Russia ETFs: Still Sporting Cheap Valuations
Russia, the "R" in the ubiquitous BRIC acronym, has a reputation for a lot of things. The country is a dominant producer of commodities. Pumping about 10 million barrels of oil per day makes Russia the largest producer outside of the Organization of Petroleum Exporting Countries. Russia also produces 2 billion cubic feet of natural gas and is the world's largest palladium producer.
The country also has a reputation for corruption. Russia ranked 133rd on Transparency International's 2012 corruption index. Beyond an abundance of natural resources and problems with corruption, Russia is known for something else: Inexpensive equity valuations.
In fact, Russian stocks have a penchant for trading at discounts to the broader emerging markets universe. And is those compelling valuations that may be a source of allure for investors considering Russia.
"What is currently attracting attention to Russia are the relatively modest valuations in these stocks—low single-digit price-to-earnings ratios – unique among equities in both developed and emerging markets today," said WisdomTree analyst Christopher Gannatti in a new research note.
Russian stocks are not only cheap relative to the broader emerging markets realm, they are now trading at discounts to their own historical standards, according to Gannatti.
"Russia's equities are not just inexpensive compared to other markets, they're also inexpensive compared to their own history. The average P/E ratio of the MSCI Russia Index over last 10 years (as of January 31, 2013) is approximately 8.9x, or nearly twice current levels," he said in the research note.
The largest ETF tracking Russian equities, the $1.6 billion Russia Market Vectors Russia ETF (NYSE: RSX) highlights the low valuations for Russian stocks. RSX, which allocates about 42 percent of its weight to energy stocks, had a P/E ratio of 7.34 and a price-to-book ratio of just 1.12 at the end of February, according to Market Vectors data.
By comparison, the iShares MSCI Emerging Markets Index Fund (NYSE: EEM) has a P/E of almost 18.4 and a price-to-book ratio of three.
Increasing the potential allure of Russia to investors is the country's push for higher dividends out of its highly profitable state-run enterprises. In a bid attract more foreign direct investment, the Russian government last year passed a law mandating that state-owned firms start doling out 25 percent of their profits in the form of dividends.
Investors looking to capitalize on that theme without making a country-specific ETF bet should consider the WisdomTree Emerging Markets Equity Income Fund (NYSE: DEM), which as Gannatti notes, went over-weight Russian equities for the first time last year.
"Historically, the WisdomTree Emerging Markets Equity Income Index (WTEMHY) had very little exposure to Russia, given the fact that few Russian companies passed its strict requirements regarding the trailing 12-month dividend yield," said Gannatti. "Then, at last year's Index screening on May 31, 2012, a number of the big Russian energy companies qualified due to their positive dividend growth and poor stock price performance. Russian equities became a 13.46% weight—a gain in weight of more than 12%."
DEM entered trading today with a 12.81 percent allocation to Russia, making the nation the ETF's third-largest country weight behind China and Taiwan. That is more than double the weight to Russia seen in EEM.
DEM's comparatively large weight to Russia has sparked some concern that the country could increase the ETF's volatility, though over the past six months DEM has been slightly less volatile than a pair of its major rivals.
"Put simply, as of January 31, 2013, more than 86% of the Index's weight was in constituents outside Russia—even though Russia is over-weight compared to traditional market cap-weighted indexes," according to Gannatti.
For more on ETFs, click here.
© 2015 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.