budget oil price of $42.40 will be transferred first into the National Welfare Fund, and then invested in the long list of national projects the government has drawn up over the past 18 months. The combination of a weaker ruble and increased investment in other sectors has helped to diversify the growth drivers of the economy and ensured the benefits are felt more broadly.

The Liontrust Russia Fund is underweight the energy sector for largely stock specific reasons. While we are cautious about the medium term prospects for oil prices as the break evens in US shale continue to fall, we acknowledge that geopolitical events can cause increased volatility at any time. The positioning and weightings within the portfolio are a result of our individual stock preferences.

We hold large positions in privately owned gas and oils companies Novatek and Lukoil while not owning state owned energy groups Gazprom and Rosneft. For the state owned companies, we continue to have concerns over capital allocation and the ability of management to generate value for minority shareholders. This is particularly the case at Gazprom where European sales will be pressured by US liquefied natural gas (LNG) exports, while at Novatek and Lukoil we are fully aligned with management and see substantial opportunities for value creation.

As the government continues to diversify the economy away from oil and gas, and as increased investment drives growth in other sectors, the Liontrust Russia Fund offers broader exposure to a number of sectors which are either very small or aren’t present in the benchmark indices, such as the industrials and IT sectors.

Despite them having performed well during 2019, we remain constructive on the outlook for Russian equities. Corporate fundamentals remain solid with low leverage, improving corporate governance and record dividend payouts, macro risks remain low given very prudent fiscal and monetary policies, and valuations remain attractive.

On the macro front, we are coming to the end of a five-year period of monetary and fiscal tightening. As interest rates continue to decline, monetary policy is approaching neutral territory (real rates still around 3%) and an end to fiscal tightening are both supportive for the economy and markets.

We believe Russian corporates have deleveraged to a point where capital structures have become inefficient. Going forward, we will either see companies investing more, which will support faster economic growth and feed through into higher earnings, or they will increase the capital returns to shareholders through higher dividends and share buy backs. Both of these outcomes should be positive for share prices.


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Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in funds managed by the Global Equity (GE) team may involve investment in smaller companies - these stocks may be less liquid and the price swings greater than those in, for example, larger companies. Investment in funds managed by the GE team may involve foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The team may invest in emerging markets/soft currencies or in financial derivative instruments, both of which may have the effect of increasing volatility. Some of the funds managed by the GE team hold a concentrated portfolio of stocks, meaning that if the price of one of these stocks should move significantly, this may have a notable effect on the value of that portfolio.


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Wednesday, January 22, 2020, 9:45 AM