Key findings:

• Russian stocks had significantly cheaper and higher Yield than the MSCI Emerging Markets
• Russian stocks had modestly lower Growth, Quality, and Size
• For Allocators the removal of Russia has largely a marginal effect on factor exposures

At the beginning of March, MSCI announced they will be removing Russia from their key indices as “the conditions required for a functioning equity market are no longer in place in Russia.”  All investors should have a sense of the implications of this change and how it will impact their exposures to factors, the systematic drivers of portfolio returns.  Using Investment Metrics’ Style Analytics toolkit, this analysis dives into these implications and what this removal may mean for investors. 

During the last decade, Russian stocks comprised on average 4.6% of the MSCI Index, and that share had been steadily declining to 3.56% at the end of December 2021.  The month prior to the Russian invasion, the total market cap of the 25 stocks included in MSCI was $600 billion USD.  Half of this weight was concentrated in these three stocks: Gazprom, Sberbank and Lukoil.

Russian stocks have a strong Value and Yield bias.  Their top stocks were cheap on all Value metrics, especially book-to-price as these Financial and Energy companies have relatively high book values, and high yields. Last year, Sberbank paid a Dividend of 6.37% and Gazprom paid 3.66%. Russian stocks had historically lower sales and earnings growth, with forecasted expectations in line with MSCI EM. Lastly, while Russian stocks had inconsistent earnings and sales, Quality was relatively neutral while Volatility was generally lower, and Momentum has been strong throughout most of 2021.

Using Style Analytics Portfolio Labs, a scenario compared the MSCI Emerging Markets Index to the MSCI ACWI Index.  The translucent bars are the portfolio before exclusion, and the solid-color bars are after exclusion.  Portfolio Labs simulates reallocating the 3.58% Russian weight (in MSCI EM) to MSCI Brazil.  For investors looking to capitalize on tight agricultural conditions, reallocating to a major agricultural exporter such as Brazil with many substitute products may be prudent. Despite having significantly higher Value and Yield tilts – reallocating to Brazil shows the change is overall marginal.

While there is no significant change for the factor categories, the biggest change in reallocating to Brazil is the increase in the 5-year earnings growth, from 0.72 to 1.06, crossing the Style Analytics tilt significance threshold. The Style Analytics DeltaZoom module – a tool to help investors understand style factor changes – decomposes this change in several ways. Exhibit 3 shows that the increase in growth exposure is both partially removing lower growth Russian stocks and adding higher growth Brazilian stocks, while the addition of VALE S, a mining company, significantly improves Growth exposure.

Instead of positioning for Agriculture, allocating to Saudi Arabia may be sensible for investors looking to replace the Energy exposure they had in Russia.  Additionally, Saudi Arabia also offers overweights to Financials.  Using Style Analytics’ Portfolio Labs for this scenario shows that the most factor categories are constant, but the decrease in Value exposure is modest.  For investors, trading Value exposure for Energy exposure will have to be assessed within a broader context.

Conclusion

While the inaccessibility of Russian equities lowers the opportunity set for stock pickers, primarily in the Energy space, the change is not a major impact from the perspective of allocators. Russia’s relevance in the EM Index had been declining as other markets have risen over the past decade. 

Disclaimer

The material presented in this document is an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any funds or any issuer or security or similar.

This document contains general information only, does not consider an individual’s financial circumstances and should not be relied upon for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should always be given to consult a Financial Advisor before making an investment decision. 

Investment Metrics, a Confluence company, does not provide investment advice and nothing in this document should be considered any form of advice. Investment Metrics accepts no liability whatsoever for any information provided or inferred in this document.