beyondbrics

By Ben Aris, Business New Europe

The Easter holidays are over and Russia’s market has sold off heavily – like it does every year. The seasonality of Russia’s equity market is so pronounced that it offers a no-brainer investment strategy that would outperform nearly every major emerging market investment fund if only someone got round to packaging it and selling it to investors.

The immaturity of Russia’s capital markets and the country’s dependence on commodities make Russian equities volatile. However, the bulk of that volatility asserts itself at certain predictable times of the year.

Russia’s RTS index started the year at 1802 and soared to a high of 2104 on April 11. But in the last two weeks, the fall of oil prices and worries over Greece’s future precipitated a sell-off that sent the index plunging back down to 1845, which should mark the bottom for this year if the market sticks to its usual pattern.

Over the last 15 years, the Russian stock market has sold off every year except for two around the May bank holiday break, says Alexander Krapivko, an equity fund manage with Renaissance Asset Managers in Moscow. (See chart above)

As he wrote in a recent note:

The two main exceptions were following the euphoria amongst international investors when president Boris Yeltsin won re-election in 1996, putting paid to any hope the Communists had of regaining power (and ending the party’s effectiveness as a political force); and the start of the strong rally in oil prices in 2005 that filled the Kremlin’s coffers to overflowing.

The down trend varies between the relatively mild 10 per cent fall in 2007 during the midst of Russia’s last boom and the crushing 88 per cent fall the market saw in 1998 following the previous ruble crisis.

Still, investors could capitalise on the regularity of these corrections: if you invested $100 on September 1 in an index tracking fund and sold again on May 1 the following year, then between 2000 and 2011 you would return an average of $24  per year – and this includes the crisis year of 2008 when the market lost three-quarters of its value over exactly this period.

That is better than most major investment funds can hope to return. In three cases (2001, 2003, 2009) the rally carried on into June, according to Alexey Zabotkin, an equities analyst with VTB Capital in Moscow, but an extended rally is not going to lose you money and in all the other years the sell-off started around the end of April.

Why? The first thing to note is that Russia’s market is a lot more volatile than those in the West, which makes it a lot more sensitive to the regular ebb and flow of both investment and state capital flows.

On the minus side of the ledger is the fact that there are almost no domestic institutional investors in Russia, which have a long-term view and usually put a floor under equity prices. Most of the investors are either local banks or foreign hedge funds, which have a short-term view and are quick to head for the door when the selling starts. And Russia’s dependence on commodities makes it vulnerable to external shocks.

On the plus side of the ledger, this very volatility means the market is prone to follow the seasonal allocations of capital. The first quarter of the year usually sees Russia’s market rise on the back of new allocations to emerging market funds: the leading RTS index has risen in nine out of the last 10 years in the first quarter, says Krapivko. New money released from Russia’s pension fund also comes late in March and boosts liquidity; and the remainder of the previous year’s federal budget transfers made in December hits the market in January.

The sell-off then starts at the beginning of the second quarter: equity prices have risen only three times in the last decade in the second quarter. By May, all the new allocations to emerging markets have been distributed. IPOs often come in the first quarter to take advantage of the extra liquidity allocated to the emerging market funds and suck all the excess cash in the market. And profit-taking at the end of April, as funds start to report, sparks the start of the selling.

Over the summer months, the market is fairly quiet as holidays take their toll on trading volumes and shares drift down due to the lack of demand. However, in five out of the last 10 years, Russian equity prices have risen as enthusiasm builds in anticipation of September when Russians come back from their long summer break.

“August is historically the worst month for Russian equity markets, which has been marked by a string of political and economic disasters; but September is the month of revival as the holidays come to an end and funds take in new allocations of cash,” says Krapivko.

In the last quarter of the year, there is usually a strong rally up to Christmas, which is given legs by the fact that the largest part of the Russian government’s budget spending happens in December and some of this money ends up in equity markets. And then the wheel turns again. Given the state is revving up for the crucial Duma elections in December and presidential elections in March 2012, which will almost certainly come with heavy spending, then this year’s White Nights Rally should be even more pronounced.

Related reading:
Fund file: Risks of rushing back to Russia, beyondbrics
Bourse tie-up clears logjam in Moscow, FT
Russia: where’s the money gone?, beyondbrics
Russia: investors still wary, beyondbrics
Will Russian valuations converge with other emerging markets?, beyondbrics
Russian IPOs: a cheat sheet for investors, beyondbrics