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Mutual Fund Commentary

An exclusive Reuters report notes that the attorneys with the U.S. Securities and Exchange Commission are contacting investment companies including mutual funds that have investments in Russia. The move is obviously crucial given the Ukraine crisis that has been affecting the financial scenario of late.

Popular funds including the ones issued by the likes of T. Rowe Price have taken a beating owing to the Russia-Ukraine tension over the Crimea region. These funds have significant positions in Russia. In fact, the tension is prominent between the West and Russia. The tension has intensified even after the vote last weekend was overwhelmingly in favor of Crimea being part of Russia.

The Crisis So Far

Tension escalated as Russia intensified its bid to make Crimea, a southern region of Ukraine, a part of its own. The Ukrainian Constitution acknowledged Crimea to be an integral part of Ukraine. However, the events over the past weeks saw Russia ignoring warnings from the West to take ownership of the land.

The vote on Mar 16 in Crimea turned to be overwhelmingly in favor of citizens from this region wanting to be part of Russia. However, US President Barack Obama and the European Union have refused to recognize the validity of the referendum.

Russian President Vladimir Putin has ignored all warnings so far and the sanctions imposed seemed to have made little difference in Russia’s bid of annexing Crimea. German Chancellor Angela Merkel recently said that Russia will witness severe EU sanctions if it fails to lower the jitters.

Recently, the Crimean self-defense forces have reportedly taken over the Ukrainian naval headquarters.
Russia’s foreign minister Sergei Lavrov said that the legal procedure to make Crimea part of Russia will complete soon. Putin has already signed a treaty to claim ownership of Crimea and the lower house has approved the treaty.

US Response: “Dangerous Situation”

President Barrack Obama had earlier warned Russia to curtail their aggression over Ukraine; otherwise they will be “forced to apply costs” to Moscow. However, the U.S. and Russia found “no common vision” over this ongoing crisis even after hours of talk last week.
Situations now seem definitely worrisome for funds with Russian exposure and the White House is planning further sanctions. White House spokesman Jay Carney said: “We are prepared to impose further costs on Russia for its violation of Ukrainian sovereignty and territorial integrity”.
Top US leaders President Barack Obama, Vice-President Joe Biden and Secretary of State John Kerry have been reaching out to allies and other countries, demanding them to condemn Russia’s military actions.

Jay Carney has gone to the extent to term the recent happenings as a “dangerous situation”.
The goods trade between US and Russia was at $38 billion in 2013. American companies are said to have $14 billion directly invested in Russia; of which mutual funds too have a large chunk. Russia has had no major trade dispute with the US since it joined World Trade Organization in 2012. However, situation is definitely different now and further sanctions may welcome retaliation by Moscow.

Flagging Confidence, Escalating Concerns

Volatility cannot be ruled out. In fact, investors and fund managers are increasingly getting worried about their portfolios. The sanctions, the military action and any fall out are most likely to cause a big economic impact. If that had not been the case, fund managers would not have been spurning from taking bets in the financial markets.

The Bank of America Merrill Lynch fund Manager Survey stated that a lion’s share of investors expressed concern over the geopolitical tensions being a threat to financial stability. Moreover, hedge funds are reported to have shunned the equities by chopping their leverage and exposure.
Already the Russian economy has suffered owing to the Ukraine crisis and the eventual annexation of Crimea. The US markets have had a mixed impact so far with investors escaping to safe-havens on certain days. European Central Bank President Mario Draghi said: “So far we've seen a major impact on the Russian economy and the Ukrainian economy, and some financial impact on countries that border that area…The impact on the Russian economy is severe”.

Russia’s MICEX Index has slumped 12% in the past one month with much of the downward move intensifying since Feb 28. Recently, Fitch chopped Russia’s rating outlook to negative from stable. Also, Standard & Poor’s has a negative outlook on Russia now and has a BBB rank. The cuts came close on the heels of European Union leaders imposing sanctions on 12 more Russians and Ukrainians.
Russia's central bank had to step in and it hiked interest rates to 7% from 5.5%. This was done to add stability to the markets and starve off the about 10% decline in ruble this year.

Time to Exit Russian Mutual Funds

As the West condemned the violation of Ukrainian sovereignty and territorial integrity, there are reports of Russia's military conducting massive aviation exercises in the northwest.
In such scenario, its best to play a little safe and exit from the following Zacks Rank # 5 (Strong Sell) mutual funds. According to mutual funds rating agency Lipper, these funds have a minimum of 10% exposure to Russian stocks.

ING Russia A (LETRX - MF report) invests primarily in equities of Russian companies. A minimum of 80% of its assets are invested in Russian companies, while the remaining 20% goes into debt securities that are issued either by Russian firms or Russian government. Thus, this fund has a huge exposure to Russia. Over the last 4 weeks, the non-diversified fund has returned a negative 13.28%.
 
As of December 2013, this fund held 36 issues. Looking at the top holdings, 14.06% of its assets are invested in OJSC Magnit (a Russia-based holding company), 11.10% in OAO Lukoil ADR (Russia-based integrated oil and gas company) and 8.61% in Sberbank Of Russia (Russia-based commercial bank).

Also, ING Russia Class I (IIRFX - MF report) and ING Russia W (IWRFX - MF report) carry a Zacks Rank #5 (Strong Sell). They have returned negative 13.27% and 13.23%, respectively, over the last 4 weeks.

T. Rowe Price Emerging Europe Fund (TREMX - MF report) invests mostly in common stocks of European emerging market countries. The emerging markets include Eastern Europe and the former Soviet Union. Over the last 4 weeks, the non-diversified fund has returned a negative 11.79%.

As of December 2013, this fund held 46 issues. Looking at the top holdings, 12.39% of its assets are invested in Sberbank Of Russia ADR, 7.32% in OJSC Magnit and 6.21% in OAO Gazprom ADR (Russia-based company involved in the operation of gas pipeline systems).

US Global Investors Emerging Europe (EUROX - MF report) invests a lion’s share of its assets in equities and related securities of companies in emerging markets of East Europe. The non-diversified fund has returned a negative 8.15% over the last 4 weeks.

As of September 2013, the fund held 69 issues. Looking at the top holdings, 5.99% of its assets are invested in Mobile TeleSystems OJSC (Russia-based telecommunication company), 5.78% in OJSC Magnit and 4.76% in OAO Lukoil ADR (Russia-based oil and gas company).

Conclusion

The standoff between Western powers and Russia seems far from over. Sanctions may not be lifted in near future. This may influence the outcome of several Russian companies. Thus, it is best to keep a close watch on these funds till the crisis is resolved.


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