Short interest in Russian ETFs declines as economic conditions improve

Jun 24th, 2015 | By | Category: Alternatives / Multi-Asset

Those pundits betting on a Russian bear market have started to reverse their outlook on the world’s tenth largest economy, as “short interest” in the Market Vectors Russia ETF (RSX), a $2.1bn Russian equity exchange-traded fund, dwindled to 3%, a significant drop from highs of 9% during May.

Short interest in Russian ETFs decline as economic conditions improve

The Russian economy has started to rebound after the financial crisis of 2014.

Short interest is widely seen as a measure of investor sentiment in the market, especially when it undergoes rapid changes. Short interest is calculated by dividing the number of shares shorted by the number of shares outstanding. The higher the ratio, the greater the number of shares being shorted.

Analysts have attributed the reversal to stabilising conditions in Russia, brought about by oil prices above $60 a barrel, as well as a major rally in the ruble.

Russia has been in the grips of a financial crisis since late 2014. The fall in oil prices, a major export of Russia, from $100 a barrel in June 2014 to under $55 a barrel in January 2015, was a major shock to the economy. Economic sanctions imposed against the financial, energy and defence sectors of the country’s economy, enforced due to the annexation of Crimea and Russia’s role in the ongoing conflict in Ukraine, added a double blow.

Investor confidence rapidly declined, prompting an exodus of capital and the fall of the ruble from 37 RUB/USD to 68 RUB/USD in the three months between September 2014 and December 2014. This encouraged intervention from the central bank who hiked interest rates to a growth-dampening 17% and spent almost $12bn of foreign reserves in December alone in an attempt to prop up the tumbling ruble.

The situation in Russia has eased markedly since then. The price of Brent Crude has been stable above $60 a barrel, bringing the price of Urals Oil (Russia’s oil benchmark) up along with it. This has provided much needed relief, especially to government revenues. Energy and energy-related production account for “a substantial share of total economic output, half of the federal budget revenues and almost two-thirds of export revenues”, according to Deutsche Bank.

The ruble has responded well by appreciating 12% this year and the MICEX Index, a decent gauge on Russia’s equity market, has increased 19%. Inflation is being reined in and unemployment seems steady at 5.8%. The markets are still potentially volatile, but this volatility seems to be mainly priced in to the equity market. This is shown from continual small rallies in price despite renewed sanctions.

Listed below are two potential ETFs for investors looking for exposure to Russian markets:

FinEx Tradable Russian Corporate Bonds UCITS ETF (FXRU)
The FinEx Tradable Russian Corporate Bonds UCITS ETF provides exposure to highly liquid Russian Corporate Bonds, denominated in hard currencies (USD, GBP, EUR, CHF). The fund employs a full replication strategy to track the returns of the Barclays EM Tradable Russian Corporate Bond Index. The current yield is 5.95%, average maturity is 2.8 years, and adjusted duration is 2.5 years. The average yield to maturity is 6.3%. Since inception, the fund has a stated volatility of 8.04% p.a.

The underlying covers mainly investment-grade debt, with ratings of Baa2 (55%) and Baa3 (26%) accounting for well over three-quarters of the composition. Currently, the largest exposures to single issuers are Gazprom (15%), Sberbank (15%), VTB (12%), and GazpromBank (11%). The ETF felt the effects of the financial crisis, with its value falling 21% between July and December 2014. Since then it has enjoyed a rally of 12.1%. The Total Expense Ratio (TER) is 0.50%.

Market Vectors Russia ETF (RSX)
The Market Vectors Russia ETF tracks the rules-based, modified market cap-weighted Market Vectors Russia Index. The index imposes size and liquidity controls by restricting the list of constituents to those with a market cap of at least $150m, and those with an average daily trading volume of $1m and a minimum of 250,000 shares per month over the previous 3 months.

The fund is naturally tilted towards the energy sector (40.1%), followed by the materials sector (15.6%), and the financial sector (12.9%). The fund has 50 holdings and the most concentrated holdings include Gazprom (7.9%), Lukoil (7.6%), Magnit (7.2%), Sberbank (6.8%), and Novatek (6.1%). The TER is 0.61%. The underlying constituent stocks trade at an average price to earnings multiple of 6.5, the lowest multiple among emerging market benchmarks.

Despite the lift in oil prices and the rebounding ruble, caution must be taken before investing in Russia. “This is a very, very volatile market,” says Dr Nicholas Spiro, managing director at Spiro Sovereign Strategy in London.

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