This Emerging Market Gets No Respect

When investors talk about emerging markets, Russia often gets left on the back burner. But the world's largest manager of exchange-traded funds, BlackRock (NYSE: BLK  ) , thinks there's potential in Russia, and it's offering a new exchange-traded fund to let investors try to cash in on America's old rival.

The odd emerging market out
Looking at the emerging markets collectively, you can come up with some ideas why Russia tends to get left out. China and India both have massive populations that are seeing improving standards of living, giving their middle classes opportunities that they've never had before. Those countries not only enjoy high growth rates currently but also have immense potential, as capital inflows could produce big productivity gains that in turn could further elevate wealth levels among ordinary citizens. Similarly, Brazil has changed from a troubled nation with a history of debt problems to one of the most solid economies in the Western Hemisphere.

In contrast, with Russia, there's always an overtone of what once was. Government interference with private businesses is still problematic, and there's a general distrust of whether investors can count on their private property rights being respected in the long run. That in turn has slowed capital investment in the nation, and despite its rich store of natural resources, Russia seems to be a less favorable partner for other emerging economies than Brazil.

Seeking value
As a result, though, investors haven't bid up shares of Russian companies nearly to the extent they have other emerging markets. Value investors are therefore coming in to look for bargains. Moreover, given skyrocketing prices of a large number of commodities, Russia is reawakening interest among those looking for safe havens from dollar devaluation and potential future currency conflicts.

It's in that environment that Blackrock's iShares unit opened the iShares MSCI Russia 25/50 Index (ERUS) earlier this week. The ETF joins SPDR S&P Russia (NYSE: RBL  ) , which itself started operating earlier this year. The veteran in the class, Market Vectors Russia ETF (NYSE: RSX  ) , began in 2007.

One reason why Russia hasn't caught on with investors is that relatively few of its big companies list shares on U.S. exchanges. Large companies such as Gazprom and Lukoil are only available on thinly traded Pink Sheets. Although some notable companies do have ADRs, including miner and steelmaker Mechel (NYSE: MTL  ) as well as dueling telecoms VimpelCom (NYSE: VIP  ) and Mobile Telesystems (NYSE: MBT  ) , it's hard to build a representative sample of the Russian economy through individual stocks. The new iShares fund will have more than 50% of its assets in energy stocks, with materials and financial companies making most of the remainder.

Why Russia?
It's likely that iShares opened the fund in response to State Street's (NYSE: STT  ) decision to open the corresponding SPDR ETF. But that fund has thus far been a dismal failure, attracting just $8 million in assets. By comparison, the Market Vectors fund has $2 billion under management, so being the first mover in the area definitely has had its advantages.

With an annual expense ratio of 0.65%, the iShares Russia ETF certainly isn't cheap. But given how difficult it is for ordinary investors to gain access to the Russian stock market, some may decide it's worth the cost.

Yet true value investors may want to look at another option: Templeton Russian and Eastern European Fund (NYSE: TRF  ) , which is a closed-end that holds a substantial number of Russian stocks, including Mechel, VimpelCom, and the energy giants Lukoil and Gazprom. Unlike the ETFs, it has a long track record, having posted 21% annual gains on average over the past decade. Even better, it currently trades at a modest discount of almost 3% to its net asset value -- a rarity for the fund, which has often fetched a premium in the past.

Think about it
Some emerging market investors ignore Russia, and with good reason. Cheaper valuations come with higher risks, and you have to be comfortable with those risks if you want to try to capitalize on the better values you can find there.

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Fool contributor Dan Caplinger has fond memories of his Russian class in college. He doesn't own shares of the companies mentioned in this article. BlackRock is a Motley Fool Inside Value pick. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy can plow through a bowl of borscht in no time.


Read/Post Comments (3) | Recommend This Article (4)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 14, 2010, at 3:29 AM, DrRonPaul4Prez wrote:

    Interesting analysis. I found this article in my course of research on MBT. Looking at the financial statements, this looks like a solid company with a promising future. The risk here may be worth the reward for the most daring of investors...which after some foolish mistakes is no longer me.

  • Report this Comment On November 23, 2010, at 11:23 PM, MegaEurope wrote:

    CEE trades at a greater discount and has a lower expense ratio than TRF.

  • Report this Comment On November 23, 2010, at 11:26 PM, MegaEurope wrote:

    CEE also pays a higher yield, is more liquid and more diversified than TRF.

    I have just about convinced myself to buy it.

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