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Time to Avoid Russia ETFs?

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Russian stocks have on a decline so far this year and they have been very volatile too. Low investment and structural factors are leading to the slow growth of the economy, which in turn have hurt the stock market.

Russia is the world’s top producer of crude oil and has more natural gas than any other country on the planet, ensuring that it will be a top player in the energy space for decades to come. However, investors should note that the sector has been underperforming lately.

In fact, , largest natural gas extractor in Russia the state run Gazprom, which is responsible for about half of the government’s revenue, has not been really successful in reducing the government’s deficit or improving the state’s pension system (Will There Be a WTO Boost for Russia ETFs?).

Also, consumer demand appears to be losing its pace attributable to the weakness in the Eurozone, which accounts for about half of Russian trade, thereby obstructing corporate investment and reducing demand for commodities.

However, Russia's industrial sector showed a sharp improvement in March, recording a rise in output for the first time after December. Industrial production recorded growth of 2.6% year over year.

The growth was mainly driven by a much weaker base effect and strengthening output in all major sectors, with the fastest year-over-year growth in manufacturing. However, the outlook for industrial production appears to be somewhat uncertain.

Oil and gas which account for a large portion of Russian export provided some support to Russia’s income level . Oil and gas account for 50% of federal government revenue and around 20% of Russia’s GDP.

The Economy Ministry has reduced its 2013 economic growth forecast to 2.4% from 3.6% issued earlier in April. Additionally, core inflation remains a matter of concern for the economy. However, low unemployment level along with high capacity utilization should provide a cushion in this uncertain environment.

Also, the ministry mentioned that the Russian economy would grow only 3.7% (down from an earlier outlook of 4.3%) in 2014 and 4.1% (4.5% projected earlier) in 2015 due to weakness in  exports, capital inflows, investment, industrial production and retail growth (Why Russia ETFs Are Not A Debt Crisis Safe Haven).

The ministry has also revised its investment growth forecast downwards to 6.6% from 7.3% for 2014 and to 7.2% from 7.9% for 2015, while industrial growth is expected to be 3.4% in both years, which is also a downward revision from an earlier forecast of 3.7% for both years.

The ministry does not foresee capital inflow in 2014, and expects just $10 billion inflow in 2015, which is also a downward revision from an earlier estimated figure of $40 billion.

Currently, for investors looking to play the Russian equity space, there are three viable options. While the options look similar, each of the products has its own key differences that investors should be cognizant of before attempting to make a bet on the beaten-down Russian economy:

iShares MSCI Russia Capped ETF (ERUS)

This product from iShares follows the MSCI Russia 25/50 Index. This index produces a fund that holds 28 securities and has a heavy concentration in the top three companies that make up nearly 75% of total assets.

The fund manages an asset base of $238.5 million and trades at volume levels of 0.2 million shares a day (The Truth about Low Volume ETFs).

Energy firms make up nearly 50.1% of total assets in ERUS, while the next biggest sector, financials, occupies just 18.4% in comparison. ERUS, which charges investors 60 basis points a year for its services, generated a negative return of 8.5% in the year-to date period.

Market Vectors Russia Small-Cap ETF (RSXJ)

For investors looking for a small-cap play on the Russian economy, RSXJ represents a solid choice. The fund provides exposure to 26 companies that are either domiciled in Russia or generate a substantial portion of their revenues in the country. The fund manages an asset base of $12 million.

While its focus might be on pint-sized securities, the product still has a heavy focus on the energy sector as RSXJ puts 26.7% of its assets in energy firms, 19% in industrials, and 17.6% in materials (Go Green with These 3 Clean Energy ETFs).

The product charges investors a net expense ratio of 71 basis points a year but has had an extremely rough year-to-date period, losing 7.02% in the period. This level is slightly higher than its large-cap counterparts.

Market Vectors Russia ETF (RSX)

For investors seeking the biggest and most liquid option in the Russia ETF world, look no further than RSX. The product trades about 3.6 million shares a day and holds $1.5 billion in assets, suggesting tight bid/ask spreads for investors.

The fund invests its asset base in a portfolio of 48 securities and appears to be concentrated in the top ten holdings. The top ten holdings constitute 60.9% of the total asset base.

In terms of sector exposure, energy dominates, making up nearly two-fifths of the total portfolio. It is closely followed by the materials sector, which accounts for another quarter of the assets. RSX has a net expense ratio of 62 basis points a year and has slumped by 9.9% in the year-to-date period (Who says iShares ETFs are not cheap).

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