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Brave deep value with JP Morgan Russian Securities

Unloved JP Morgan Russian Securities looks a good value play with useful income too
August 5, 2021
  • While the risks are high, Russian stocks still look very cheap
  • Possible tender offer limits the downside

If you want an investment trust whose shares offer a high yield, trade on a wide discount to net assets and offer notable capital growth potential, take a look at JP Morgan Russian Securities (JRS). True, the trust invests in a volatile and concentrated market with significant political risks, so its shares are only appropriate for adventurous investors with a high risk tolerance. And a large exposure to oil and gas companies might be enough to deter environmentally-focused investors. 

Owing to its heavy exposure to oil & gas, banks and mining, the Russian stock market is a strong play on a cyclical recovery and this sector mix also tends to make it look cheaper than other countries. However – unlike in the US and the wider emerging markets region – the Russian market is currently relatively cheap compared with its historic valuations. The price-to-book ratio of the MSCI Russia Index is 1.1 times, compared with a 25-year average of 1.3 times and a range of 0.9 times to 7.2 times, according to Mick Gilligan, head of managed portfolio services at Killik and Co. Meanwhile, the price-to-book ratio of the S&P 500 index of US stocks is currently the highest it has been since the dotcom boom at 4.7 times, according to FactSet data.

Much of the performance of Russia’s stock market depends on the oil price. Despite poor performance last year, the stock market has been strong so far this year as the oil price has recovered and the International Monetary Fund forecasts real growth in Russia's gross domestic product of 3.8 per cent in 2021 and 2022. According to broker Numis Securities, the Russian budget is based on an oil price of $42 per barrel and current prices of over $70 per barrel will boost the government’s ability to support investment projects.

 

 

Trust holdings

For investors looking for exposure to Russia, the most credible options are probably an index fund, such as iShares MSCI Russia ETF (ERUS) or JPMorgan Russian Securities. Oleg Biryulyov, who has run the Morgan fund since 2002, has a bias for quality companies with more predictable profitability and stronger balance sheets than the index average, as well as income-generating businesses with long-term growth opportunities. However, the construct of Russia's stock market means there are still large weights in the cyclical sectors. At the end of May the trust – which has a 72 per cent crossover with its benchmark index – was 39 per cent invested in oil and gas companies, 21 per cent in mining and 18 per cent in financials.

The trust is highly concentrated with 30 holdings and the top three making up 40 per cent of the assets at the end of June. The trust’s top holding is Gazprom (RU:GAZP), the largest listed gas producer in the world, with a 30 per cent market share in Europe, and growing share in Asia. Gazprom is benefiting from increasing demand for gas as Europe moves away from coal-fired power. For some time, the manager was wary of the company on governance, capital allocation and dividend policy grounds, but Biryulyov says the situation has been improving with the development of the Nord Stream 2 gas pipeline running from Russia to Europe across the Baltic Sea and expectations of improved cash generation, which will help reduce leverage and support a dividend payout of 40 per cent of earnings and 50 per cent in 2022. 

Sberbank of Russia (RU:SBER), the trust’s second-largest holding, dominates the Russian banking sector. The manager says he is impressed by the company’s dynamism and innovation, as it expands into non-financial ventures. Sberbank is invested in services, including food delivery, taxis, real estate and payment systems, and aspires to generate half of its revenues from these by 2030. 

Norilsk Nickel (RU:GMKN), the third-largest holding, is a nickel and palladium mining and smelting company. It provides exposure to the electrification of the global transport system, producing nickel, platinum and copper, and offers good value in the manager's view based on the outlook for precious metal prices. Its shares currently generate a 7.6 per cent annualised dividend yield. 

The trust also contains some newer companies, such as Yandex (US:YNDX), Russia’s leading search engine with other services such as ecommerce, and X5 Retail Group (RU:FIVE), Russia’s second-largest food retailer. It has a number of small-cap companies too, such as payment services Qiwi (US:QIWI) and women's and children’s healthcare provider MD Medical (RU:MDMG). However, exposure to these companies, with their bias towards domestic consumers, has been reduced over the past year as Biryulyov has positioned the trust for a global cyclical recovery.  

The trust has a flexible approach, which allows it to take relatively large positions but also to sidestep some of the big index stocks. Ewan Lovett-Turner, head of investment companies research at Numis Securities, says “in many ways the ability to be concentrated is a key benefit and allows JRS to provide broad access to the market in a way that isn’t possible for some open-ended funds which are limited in position size and therefore struggle to deliver runs that are comparable to the wider market".

Reflective of the Russian stock market, the trust also offers an attractive dividend yield of 4.7 per cent. Since 2019, the Russian government has mandated that state-controlled companies should pay out at least 50 per cent of net profits in dividends, with the exception of Gazprom, which is expected to pay 40 per cent in 2021. As a result, Russia has one of the highest payout ratios globally. 

Since Biryulyov took over management in December 2002, the fund has delivered strong absolute NAV total returns of 13.7 per cent per year, and outperformed the RTS index, which has returned 12.8 per cent per year, according to Numis. However, the trust has slightly underperformed its benchmark over the past 12 months owing to the outperformance of Russia’s largest companies. However, Numis calculates it has had the best performance of any sterling-denominated fund investing in Russia over the past five years.  

 

Trust discount

The trust was trading at a discount to net assets of 11.3 per cent on 1 August. While it has consistently traded at a wide discount, it is likely that the size of the discount is limited by a buyback programme for at least 6 per cent of share capital per year and a performance-triggered tender offer for up to 20 per cent of share capital at just a 2 per cent discount if the net asset value total return lags the RTS Index over the five years to 31 October 2021. For the five years to 30 July, the trust’s NAV increased 149 per cent, compared with 131 per cent for the RTS Index.  

Analysts at Numis say the chances of the discount narrowing significantly through buybacks is limited, however, by the concentrated shareholder register, which is dominated by value-sensitive institutions such as City of London (29.2 per cent), Lazard (18.3 per cent) and Wells Capital (5.6 per cent).

True, the trust’s performance has been volatile, with its share price falling by 46 per cent in 2014 and rising by 87 per cent in 2016, for example. That is a function of the risks of investing in Russia: sanctions have and will continue to weigh on stock prices, inflation recently hit 6.5 per cent, the domination of oligarchs does little to inspire entrepreneurial activity and governance practices across the stock market are questionable. It is also highly weighted to oil and gas – an industry in decline. However, oil will not seep into insignificance for decades and for income-seekers looking for the potential of capital growth, at current valuations this high-risk play could pay off nicely in the shortish term. Buy.

 

 

Trust overview
Fund name and ISINJPMorgan Russian Securities (JRS)  
Price752pGearing2%
AIC sectorCountry SpecialistNAV 825.6p
Fund typeInvestment trustPrice discount to NAV†-11.30%
Market cap£314mOngoing charge†1.18%
No of holdings*30Yield4.7%
Set-up date20/12/2002More detailsam.jpmorgan.com
Source: Winterflood 30.07.21, *JPM 30.06.21  †AIC 30.07.21 

 

Performance
Fund/benchmark1 year total return3 year total return5 year total return
JPMorgan Russian Securities price29.4%57.4%127.3%
JPMorgan Russian Securities NAV27.3%67.7%149.3%
RTS Index (GBP) 31.7%60.5%131.4%
Source: Datastream, 30.07.21

 

 

Top 10 holdings (%)
Gazprom ADR17.0
Sberbank of Russia13.3
Norilsk Nickel9.8
Lukoil8.3
Rosneft GDR6.8
Novatek GDR4.9
X5 Retail Group4.3
Yandex3.2
Halyk Bank2.7
Epam2.7
Regional breakdown (%)
Energy41.5
Financials20.5
Materials17.2
Communication services6.0
Consumer staples4.3
Information technology3.7
Consumer discretionary2.8
Utilities1.1
Health care0.9
Industrials0.1
Cash1.9
Source: JPMorgan as at 30.06.21