Russia has been in the headlines for all the wrong reasons in recent years, with the annexation of Crimea, subsequent sanctions and accusations of interference in the US presidential race all taking a toll on sentiment surrounding the country.
Against this unpromising backdrop, BNP Paribas Asset Management’s Dan Fredrikson has steered his Russia equity funds to success, returning 87.3% over five years to July 2017, compared with the sector average manager’s total return of 69.2% over the same period.
Alongside his PARVEST Equity Russia Classic fund, Fredrikson also runs the Ryssland fund for Alfred Berg, a Nordic asset manager that is part of BNP Paribas. Fredrikson joined Alfred Bergin 2002 as a result of the firm’s partnership with Länsförsäkringar (LF).
The key to his outperformance, he says, is a relentless focus on understanding the mechanics of how companies make their money – and a refusal to stop scrutinising the numbers once they are inside the portfolio.
‘You need to know the company, meaning you need to follow their businesses and results very closely,’ says Sweden-based Fredrikson. ‘The most important thing when running a portfolio is to do the correct analysis of each company.’
Fredrikson deploys both fundamental and bottom-up approaches to uncover the most promising stocks in the MSCI Russia index. ‘Consistent outperformance can result from focusing on stocks with substantial total return potential, either from dividend yield or superior earnings growth prospects, coupled with a discount to fair price,’ he says.
‘A true understanding of a company’s potential can only be achieved through close monitoring of its business activity,’ he says, adding that his single most important data source is half-yearly and yearly company earnings reports.
Reasons to be cheerful
Fredrikson is bullish on the outlook for Russian equities, citing both structural factors and entrepreneurial innovation as reasons for optimism.
The rouble is likely to remain steady or even appreciate, he believes, supported by rising oil prices. ‘Following the agreement to cut oil output in November 2016 between Organisation of the Petroleum Exporting Countries (OPEC) and eventually non-OPEC oil producers, we became more confident that oil is likely to continue its recovery to a medium-term equilibrium range of $60-70 per barrel within the next one to two years,’ Fredrikson says.
Russia is a resources powerhouse, with energy accounting for 40% of the MSCI Russia index. ‘Russia has one of the largest proven gas reserves in the world, and is also one of the largest oil producers’, Fredrikson says. ‘These resources are also extracted at a very low production cost.’
Another factor supporting the currency is falling pressure from external debt payments. This is because many Russian companies and institutions have reduced their external debt obligations over the past two years.
Meanwhile, the Russian Central Bank (CBR)’s intention to maintain real yields at a relatively high level should continue to stimulate carry-trade activity.
Fredrikson says that many Russian companies can earn a substantial amount of money for their shareholders through their double-digit free cash-flow yields and high single-digit dividend yields.
What’s more, ‘there will be further rate cuts by the CBR, given that inflation remains relatively low,’ he says. In terms of the entrepreneurial potential of the country, Fredrikson points to the consumer space, with the expansion of modern food retail serving as a particularly striking example of how the country is moving with the times.
Fredrikson is positive on the utility and industrial sectors too. ‘In the utility sector, many companies deliver a double-digit free cash flow yield, which in the next step will be distributed to shareholders,’ the manager says.
In terms of the industrial sector, Fredrikson says some companies related to this sector are doing well, such as railway firms.
While he is positive on the utility and materials sectors, Fredrikson has reduced holdings in the materials sector. ‘That’s mainly due to [the fact that] some of the companies’ valuations are quite high’, he says.
When asked about the impact of US president Donald Trump’s trade protectionism on the Russian market, Fredrikson says the country won’t be hurt by Trump’s policy any more than other countries. ‘Since the sanctions were imposed in 2014, Russia has adapted and learnt to cope with import and export restrictions,’ he says.
‘The country set an example, replacing imports of groceries with domestic substitutions.’ During 2014 – one of Russia’s most challenging years in recent history, with the eyes of the world trained on the state’s annexation of Crimea – the fund was run in a defensive mode.
2016, by contrast, was a year of recovery, despite weak economic growth. But Fredrikson’s fund still performed well, even though it took a less aggressive approach.
Turning to the current allocation of the PARVEST Equity Russia Classic Cap fund, Fredrikson intends to keep its positioning largely unchanged.
He believes that it is well suited to a low-growth scenario in the Russian economy. ‘The portfolio is largely invested in value stocks of the companies which, in our assessment, are able to generate double-digit free cash-flow yields in the medium term and are keen to share a substantial part of this cash with their shareholders.
‘A smaller part of the portfolio is in the stocks of companies which we think are able to invest efficiently in growth, even in a rather tough macroeconomic environment,’ he says.
‘The portfolio also includes companies that can pay an above-market average dividend yield and at the same time maintain a relatively high expansion of their capital expenditure.’
Fredrikson’s investment style is influenced by his role models, including Benjamin Graham and Warren Buffett. ‘Graham is the father of value investing. His books are quite old, but it still works in today’s market – the value of the stock and the price on the market are two different things,’ he says.
On Buffett, he says: ‘He is one of Benjamin Graham’s students and uses his theories a lot. He is a value investor and he is the opposite of what we see today in many
of the markets with day trading, short-term investing and high-frequency trading. I think Buffett’s investing style is quite interesting.
Fredrikson started working in the equity business while he was at college. ‘I started working at a retail bank handling the equity side,’ he says. Back then, the market was virtually unrecognisable from today’s, he says. ‘We didn’t have electronic trading at that time, the stock exchanges weren’t open and it was a very different market. The stock exchange at that point was a live exchange with people running around making trades.’
This article appeared in the September issue of the Citywire Asia magazine.