Russian Market Watch

Leveraged ETFs don't suffer from leverage

noreply@blogger.com (Nicholas) — Sun, 12 Jun 2011 01:29:34 PDT

I took an interest in mechanics of leveraged ETFs when I knew about two new products by direxion with exposition in RSX. I faced a huge number of critics on such investment products, also lot of critics on these critics. Even I found some strategies based on myths and misunderstanding these and similar financial instruments. I cannot say that leveraged products are better than investment without leverage exactly. As I can't conclude that leveraged products are better or worse leveraged exposition on underlying benchmark. It depend from investment policy of everyone, everyone's preferences which are different, as it well known.

Anyway usually conclusions are based on insufficient data. This can explain why some myths are so popular and why there are to many misunderstandings. I point on effect of leverage. When we judge some investment product we compare it with related benchmark. Usually we either watch changes in final worth or study compound rate of return. At the practice (and at theory too) leveraged scheme can not beat its own unleveraged underlying very often. But it does not mean that future value of worth (expected value) suffer from leverage definitely.

To prove this let's perform simplest experiment based on Monte-Carlo Simulation. Why MC? Because it is

easy (every one is able repeat this)
illustrative (you can "touch" it and feel its mechanics)
representative (much more data, actually here is artificial data)

Assume, RSXs dynamics is based on Geometric Brownian Motion with growth 12% annual and volatility 30%. These numbers are much close to reality (at least close to some popular estimations). Let's study three investment strategies. First one: buy and hold RSX directly. Second: borrow money and buy and hold RSX with leverage 3x ether till end of some defined period or till "margin call" happens. Third scheme are purchasing of some leveraged ETF (or other product) which adjusts leverage every day to 3x.

Additional conditions: At second strategy when investor's worth falls below "zero" worth becomes equal "zero" (here we model limited liability kinda like shareholder's liability). At the third scheme let's define maximum daily change of worth as 100% from previous value.

Suppose we start a 500 days period (approximately, two years) with a portfolio consisting of equal amounts of capital in these three schemes (let it be 1 dollar in each strategy). What do we get after 2 years? Final worth in 1st, 2nd and 3rd strategies are 1.27 (+27%) 2.05 (+105%) and 1.84 (+84%). Expected worth of leveraged ETF beats and direct investment (1st strategy) and "buy and hold" scheme with borrowing (2nd).

But what about chances to beat market? So for each 7 from 10 time Leveraged ETFs were worse then benchmark purchased following 2nd strategy (borrow money)!!! There is 2 chances from 3 that unleveraged benchmark beat leveraged ETF and only 37 from 100 that benchmark will be better then 2nd scheme.

Results of this simple experiment (study) show following:

expected value of final worth does not suffer from leverage
leverage cut rapidly your chances for success

If you have any questions about this simulation or you interested in simulation of another strategies (products) don't hesitate ask me (contacts: fincolonel@gmail.com)

Russian Top Stocks (Valuation Measures & Dividend yield)

noreply@blogger.com (Nicholas) — Sun, 22 May 2011 16:03:06 PDT

NAME	BETA	RISK	% 12MO RETURN	P/E	P/BV	LAST DIVIDEND	%12MO DIV. YLD.
Aeroflot - Russian Airlines OJSC	0.77	23.9	24.3	29.9	2.8	1.085	1.582
Severstal OAO	1.23	32.0	49.1	9.4	2.5	2.420	0.894
Unified Energy System JSC	1.04	40.0	10.7	23.6	0.5	0.002	0.594
Gazprom OAO	1.04	30.4	34.0	4.7	0.8	3.850	1.956
MMC Norilsk Nickel OJSC	1.10	29.4	51.3	9.7	3.3	180.000	5.539
Federal Hydrogenerating Co JSC	0.86	24.7	-11.5	33.8	0.9	N/A	N/A
Lukoil OAO	0.97	25.1	20.5	5.6	0.8	59.000	3.440
Magnitogorsk Iron & Steel Works	0.87	31.0	-8.7	38.4	1.0	0.330	1.337
Mosenergo OAO	1.09	19.2	-22.7	11.6	0.5	0.013	0.000
Mobile Telesystems OJSC	0.73	15.7	6.9	16.0	3.7	14.540	6.160
Novolipetsk Steel OJSC	1.02	34.4	13.9	17.7	2.3	1.200	1.744
NovaTek OAO	0.88	29.9	97.4	22.4	7.3	2.500	1.126
PIK Group	0.97	31.9	-11.2	N/A	N/A	N/A	N/A
Polyus Gold OJSC	0.77	26.5	43.8	41.9	4.2	11.250	1.045
Polymetal JSC	0.75	35.7	51.7	25.2	6.4	N/A	N/A
Rosneft Oil Co	1.04	28.7	10.3	6.5	1.3	2.760	1.215
Rostelecom OJSC	0.69	38.1	63.6	29.9	2.2	0.000	0.680
Sberbank of Russia	1.13	28.0	37.2	11.1	2.1	0.920	0.978
Gazprom Neft JSC	1.01	30.1	-0.8	5.0	1.1	4.440	3.688
Surgutneftegas OJSC	0.99	25.8	3.8	8.2	0.8	0.500	1.883
Tatneft	0.97	30.1	28.0	7.0	1.0	5.020	3.239
Uralkali	1.00	34.6	121.8	27.4	8.1	4.550	0.000
VTB Bank OJSC	1.16	29.6	20.9	14.9	1.6	0.001	0.700
Source: bloomberg.com

Russian Government privatization plans may lift market to the new highs.

noreply@blogger.com (Nicholas) — Fri, 17 Dec 2010 17:18:45 PST

I don't envy short-sellers in Russia.

Currently the budget deficit in Russian Federation is equal 911 bln of Rubles in jan-nov (~$29 bln, wich approximately are equal 10% of GDP), as Russian Ministry of Finance reports. And its value will increase, as Authority expects. Also there are few way to cover budget deficit (there listed in Government's plan). There are:

tax increases,
borrowing (issue bonds at 1 trillion Rubles),
privatization (sell property at 1 trillion Rubles or more).

Early, at November, the Russian government has approved a privatization plan for sale of federal property in 2011-2013. As it expected, revenue of this sell-off could yield 1 trillion Rubles.

MOSCOW, November 17 (RIA Novosti)

The government hopes to get most of the privatization revenues from the sale of shares in ten major state-owned banks and companies. All decisions on the sale of these companies have been confirmed, Nabiullina said.

The list of privatizations includes the sale of shares in oil major Rosneft (RNGZY.PK, 25 percent minus one share), RusHydro hydropower generator (7.97 percent minus one share), the Federal Grid Company of Unified Energy System (4.11 percent minus one share), the country's largest shipping company Sovcomflot (50 percent minus one share), Russia's top bank Sberbank (7.58 percent minus one share), the country's second largest lender VTB bank (35.5 percent minus one share), the United Grain Company (100 percent by 2012), Rosagroleasing agricultural leasing company (50 percent minus one share from 2013), the country's rail monopoly Russian Railways (25 percent minus one share from 2013) and Russian Agricultural Bank (25 percent minus one share by 2015), Nabiullina said.

So ... Goals are obvious: "The government hopes to get most of the privatization revenues". This may mean that tax pressure increases will be delayed for a time, likely, at the first. At the second, Government need to put the stock's price on highest level. It's normal practices of initial offering. They gotta give some positive to markets.

Roadshow started, didn't it? (the greatest Roadshow since 2008)

At Dec 9, 2010 reuters writes

Russia's largest oil producer, privatization target Rosneft (RNGZY.PK), is around three times undervalued when compared to international peers, Deputy Prime Minister Igor Sechin said on Thursday.

"We think Rosenft is undervalued. Compare the structure of Rosneft's reserves and those of (Brazil's) Petrobas (PBR), for example. Rosneft is undervalued by around three times," Sechin told reporters.

And

As interfax reports At Dec 9.

ROSNEFT CHIEF UPS STAKE IN COMPANY FROM 0.0028% TO 0.0051%

Also

Alexey Miller's column

Gazprom is becoming ever more valuable, which is clearly evidenced by the fact that the Company's share value steadily goes up. The Company's capitalization has increased by nearly 35 per cent since the most recent Gazprom Shareholders Meeting.

The global economy is reviving, investors' confidence is growing. By purchasing Gazprom shares, the investors once again cast their vote for the course we have shaped for the Company's comprehensive development on a global scale, they invest funds in the most promising securities putting their trust in the future.

I have no doubt that Gazprom's capitalization will not only reach the pre-crisis level, but go up to its fair value. I give a buy recommendation!

Local TV shows following commercials (or similar):

Enjoy, this isn't as boring as commercials of Shell, ExxonMobil, etc

And more one funny fact: earler, at may, "German Gref, the head of Sberbank, Russia's biggest lender, became a shareholder in the firm for the first time after buying a 0.000004 percent stake worth $2,500, the bank said on Monday." //reuters

to be continued ... (?)

So, when you and authority banded together, you have significantly greater chances for success. Of course it may seem unconvincing for someone, but look it this way: you buy stocks and Government care about the market growth, 'cause they are interested in higher prices, at least till the sell-off.

In fact, Russian stocks are undervalued on comparing to international peers (even taking into account the country risk premium). And this Government media propaganda is able to lift market higher. This is a powerful support for equity prices, for a time. Any way, I don't envy short-sellers.

ETF Overview: Risk Premiums for Some Countries.

noreply@blogger.com (Nicholas) — Sun, 28 Nov 2010 18:36:18 PST

"RUSSIAN RTS INDEX $ (priced in USD)" trades at eight times earning, meanwhile S&P500 has 14.891 (approximately 13-14 P/E for next year). Assume that US Equity market is correctly priced. So, based on the comparative P/E ratio we conclude that investors agree to pay only 54 cents for one dollar of profit. Is it normal? Actually I don't know. Let's estimate risk premium for some countries.

Equity Risk Premium (US).

First metric is difference between the geometric average of historical rates of returnable on equity market and 10-years Treasury Bonds - 9.26% and 4.97% respectively (for the period 1928-2009). Premium is equal 4.29% (see Historical Returns on Stocks, Bonds and Bills - United States, for instance).

Second one - difference between current or expected Earn-Price ratio and current 10-years Treasury Bonds Yield (we used current Earn-Price ratio). It's aproximately 4.09%. If we assume that expected P/E is equal 14, given this, we get 4.52%.

At the third, Implied Equity Risk Premium. Parameters used in model and results see in following table.

Table 1: Implied Equity Risk Premium (US)
At Nov 25th 2010.

S&P 500 INDEX (20-Day Average), pts
1199.58
Dividends and Buybacks Trailing 12-m, pts
48.2
Expected growth rate in earnings for next 5-y, %
7.2
Expected growth rate in the long term, %
2.84
CBOE Interest Rate 10-Year (5-Day Average), %
2.84
Expected income rate, %
7.51
Implied Equity Risk Premium, %
4.67

see "Implied Equity & Counrty Risk Premium weekly report"
Sources: finance.yahoo.com, standardandpoors.com, damodaran.com
Calculations: invest2russia.blogspot.com

So we have three estimates of equity risk premium, which are enough closely each to other. Let us assume that risk premium is 4.67% and expected rate of return on equity is equal 7.75% (free risk "plus" risk premium) for US market.

Country Risk Rates.

There are many approaches to estimate Country Risk Premia. We use following ones: approach based on Moody's Long-Term Credit Rating, based upon AAA-JPM CEMBI yield spread market volatility adjusted and upon the CDS-rates volatility adjusted.

Table 2: Bonds and rates

Country
Moody's LT Rating
10Y-Gov bond local currency, %
JPM CEMBI, pts
CDSs, %
Brazil
Baa3
12.50
5.94
1.15
China
A1
3.99
7.99
0.74
Hong Kong
Aa2
2.66
4.78
0.43
India
Ba2
8.38
5.34
1.26
Indonesian
Ba2
7.50
7.15
1.02
Mexico
Baa1
6.27
5.75
1.18
Russia
Baa1
7.73
5.79
1.63
Australia
Aaa
5.500

0.83
Japan
Aa2
1.160

0.61
U.K.
Aaa
3.361

0.70
USA
Aaa
2.91

Sources: wsj.com, markit.com, bloomberg.com

Table 3: Equity Markets (local currency)
Country
Index
Risk, %
P/E
E/P, %
Brazil
IBOV
17.85
13.75
7.28
China
SHSZ300
26.41
18.95
5.28
Hong Kong
HSI
15.84
11.75
8.51
India
SENSEX
15.59
14.12
7.08
Indonesian
INDEXCF
15.77
17.55
5.70
Mexico
MEXBOL
12.71
17.48
5.72
Russia
INDEXCF
15.30
8.76
11.41
Australia
AS52
13.64
39.41
2.54
Japan
TPX
17.31
15.62
6.40
U.K.
UKX
15.15
16.87
5.93
USA
SPX
15.34
14.89
6.72

Sources:bloomberg.com

Table 4: Equity Markets (US dollars)
Country
Index
Risk, %
P/E
E/P, %
Brazil
MXBR
22.47
12.47
8.02
China
MXCN
17.02
14.59
6.85
Hong Kong
MXHK
14.48
12.81
7.80
India
MXIN
16.07
17.41
5.74
Mexico
MXMX
17.35
19.70
5.08
Russia
MXRU
19.72
8.13
12.31
Australia
MXAU
13.85
16.34
6.12
Japan
MXJP
17.53
15.50
6.45
U.K.
MXGB
15.06
16.88
5.92
USA
SPX
15.34
14.89
6.72

Sources:bloomberg.com

Table 5: Country Risk Premium

Country
Based upon Moody's rating
Based upon JPM CEMBI-AAA Spread
Based upon JPM CEMBI-AAA Spread, Volatility adjusted
Based upon CDSs, Volatility adjusted
Brazil
3.00
1.44
5.45
6.47
China
1.35
3.49
7.43
3.51
Hong Kong
0.90
0.28
0.85
1.90
India
4.50
0.84
2.53
4.93
Indonesian
4.50
2.65

Mexico
2.40
1.25
3.77
5.08
Russia
2.40
1.29
4.39
7.18
Australia

3.13
Japan
0.90

3.11
U.K.

2.99
USA

0.00

Sources: damodaran.com
Calculations: invest2russia.blogspot.com

Table 6: Total Risk Premium

Country
Based upon Moody's rating
Based upon JPM CEMBI-AAA Spread
Based upon JPM CEMBI-AAA Spread, Volatility adjusted
Based upon CDSs, Volatility adjusted
Brazil
7.67
6.11
10.12
11.14
China
6.02
8.16
12.10
8.18
Hong Kong
5.57
4.95
5.52
6.57
India
9.17
5.51
7.20
9.60
Indonesian
9.17
5.92

Mexico
7.07
5.92
8.44
9.75
Russia
7.07
5.96
9.06
11.85
Australia
4.67

7.80
Japan
5.57

7.78
U.K.
4.67

7.66
USA
4.67

4.67

Calculations: invest2russia.blogspot.com

Table 7: Expected Rate of Return (free risk rate "plus" total premium)

Country
Based upon Moody's rating
Based upon JPM CEMBI-AAA Spread, Volatility adjusted
Based upon CDSs, Volatility adjusted
Average
Brazil
10.51
12.96
13.98
12.48
China
8.86
14.94
11.02
11.61
Hong Kong
8.41
8.36
9.41
8.73
India
12.01
10.04
12.44
11.50
Indonesian
12.01

12.01
Mexico
9.91
11.28
12.59
11.26
Russia
9.91
11.90
14.69
12.17
Australia
7.51

10.64
9.08
Japan
8.41

10.62
9.52
U.K.
7.51

10.50
9.01
USA
7.51

7.51
7.51

Calculations: invest2russia.blogspot.com

What does it means? (Conclusion)

We can use these results as estimation of required rates of return for equity markets, for the risk weighting purposes and P/E forecasting.

Actual current P/E for S&P500 is equal 14.891 times earning. Expecting P/E is 13.32. Its very close to some forecasts. Russia has 8.22 current and 8.13 estimated P/E. It's close to actual ratio too. In other words 55 cents for one dollar of current profit in Russia is normal. Also Hong Kong trades near its P/E estimation.

Following our results, required rates of return on equity are 12.48, 11.61 and 11.5 for Brazil, China and India respectively. Current earn-prices marks are equal 8.02, 6.85 and 5.74. So Brazilian, Chinese and Indian companies should increase their profit. The expecting GDP's growth looks like the great opportunity for companies from these countries to demonstrate the rising of their earning. Otherwise if they will not use it Investors will be very disappointed (it looks very risky). In a nutshell there are no significant upside potential and very weak downside protection at this moment.

Are Russian Gas & Oil Producers really undervalued?

noreply@blogger.com (Nicholas) — Sat, 13 Nov 2010 08:47:05 PST

The 4 largest publicly-listed Russian Oil and Gas Producers included in RSX portfolio: OGZPY.PK (7.67%), LUKOY.PK (7.52%), SGTPY.PK (5.38%), and RNGZY.PK (7.76%).

The average P/E of presented Russian companies is equal approximately 5-6 (weighted by market cap). Is it very attractive? I don't think so.

When you invest to emerging you get more risk (it's generally accepted idea). If you get more risk be sure that risk reward is really adequate.

Modern finance theory identifies two components to asset returns: a systematic (oil, gas, gasoline prices; world consumption and supply energy resources, phase of business cycle etc...) component and a nonsystematic, or idiosyncratic, component (regional economy environment, country's/region's monetary and fiscal/taxes policies, cost of mining, etc... for example).

Assume that government bond yield is some measure of region's idiosyncratic risk. And let's compare some well known companies with more then $50 billion market cap by P\E ratio.

We use current stock prices, divided by forecast earnings per share (that well known as P/E ratio). But also we multiply this value by relevant bond yield rate. Thus we get some relative index, which could help us to compare companies from one region with companies from another regions.

A lower value indicates that company is undervalued then other.

So, what should we see? Emerging markets have higher P/E - bond yield ratio then developed. And Russian companies are not outstanding ones on rest emerging background. Of course OGZPY.PK looks undervalued, little bit. But the prospective payoff is approximately 30-50%. Also SGTPY.PK is likely little bit less then other companies. But basically Russian Oil & Gas industry have the same valuation that emerging.

Related ETF: Market Vectors-Russia ETF (RSX)

Comparing Country ETFs By P/E - Government Bond Yield - GDP

noreply@blogger.com (Nicholas) — Sat, 13 Nov 2010 17:58:48 PST

Some countries have low P/E ratio, while other, by contrast, high. But this does not mean, that some countries are more attractive for investors, then other. So this simple compare may be useless. Actually, countries have different P/E ratios, but also they have different interest rates.

Let's follow the "FED" model. This comparison is more adequate. So, P/E ~ 1/r, where r is 10 year Government Bond yield. Or (P/E)*r=k, where k is adjustment coefficient. In general, Lower k may indicate cheaper equity market (under-priced or troubled). At least, lower k (k<1) means that stock price is less then it's theoretical value.

What about GDP expectation?

OK. Let's include this parameter in our model. Actually, you don't find any strong relationship between GDP and P/E (or r*P/E) on historical data. However, higher GDP indicates stronger economics. Hence, higher GDP may indicates more attractive environment of country's equity market.

Thus, most attractive countries correspond to points at the bottom-right on diagram (see below). Conversely, overvalued markets at the background of weak GDP situated top-left on figure. Data and data sources.

Data (t1.bmp) | Source (Source.txt)

Conclusion: obviously, China (GXC, FXI, PGJ) is leader. Chine will stay leader, even GPD forecast reduce to 6%. Hong-Kong (EWH) and Singapore (EWS) are another most atractive countries. Concerning India (INDY, INP, PIN, EPI), I am not assured: strong GDP forecast, but equity market is overvalued. Brazil (EWZ) also have most overvalued k ratio and 5.5% GDP. Canada (EWC), USA (IWV) and Russia (RSX) are somewhere in the middle of our rankings. So I don't find Russian Markets very attractive. Switzerland (EWL) and Germany (EWG) are most preferable in Europe.

S&P 500 INDEX (20-Day Average), pts	1199.58
Dividends and Buybacks Trailing 12-m, pts	48.2
Expected growth rate in earnings for next 5-y, %	7.2
Expected growth rate in the long term, %	2.84
CBOE Interest Rate 10-Year (5-Day Average), %	2.84
Expected income rate, %	7.51
Implied Equity Risk Premium, %	4.67

Country	Moody's LT Rating	10Y-Gov bond local currency, %	JPM CEMBI, pts	CDSs, %
Brazil	Baa3	12.50	5.94	1.15
China	A1	3.99	7.99	0.74
Hong Kong	Aa2	2.66	4.78	0.43
India	Ba2	8.38	5.34	1.26
Indonesian	Ba2	7.50	7.15	1.02
Mexico	Baa1	6.27	5.75	1.18
Russia	Baa1	7.73	5.79	1.63
Australia	Aaa	5.500		0.83
Japan	Aa2	1.160		0.61
U.K.	Aaa	3.361		0.70
USA	Aaa	2.91

Country	Index	Risk, %	P/E	E/P, %
Brazil	IBOV	17.85	13.75	7.28
China	SHSZ300	26.41	18.95	5.28
Hong Kong	HSI	15.84	11.75	8.51
India	SENSEX	15.59	14.12	7.08
Indonesian	INDEXCF	15.77	17.55	5.70
Mexico	MEXBOL	12.71	17.48	5.72
Russia	INDEXCF	15.30	8.76	11.41
Australia	AS52	13.64	39.41	2.54
Japan	TPX	17.31	15.62	6.40
U.K.	UKX	15.15	16.87	5.93
USA	SPX	15.34	14.89	6.72

Country	Based upon Moody's rating	Based upon JPM CEMBI-AAA Spread	Based upon JPM CEMBI-AAA Spread, Volatility adjusted	Based upon CDSs, Volatility adjusted
Brazil	3.00	1.44	5.45	6.47
China	1.35	3.49	7.43	3.51
Hong Kong	0.90	0.28	0.85	1.90
India	4.50	0.84	2.53	4.93
Indonesian	4.50	2.65
Mexico	2.40	1.25	3.77	5.08
Russia	2.40	1.29	4.39	7.18
Australia				3.13
Japan	0.90			3.11
U.K.				2.99
USA				0.00