Traders Flee Russia ETF as Ukraine Standoff Continues

President Vladimir Putin’s intensifying standoff with the U.S. and its allies over the war in Ukraine has stock investors pulling money out of Russia as they pile into other emerging markets.

Traders took $12.3 million out of the Market Vectors Russia ETF, the largest U.S. dedicated exchange-traded fund tracking the nation’s stocks, last week through July 24, according to data compiled by Bloomberg. The moves added to redemptions of $90.8 million in July, putting it on pace to be the biggest monthly outflow since February.

Withdrawals from the Russian ETF are accelerating as the U.S. and European Union seek to punish Putin for supporting separatists in eastern Ukraine with deeper sanctions intended to squeeze the $2 trillion economy. The International Monetary Fund said July 24 that Russia’s gross domestic product will expand 0.2 percent this year, less than half the government’s forecast of 0.5 percent growth, after increasing 1.3 percent in 2013.

Irene Bauer, the chief investment officer at Twenty20 Investments, said emerging-market ETFs make up about 25 percent of the firm’s portfolio, versus “hardly any exposure” six months ago, while it is avoiding Russia altogether. The London-based company specializes in ETFs.

“We are not investing in Russia because the tail risk is too high,” Bauer said by phone on July 25. “You just don’t know where the crisis in Russia is going. Political risk is higher than in other emerging markets, and the economics don’t look very good.”

Sanctions Risk

Flows into emerging-market ETFs turned positive for the year on July 24, by $109 million, reversing investor flight that had drained as much as $13.9 billion in the first 2 1/2 months of 2014. Outflows from the Market Vectors Russia ETF over the past two weeks were more than double the withdrawals of any of the other 228 emerging-market funds tracked by Bloomberg.

Russia’s benchmark Micex Index dropped 1.2 percent by 12:47 p.m. in Moscow. State-run Sberbank, the nation’s biggest lender, fell 1.8 percent. OAO Rosneft slumped 1.3 percent after the Permanent Court of Arbitration in The Hague today ordered Russia to pay $50 billion in damages to the former owners of Yukos Oil Co., according to Tim Osborne, head of GML Ltd., the former holding company for Yukos’s main shareholders. The Bloomberg Russia-US Equity Index on July 25 posted a third straight weekly drop, falling 3 percent to 85.20.

A ban on European purchases of bonds or shares sold by Russian state-owned banks is among options the EU is considering, according to a proposal presented to member states last week. The 28-nation bloc is proposing deeper sanctions as international sentiment galvanizes against Putin following the downing of a civilian jet in eastern Ukraine. Russia and the separatist rebels fighting in the region deny any involvement in the crash, which killed all 298 people aboard.

Relative Value

Russia has been the worst performer among the world’s 20 biggest stock markets this year as the dollar-denominated RTS Index dropped 14.9 percent. Equities touched a four-year low in March after Putin moved to annex the Black Sea peninsula of Crimea. The benchmark Micex index trades at 5 times estimated earnings. Its 57 percent discount to the MSCI Emerging Markets gauge is the biggest since the end of 2008.

While Russia’s already slowing economy will be further pressured by the sanctions, there may still be pockets of opportunity for stock buying among companies that depend on domestic consumption, according to Mirae Asset Global Investment.

“Consumption related stories will be the drivers for economic growth and the structural winners from an increasingly consumption-led economy,” Jose Morales, who oversees $2.5 billion in global equities at Mirae in New York, wrote in an e-mail on July 24. “The other area of optimism is cyclical companies, currently trading at a significant discount to global peers, which have the potential for increased capital distributions as their free cash flow improves.”

Volatility Surge

Russia’s central bank unexpectedly increased borrowing costs for a third time this year on July 25 as the threat of wider sanctions squeeze the economy and undercut the ruble. The currency has depreciated 6.5 percent against the dollar this year, the third-worst performance in emerging markets.

Net capital outflows from Russian assets jumped to $74.6 billion in the first half, compared with $61 billion in the whole of last year, central bank data show. Outflows may be near $100 billion in 2014, according to the Economy Ministry in Moscow.

The RTS Volatility Index, a measure of expected swings in the futures, jumped 15 percent last week to 36.22, the biggest increase since April.

“We are getting to the point when sanctions will be painful and double-edged, but if we don’t introduce them the situation could get even worse,” Polish Foreign Minister Radoslaw Sikorski told TVN24 on July 24.

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