Investing in Russia During a Trump Presidency

Overtures by President-elect Donald J. Trump to Russia have been the most generous by an incoming U.S. president in years, and U.S. dealings with Moscow may become more conciliatory if Trump's pick of Rex Tillerson for secretary of state is approved.

As Exxon Mobil Corp. (ticker: XOM) chief, Tillerson had many dealings with Moscow and has even received an Order of Friendship award from President Vladimir Putin, a state decoration.

There are also some positives for investors in Russia aside from Trump's pro-Russian comments as the country's stock market and currency performed solidly in 2016.

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Even with a rally in its stock market and currency, some market watchers think select Russian assets are undervalued and may represent good deals. Given these factors, there are a few reasons investors might consider looking at the region again, but should make any portfolio additions small.

Emerging markets improve. Russia is lumped into emerging markets when it comes to investment sectors -- it was the R in the BRIC acronym of Brazil, Russia, India and China -- the four emerging market powerhouses that U.S. investors consider when thinking about the region.

Emerging markets as a whole rose in 2016. Using the iShares MSCI Emerging Markets exchange-traded fund ( EEM) as a proxy, emerging markets returned 10.87 percent last year, according to Morningstar. While that's less than the 12 percent return for the SPDR S&P 500 ETF ( SPY), the VanEck Vectors Russia ETF ( RSX), the main Russia-themed ETF, returned 47.23 percent in 2016.

That showing made Russia one of the top three best-performing emerging markets behind Brazil and Peru, says Gaurav Mallik, managing director and portfolio strategist of State Street Global Advisors in Boston.

Rising commodity values, particularly gains in crude oil and steel prices, powered the Russian market's performance, Mallik says. Russia's currency, the ruble, also was the second-best performing currency in 2016 because of the oil price rebound, he adds.

Jay Batcha, founder and chief investment officer at Optimal Capital Advisors in Traverse City, Michigan, says even with the rally in Russian markets, valuations are less than six times earnings, which he describes as "super cheap."

Before investors get too enamored with Russia, Arnab Das, head of EMEA and emerging markets macro research for Invesco in London, says "it's still early" to see how a friendlier U.S. stance toward Russia may play out.

Russia still faces U.S. sanctions imposed in response to its 2014 invasion of Crimea, and European leaders have a mixed stance toward Putin, Das says. He expects some alleviation of the selectively targeted sanctions, but how quickly and straight-lined that removal will be isn't clear.

It's those sanctions that make Russia undervalued, Batcha says.

Weighing investment options. Investors may want to consider their view on emerging markets as a whole before looking at Russia individually. Rob Haworth, senior investment strategist with US Bank Wealth Management in Seattle, says they're neutral on the region at least to start the year because of generally slow global growth.

Russian values are cheap based on price-to-book and price-to-earnings value in the broad market, but he says there's a reason for that.

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"You have relatively cheap valuation, a relatively cheap currency, so there's probably some opportunity for Russian investment," Haworth says. "In our mind, that would be moderated somewhat by the utter dependence on oil."

With Russia agreeing to cut crude oil production as part of an agreement with the OPEC to reduce the global glut of oil, that takes away some of the attractiveness of investing in Russia, Haworth says.

"You need a couple of other things to fall into place to make it much more interesting from a valuation perspective," he says. "You need opportunity for growth in an oil-dominated country. That means you need significantly higher oil prices or significantly ramping up of economic growth in Europe and Japan, where Russia would sell their oil, and I don't see any evidence of that, either. Russia is interesting, but not interesting enough."

Exercising caution. Mallik is also neutral on emerging markets. He sees some upsides in the region because of Russia and Brazil, but he also advises caution.

"Russia always trades at a discount because there are always concerns about the respect for property and laws," he says. "That's been the case since the Yukos incident back in 2003-04."

Mallik referred to the oil company forcibly broken up by Russia for allegedly not paying taxes, although the Parliamentary Assembly of the Council of Europe said the break up was for political reasons.

In the short term, Batcha says don't be surprised to see Russian stocks retreat, especially after the Trump inauguration. For investors with a longer timeframe, Russia is worth buying, he says. For retail investors, he says the easiest way to own Russian investments is the VanEck Russia ETF because of its broader exposure, an ETF he owns.

"Russia is cheap, sanctions are likely to be diminished through a more productive relationship and negotiation, and the energy complex is likely to stabilize," he says. "And as they (U.S. and Russia) get control of ISIS and align with interest in the Middle East, that supports oil prices as well. That's the big deal."

Mallik prefers Russian small-cap and mid-cap companies over large-capitalization companies.

"The problem with the large cap segment ... for the sector to rally you need things to change on a fundamental basis because the top names in Russia are all linked to the state," he says.

Batcha says for investors who can stomach volatility and want to try Russian small-cap stocks, the VanEck Vectors Russia Small-Cap ETF ( RSXJ) is one way to play it. He doesn't own that ETF, but says he's looking at it.

[See: 7 Ways to Trade Volatility With ETFs and ETNs.]

"Small-to-medium enterprises make up a bigger piece of emerging-market economies than even here in the U.S.," Batcha says. "If you really want high octane and believe in the story and want more leverage, you can buy that small cap Russian index. That was up 103 percent last year."

Debbie Carlson has more than 20 years experience as a journalist and has had bylines in Barron's, The Wall Street Journal, the Chicago Tribune, The Guardian, and other publications. Follow her on Twitter at @debbiecarlson1.