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Broadgate: Weekly Briefing 25/11

25 November 2013Japan – Japan’s exports have seen their biggest annual rise for three years.

Exports rose 18.6% to 6.1tn yen ($61bn) in the year to October, largely thanks to more car shipments, its ministry of finance said, this was above analysts’ forecasts of about 16.5%.

A weak yen and an improving global economy has seen oversees demand pick up, but despite this and Prime Minister Shinzo Abe’s looser monetary policies, Japan’s economy remains fragile.

The yen has fallen approximately 14% against its U.S. dollar value in 2013, making Japanese goods cheaper for foreigners to buy. Car exports rose 31.3% year-on-year, while the volume of overall exports to the U.S. and European Union grew 5.3% and 8% respectively.

“U.S. private-sector demand remains strong and European economies appear to be bottoming out,” said Takeshi Minami, chief economist at Norinchukin Research Institute in Tokyo, “If advanced economies recover, Japanese exports can rise more,” he added.

China – China has attracted 5.77% more foreign direct investment (FDI) in the first 10 months of the year, compared to 2012. Government figures show FDI totalled $97bn over the period.

In October alone, the country attracted $8.4bn, an increase on a year earlier but down from September’s figure.

Ministry of Commerce spokesman Shen Danyang said foreign investment policy would remain stable and transparent as China carried out its reform agenda.

U.S. – The leading U.S. equity markets hit fresh record highs on Monday, suggesting a ‘Santa rally’ is well underway in the run up to Christmas.

The Dow passed the 16,000 mark for the first time ever, while the S&P 500 recorded a fresh high above 1,800.

Year to date, the Dow is up 22% and the S&P is up 26%, showing growing investor confidence following a strong results season and a continuation of QE.

Janet Yellen, who is soon expected to take over as the head of the U.S. central bank, mounted a defence of quantitative easing in her first address to Congress last week, giving investors hope loose monetary policy will remain in place to support equity markets for some time to come.

Brazil – The Brazilian Ibovespa index declined the most in seven weeks this week, on speculation Latin America’s largest economy will remain stalled, making stock rallies hard to sustain.

The Ibovespa slid 2.3% at Tuesday’s close in Sao Paulo, the biggest decline since Sept. 30 and the worst performance among major global benchmarks. Sixty-nine of 72 stocks on the index fell. The real weakened 0.5% to 2.2759 per dollar.

Brazil’s gross domestic product will expand 2.45% this year and next, according to the median forecast of analysts surveyed by Bloomberg. The economy grew 0.9% last year, the worst performance since the 2009 financial crisis.

Trends – New York has overtaken London as the world’s top financial centre, according to a survey of senior financial services executives commissioned by Kinetic Partners, the global professional services firm.

Those surveyed also said they foresaw London’s influence declining further in coming years, with “only a quarter of banking, asset management and hedge funds leaders now thinking that London will still be a contender for the world’s pre-eminent global financial centre in five years’ time,” a summary of the survey’s findings said.

The survey for Kinetic Partners’ 2014 Global Regulatory Outlook report sees the proportion of executives who name London as the leading financial centre drop to 40%, down from 65% in the same survey last year.

Almost half, or 49%, now name New York instead, up from 31% a year ago.

Looking forward, 40% still expect New York to be top of the global financial world in 2018, but just 26% – and only 24% of the 132 chief executives questioned – think the same of London, down from 41% last year, the summary of the survey’s findings noted.

Spotlight on: Un-loved Russia?

Robin Geffen, fund manager & CEO of Neptune Investments (the managers of the underlying asset to MC148 & MC148S2, the HIL Neptune Russia & Greater Russia fund) shares his thoughts on the lack of appreciation for the favourable position that Russia now finds itself in.

At a time of emerging market fragility, Russia stands out for the resilience of its economic framework. In the near term, lower oil prices and tighter monetary conditions have weighed on Russia’s economic activity, but as global interest rates begin to recover alongside improving global economic growth, countries with demands on foreign capital in the form of current account deficits will be vulnerable. Russia has one of the larger current account surpluses within emerging markets and a debt to GDP ratio of just 11% – compared to 60% in 2000 – and is far less dependent on foreign capital. This, along with a more stable foreign exchange landscape and a target of decreasing inflation year-on-year, is creating a stable savings and investment platform which we believe will significantly benefit the equity market.

Indeed, policymakers have been addressing the systemic weaknesses that were exposed in the global financial crisis and, as a result, Russia’s resilience to external shocks has improved dramatically. These reforms, however, have been significantly underappreciated by market participants: whilst there has been a significant reduction in systematic risk, the market’s valuation suggests precisely the opposite.

Dividends

Following the MSCI Russia Index’s 76% increase in dividends in 2012, the market now offers an attractive 4% yield. The driving force behind this increase in dividends has been the government itself, which last year gave the final approval to legislation requiring state-owned entities (SOEs) to pay out 25% of their net income to shareholders. This measure affects a large number of Russia’s blue-chip stocks, ranging from energy-sector heavyweights such as Gazprom and Rosneft to consumer-facing companies that include the national airline carrier Aeroflot and telecommunications provider Rostelecom.

Moreover, these higher payouts have not been confined to state companies and have catalysed a response in the private sector too. Companies are deeply concerned with their own low valuations and are determined to remain competitive with their state-run peers. A good example of this is Lukoil, the largest private oil producer in Russia. Management at Lukoil has engaged very actively with the investment community and has listened to the demands of its shareholders. Having never cut its dividend, Lukoil has committed to grow its dividend by at least 15% annually. We consider these strong cash returns to shareholders to be an increasingly compelling argument to invest in Russia at these historically low valuation levels.

Improving business environment

To quantify progress, the government has targeted moving from 122nd in the World Bank Doing Business Index in 2010 to 20th by 2020. Progress so far has been impressive, with Russia rising to 92nd in the recently announced 2014 report. The main focus is on speeding the process of starting a business, simplifying doing business and making it cheaper to operate businesses. Improvements include shortening the number of days to receive a construction permit, reducing the number of hours to complete tax returns, and cutting the time taken to pass goods through customs, among many others. These policies provide a very supportive backdrop to investing in Russia and will be key to improving sentiment and unlocking value.

Fixed asset investment

With the 2014 Winter Olympics in Sochi just one of many ongoing infrastructure projects, capital investment is becoming a burgeoning investment theme. In 2012, Russia’s investment-to-GDP ratio stood at 22%, a ratio the government is aiming to raise to 27% by 2018. The key levers behind this will be a growing savings base, issuing infrastructure bonds and the development of public-private partnerships, all things the government is actively pursuing.

In particular, the government’s target of increasing fixed asset investment provides significant opportunities for industrial stocks with exposure to priority areas. One of these areas is transportation infrastructure, which is consistently increasing its share of total fixed asset investment spending. For example, the Federal Target Programme (FTP) spend on the rail system is expected to reach RUB300bn by 2014, up from just over RUB200bn in 2011.

Neptune Russia & Greater Russia Fund

The Fund is exposed to three key themes: rising consumer spending, energy and infrastructure spend.

Rising consumer spending power has been a long-held theme of ours in Russia. We continue to favour consumer staples, where strong top-line growth is now being complemented by rising gross margins. There remains significant scope to increase margins through greater scale as retail penetration continues to rise and the market consolidates. For example, we have seen a significant gross margin improvement across the sub-sector in the past 24 months as increasing scale is providing better purchasing terms with suppliers. Furthermore, food retail sales continue to grow at high single digit levels despite historically low inflation. We also continue to access the consumer theme through the financials, consumer discretionary and information technology sectors.

We also maintain significant exposure, albeit a large underweight relative to the Index, in the energy sector. Russian oil companies continue to have the lowest ‘lift’ costs in the world, extracting oil at much lower costs than their competitors. They are therefore well-placed to outperform, even if the oil price does drift lower, whilst benefiting from growing dividends.

The third sector that we have strong conviction in is industrials, which we expect to benefit from increasing investment into infrastructure and logistics.

Looking forward, we remain positive on Russia. We consider the market to be very attractively valued and the scale of its discount wholly unjustified. Reflecting this outlook, the Fund remains fully invested in its favoured sectors and is well-positioned to take advantage of this investment opportunity.

Summary

In our opinion, reforms that have been undertaken in Russia have been underappreciated by the market. We believe that there has been a significant reduction in systemic risk, whilst the market has suggested precisely the opposite. Consequently, we believe that the Russian market has significant re-rating potential and that when investor sentiment begins to improve there is enormous value to be unlocked. The Neptune Russia & Greater Russia Fund remains very well positioned to capture this value through our focus on high growth consumer-facing sectors and companies that provide strong cash returns to shareholders.

BWB

The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.

Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.

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