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Mutual Fund Commentary

MH17 Crash, Fresh US Sanctions: Beware of Funds with Russia Exposure

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The Russia-Ukraine crisis had never vanished and the latest crash of the Malaysian Airlines passenger jets proves that. The news desks yesterday were kept busy with news that a Malaysian Airlines passenger jet, MH17, was shot down near the Russia-Ukraine border. The news came in after the National Security and Defense Council of Ukraine said a Russian plane shot down a Ukrainian SU-25 fighter jet.

Moreover, late Wednesday, President Barack Obama had announced fresh sanctions targeting Russia’s large-cap companies that included bellwether energy and banking companies.

These events dragged the blue-chip MICEX index down by 2.3% to 1,440.63, its biggest fall in nearly a month.  The Russian Ruble too was under pressure. Micex is down 3.6% so far this month and has lost 4.2% year to date.

An exclusive Reuters report in March stated that the attorneys with the U.S. Securities and Exchange Commission were 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. The latest round of geopolitical tension and sanctions intensifies the concerns and brings the focus back on the fate of investments in Russia. Funds with significant exposure in Russia look in threat of losing once again and investors do need to be watchful.

Sanctions on Russia’s Bellwethers

“We have to see concrete actions, and not just words that Russia in fact is committed to trying to end this conflict along the Russia-Ukraine border,” Obama stated at the White House after announcing fresh sanctions on Russia’s large-caps.

Fresh sanctions were imposed on Russia’s two banks, two energy companies and defense companies. The sanctions now bar Russian companies including oil giant Rosneft and Russia’s third-largest bank Gazprombank OAO from getting new financing from U.S. capital markets.

These actions are strong signals to US and Western investors about their decision to keep holding equities or funds that have large Russia exposure.

The fresh sanctions are said to be more impactful as 17-25% of Russia's GDP is estimated to be coming from oil and gas. Moreover, Russian banks are not too good with raising domestic capital and have to rely on foreign money. Russian firms are said to be mostly dependent on foreign countries for long-term money and the nation faces hurdles with long term domestic capital. The US sanctions thus targeted to hit Russia hard. An administration official involved in the sanctions said: “This hurts them…If it doesn’t cripple them, it bleeds them pretty hard”.

Vladimir Putin Retaliates

The sanctions were imposed owing to Russia’s failure to end the Ukraine conflict. President Obama said: "What we are expecting is that the Russian leadership will see once again that its actions in Ukraine have consequences, including a weakening economy, and increasing diplomatic isolation”.

However, what followed was a warning from Russian President Vladimir Putin, accusing the US of pushing Ukraine to continued conflicts. He said Russia wants an immediate termination of the hostilities and a negotiation including all sides.

On the sanction Putin said: “They generally have a boomerang effect and, without a doubt, in this case, are driving the Russian-U.S. relations into a stalemate and seriously damaging them…I am certain that this is harmful to the U.S. Administration and American people's long-term strategic national interests”.

The Boomerang Effect

If the “boomerang effect” that Putin talks of is true, Texas-based Exxon Mobil Corporation is one energy firm that may be in a spot of bother. Apart from sanctions on banking giants Gazprombank and VEB, sanctions were also imposed on Novatek (largest independent gas producer in Russia) and state-owned Rosneft. Exxon and Rosneft have a major deal to develop Arctic and certain US oilfields.

ExxonMobil and Russian state controlled Rosneft had worked together on an approximately $500 billion deal to explore an oil field in Western Siberia. Exxon has been planning to construct a LNG terminal project in the oil field worth $15 billion. In fact, it also has joint venture projects to explore the Black Sea reserves.

Malaysian MH17 Jet Crashes, Ukraine Accuses Russia of Shooting Down Warplane

A surface-to-air missile was reported to have shot down a Malaysia Airlines jet that was carrying about 300 passengers. The MH17 jet was shot down over separatist-controlled eastern Ukraine, killing all on board. According to Associated Press, a Ukrainian official in his Facebook page said that the Boeing 777 was shot down while flying at an altitude of 10,000 meters. Malaysian Airlines had stated via its Twitter account they lost contact with flight MH 17 and “the last known position was over Ukrainian airspace.”

Ukrainian officials have stated that Russia recently delivered mobile Buk surface-to-air launching system to the separatists. U.S. intelligence sources confirmed that data from spy satellites and radar showed that the MH17, flying to Kuala Lumpur from Amsterdam, was shot in midair. However, the US intelligence could not identify from where the where the missile was launched.

Both Ukrainian government forces and pro-Russian separatists, who are fighting against each other in the war-tone eastern Ukraine, denied shooting down the plane.

The MH17 crash came close on the heels of accusations by Ukrainian officials that Russian forces had shot down a Ukrainian warplane. The National Security and Defense Council of Ukraine said a Russian plane shot down a Ukrainian SU-25 fighter jet, which was on a military operation over eastern Ukraine.

US Stocks Tank

The geopolitical tensions turned investors jittery and US stocks suffered their biggest losses in months. The Dow Jones Industrial Average (DJI) declined 0.9% to close Thursday’s trading session at 16,976.81. The Standard & Poor 500 (S&P 500) dropped 1.2% to finish at 1,958.12. It was the Dow’s biggest one-day percentage decline since May 15. S&P 500 registered its biggest one-day drop since April 10.

The recent events shift focus back to the Russia-Ukraine crisis that started early last year. Reportedly, 500 lives have been lost in eastern Ukraine alone since the fighting commenced. The Crimean crisis and the Russia-West standoff looked threatening to the financial stability since early last year. (Read: Russia-Ukraine Crisis Deepens: Key Stocks in Focus)

Beware of These Funds with Russian Exposure

The crisis is indeed far from resolved and volatility cannot be ruled out. The Bank of America
Merrill Lynch fund Manager Survey had stated earlier this year that a lion’s share of investors expressed concern over the geopolitical tensions being a threat to financial stability.

It's best to play a little safe and exit from the following funds that carry either a Zacks Mutual Fund Rank #4 (Sell) or Zacks Mutual Fund Rank #5 (Strong Sell). According to mutual funds rating agency Lipper, these funds have decent exposure to Russian stocks.

ING Russia A 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 the Russian government. Thus, this fund has a huge exposure to Russia. The non-diversified fund has returned a negative 6.33% year to date.

ING Russia A carries a Zacks Rank #5 (Strong Sell).

Among 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 and ING Russia W carry a Zacks Rank #5 (Strong Sell). They have returned negative 6.28% and 6.25%, respectively, year to date.

US Global Investors Emerging Europe 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 5.90% year to date.

US Global Investors Emerging Europe currently carries a Zacks Mutual Fund Rank #4 (Sell).

Among the top holdings, 4.03% of its assets are invested in GMK Noril'skiy nikel' OAO (Russia-based mining and metallurgical company), 3.50% in OAO Lukoil ADR and 2.47% in Mobile Telesystems OJSC ADR (Russia-based firm in telecommunication industry).

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