With the Ukraine crisis making the headlines on a daily basis, investors are understandably questioning the risks of investing in Russia right now. Our view is that, despite heightened tensions over a potential Russian invasion of Ukraine, there continues to be a good case for having some Russian exposure as part of a diversified portfolio. When one considers the low share price valuations of Russian companies, the possibility that tensions between Russia and the West will eventually ease following talks, and the practical considerations that could constrain the extent of any sanctions, we believe that selected Russian stocks have the potential to present attractive opportunities.

The significant Russian troop build-up on its border with Ukraine and the relatively recent experiences of Russia’s conflict with Georgia (2008) and its annexation of Crimea (2014) have led some to conclude that a Russian invasion of Ukraine is not just possible but certain. In our view, such an outcome is far from being a certainty, given the substantial risks that this would entail, along with the immediate human and economic costs, which would be on a completely different scale to the previous two conflicts. Russia’s military exercises have already proven effective as a negotiating tactic, and it may be that this is the extent of their purpose. Dialogue between the West and Russia is ongoing, and despite the public disagreements on issues such as Ukraine’s right to join NATO, there are signs that common ground could be found in other important areas, including limiting missile deployments and military exercises. Ukrainian NATO membership – theoretically on the agenda since 2008 – has always been such a remote prospect that it doesn’t make for a plausible justification for war. In the event of an agreement followed by de-escalation, in our view Russian assets would be likely to rebound from depressed levels that still have a lot of pessimism baked into the price.

The Jupiter Emerging and Frontier Income Trust has investment in three Russian companies, which in aggregate represent 7.3% of the portfolio, while the Jupiter Emerging European Opportunities Fund – a fund mandated specifically to focus on equity investments in Central and Eastern Europe – has a Russia weighting of around 60%.¹

Norilsk Nickel, the shares of which are currently valued at just six times its estimated earnings for 2022,² is a top 10 holding in both funds. In our view the company faces a lower risk than some other Russian companies from any sanctions that might be imposed in the event of a conflict. Norilsk Nickel is what might be described as a “systemically important” metals producer. The company produces 44% of the world’s palladium³. – a commodity that all of the world’s major automotive manufacturers (with the exception of Tesla) have to use for catalytic converters. Without palladium, these companies would be unable to produce petrol cars that meet legal emissions requirements. Norilsk Nickel also supplies 22% of the world’s high-grade nickel⁴, which is the main raw material used in electric vehicle batteries. It is hard to imagine a scenario where sanctions could be imposed on Norilsk Nickel without causing an unacceptable level of collateral damage to Western economies. Previous attempts to sanction large Russian metals producers were ultimately watered down, then reversed, in part due to similar considerations.

Another common holding across both funds is Russia’s leading bank, Sberbank – a very profitable business, which consistently delivers a high level of dividends, while also reinvesting in technology initiatives, which have enhanced the service it offers to customers and improved its operating efficiency. While it is likely that Sberbank would be targeted in some way by any new sanctions in the event of conflict, in a de-escalation scenario we believe it would have good prospects to rebound from a depressed valuation that values the company at less than five times its estimated earnings for 2022.⁵ There has been talk of Russian companies potentially being shut out of the global ‘Swift’ payment system, but we are not certain that Western countries would follow through with this threat, as it would cause a lot of short-term disruption to the global financial system and encourage countries that have disagreements with the West to transition towards alternative means of transaction that are beyond Western control.

There are two general observations that we feel are also worth making. Firstly, in the event that sanctions are imposed against Russia, whoever is designing them will want to minimise collateral damage to Western investors. We have seen that in the past, when specific companies have been put onto the SDN (‘Specially Designated Nationals’) sanctions list, investors have been given time to divest their holdings – a process that could be completed very rapidly for large, liquid stocks such as Norilsk Nickel and Sberbank if need be. Secondly, if the West does impose sanctions, we need to gauge the risks that Russia could respond in kind. It’s a possibility that can’t be ruled out – but we note that when the West imposed sanctions in 2014, Russia’s counter-sanctions did not target foreign portfolio investors. Instead, they targeted Western food imports that could be substituted by increased domestic production. If Russian assets held in the West were confiscated, the risks could increase, but we believe that large foreign companies operating in extractive sectors, e.g. mining, would be more exposed in such a scenario than the foreign portfolio investors that Russia has been cultivating with some success in recent years.

The ultimate outcome of this crisis has yet to be determined – at the time of writing, the possibility of a negotiated solution remains open, as well as that of conflict. We believe that certain Russian equities have scope to deliver significant returns in a peaceful scenario, and that the impact of a conflict on the Russian stock market would not be as unmanageable as the dramatic headlines suggest. When Russia seized Crimea in 2014, many investors declared that Russian equities had become “uninvestable”. Yet an investor who held Russian shares at the beginning of that year would have earned an 8-year total return of 85% in sterling terms by the end of 2021, a figure that is 30 percentage points higher than the UK’s FTSE All-Share Index.⁶ Of course, it could be different this time round! After all, high potential rewards do come with high risks. But when positions of this kind form part of a diversified portfolio, we believe they can help to improve its risk-adjusted returns.

Jupiter Emerging & Frontier Income Trust: Investment trust companies are traded on the London stock exchange, therefore the ability to buy or sell shares will be dependent on their market price, which may be at a premium or discount to their net asset value. Before making an investment decision, please read the PRIIPS Key Information Document which is available from Jupiter on request and at www.jupiteram.com. This content is for information only and nothing herein is to be construed as a solicitation or an offer to buy or sell any investment. The Company currently conducts its affairs so that its shares can be recommended by financial advisers to ordinary retail investors in accordance with the Financial Conduct Authority’s (FCA) rules in relation to non-mainstream pooled investment products and intends to continue to do so for the foreseeable future. The Company’s shares are excluded from the FCA’s restrictions which apply to non-mainstream pooled investment products because they are shares in an investment trust.

Please bear in mind that all investments involve risk and the value of, and any potential income from, your investment may fluctuate and are not guaranteed. The company examples mentioned above are for illustration only and not a recommendation to buy or sell or investment advice. We recommend you discuss any investment decisions with a financial adviser, particularly if you are unsure whether an investment is suitable. Jupiter is unable to provide investment advice. The views expressed are those of the authors at the time of writing and are not necessarily those of Jupiter as a whole and may change in the future. This is particularly true during periods of rapidly changing market circumstances. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. Past performance is no guide to future performance.

The Jupiter Emerging and Frontier Income Trust can borrow money and use it to invest, also known as ‘gearing’ or ‘leveraging’. The risk with gearing is that when the borrowed money has to be repaid the value of the Company’s investments may not be enough to repay it and any interest and the Company will make a loss. If the value of the Company’s investments falls, any invested borrowings will increase the value of this loss. Investors may get back nothing at all if the fall in value is sufficiently large. The Company invests in developing geographical areas and there is a greater risk of volatility due to political and economic change, fees and expenses tend to be higher than in western markets. These markets are typically less liquid, with trading and settlement systems that are generally less reliable than in developed markets, which may result in large price movements or losses to the Company. The Company invests in smaller companies, which can be less liquid than investments in larger companies and can have fewer resources than larger companies to cope with unexpected adverse events. As such price fluctuations may have a greater impact on the Company. This Company invests mainly in shares and it is likely to experience fluctuations in price which are larger than Companies that invest only in bonds and/or cash.

Jupiter Emerging European Opportunities Fund: The fund invests in developing geographical areas and there is a greater risk of volatility due to political and economic change, fees and expenses tend to be higher than in western markets. These markets are typically less liquid, with trading and settlement systems that are generally less reliable than in developed markets, which may result in large price movements or losses to the fund. The fund invests in a small number of holdings and as such carries more risk than funds which invest across a larger number of holdings. This fund invests mainly in shares and it is likely to experience fluctuations in price which are larger than funds that invest only in bonds and/or cash. The Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. This fund can invest more than 35% of its value in securities issued or guaranteed by an EEA state.