American investors looking to diversify their portfolio to include international stocks can do so easily by purchasing shares of American Depository Receipts (ADR). These shares trade on U.S. stock exchanges and are priced in dollars, yet they represent shares of the foreign company. ADR prices tend to move in tandem with their foreign counterparts.
While adding exposure to international equities can add the benefits of diversification and the potential for higher portfolio returns, each individual company and the country within which it operates carries unique risks and circumstances that must be carefully considered. (For more, see: Understanding The Risk In The BRICs.)
Of particular interest are companies in Russia. The Russian economy relies heavily on its stock of natural resources and therefore may be impacted by sharp moves in the price of oil, ore or other commodities. There is also currently rising uncertainty regarding geopolitical stability in the region making for potentially more downside risk. Certain Russian companies have been hit hard recently by Western economic sanctions levied in response to the situation in Ukraine and Crimea. Despite the volatile situation surrounding the Russian economy, it may present itself as a value opportunity to pick up relatively cheap securities.
Allocating a portion of international stocks to a portfolio can help augment return while reducing overall risk in a portfolio if the correlation between the two markets is less than one. Since 2009, the correlation between the broader U.S. and Russian stock markets has been +0.49, meaning that it offers some modest diversification potential. (For more, see: Investing In Russia: A Risky Game?)
Allocating a portion of international stocks to a portfolio can help augment return while reducing overall risk if the correlation between the two markets is less than one. Modern portfolio theory teaches that diversification benefits a portfolio as the correlations of the assets held in it diverge, meaning the less that asset prices move in tandem the greater the benefit. Correlations close to 1.0 would indicate that the prices of those assets move largely in the same direction by the same magnitude at the same time, while correlations close to 0.0 would indicate that there is no statistical relationship between the price movements of the assets.
American investors looking to gain exposure to Russian companies might consider the following ADRs, ranked by market capitalization:
|Gazprom OAO||OGZPY*||Oil & Gas||63.45|
|Rosneft Oil||RNFTF*||Oil & Gas||57.76|
|Lukoil||LUKOY*||Oil & Gas||39.24|
|Surgutneftegaz OAO||SGTZY*||Oil & Gas||25.97|
|Gazprom neft'||GZPFY*||Oil & Gas||14.22|
|Mechel OAO||MTL||Metals & Mining, Steel||0.18|
Source: BNY Mellon, data as of 12/5/2014, *Indicates shares are traded Over The Counter (OTC) market.
Many of the largest Russian companies with shares traded in the United States trade Over The Counter or OTC. These exchanges are generally less regulated and the listing criteria is less strict than for stock exchanges such as the NYSE/EURONEXT or NASDAQ. The risks associated with OTC stocks therefore are sometimes greater than trading stocks listed on larger stock exchanges, and this must be kept in mind when considering to invest in any of the OTC shares on Russian companies. Not to be confused with "penny stocks", the companies listed in the table above have large market capitalizations and are actively traded in the OTC markets.
Exchange Traded Funds (ETFs) that track the broader Russian stock market or track the currency (Russian Ruble) are also tradeable on U.S. Stock markets. Trading in ETFs also removes some of the risks associated with shares of individual Russian companies that only trade on the OTC market.
|Market Vector Russia ETF||RSX
|SPDR S&P Russia ETF||RBL
|Ishares Msci Russia Capped Index ETF||ERUS
|CurrencyShares Russian Ruble||FXRU
The Bottom Line
Russia (the 'R' in the so-called BRIC countries) is a country that has a lot of risk, but also a lot of potential. Being heavily reliant on natural resources and with geopolitical regional risk looming, both the Russian stock market and currency have taken a beating recently. Potentially these markets have been oversold and may represent a buying opportunity.
Adding ADRs or international ETFs to an investment portfolio can help with diversification, increasing potential returns while minimizing overall portfolio risk. The less each foreign market is correlated with the U.S. market, the greater for diversification potential. Any one individual foreign stock or even individual countries pose their own unique risks that must be considered. The political and economic climate of each country varies and can be volatile, especially in emerging markets.