This is a piece about an odd situation in the investment trust sector. It’s also about Russia’s invasion of Ukraine, sanctions and what a ceasefire might look like.
Everyone should want this immiserating conflict to end. But what follows isn’t my take on how that should happen or how Europe and the US should handle Russia. Yes, that might seem like a cop-out. But this isn’t the magazine for it, I’ve no reason to think you care, and in any case, it appears much of the current decision-making is happening without any of our say, Ukraine included. Which is just as it started.
Anyway, let me explain what I’m talking about.
Exactly three years ago, things fell apart for JPMorgan’s Russian Securities trust. When it released its annual report on 24 January 2022, amid the build-up of forces on Ukraine’s border and the ongoing collapse of diplomatic relations, both its reported net asset value (NAV) and share price had fallen around a fifth over the preceding three weeks.
With less than six weeks left in the job, the trust’s chair, Gill Nott, noted that the developments had the “potential to derail [a] more positive economic outlook”. But she reserved almost as much comment for the recent unrest in Kazakhstan. Nor did the fund’s managers sound too concerned. Covid-19’s impact on economic activity remained the “major uncertainty”, while “actual conflict” was not anticipated.
Instead, wrote Oleg Biryulyov (today still at the trust) and Habib Saikaly (now of Goldman Sachs): “The current stalemate is most likely to persist until there are leadership changes in the countries involved in the conflict, or until a deterioration in Russia’s economy increases pressure for a resolution.” Existing sanctions were expected to stay, while Russia’s strong trading with the EU looked like a source of security.
Nor was investors’ risk appetite shifting, at least as expressed by the shares’ discount to NAV. A peak discount of 15 per cent came and went on the first day of 2022. As Nott reminded the market, the trust was proof of the rewards available to those happy to ride out Russian market volatility.
But as Putin’s tanks rolled in in late February that year, and international investors abandoned Russian stocks, the value of the trust’s holdings imploded. On the eve of invasion on 23 February, the trust’s NAV was £6.08. By 4 March, Russian brokers were banned from selling Moscow-listed stocks on the instruction of non-residents, Russian companies were prohibited from paying dividends to western shareholders, prices on the trust’s holdings were suspended, and two trust directors had abruptly left. And NAV had fallen to 40p.
The value of the trust’s Russian holdings was written down by 99 per cent. Institutional investors – save for a few holdouts – scarpered, while individuals piled in. In June, the share price hit a low of 58p – still a 30 per cent premium to NAV but pointing to fading hopes that the trust could recover anything.
In this situation, you might expect the trust to wind up. It didn’t. That’s because on 4 March 2022, just days into the full-scale war, sanctions already biting hard and with admittedly little to lose, shareholders passed a continuation vote that allowed the trust to carry on for another five years.
The period since can be characterised by that initial defiant optimism. And although shares in the trust’s successor, JPMorgan Emerging Europe, Middle East and Africa (JEMA), have been nothing if not volatile, that 2022 summer price dip did not last.
In recent weeks, the stock has caught fire as investors ramped up their two-leg accumulator bets that Donald Trump will make good on his promises to end the war in Ukraine, and that tit-for-tat financial assets freezes will be unwound, leading to a massive revaluation in JEMA’s Russian stakes, worth around £1.4mn at last count. JEMA shares are up a third since the US president’s call with Vladimir Putin on 12 February, pushing them above a previous post-2022 peak shortly after Trump’s re-election.
The effect of this speculation has rendered the trust’s market value more disconnected from its NAV than any UK-listed investment trust. At a 370 per cent premium, it is also more than three standard deviations away from its 12-month average, according to Winterflood Research. That makes it an extreme outlier among both its peers, and its own trading history.
Bullish about the bear
Why, then, are shareholders so bullish? There are three ways to answer this question, none of which are likely to involve a desire for sustained exposure to Russian equities.
The first is the most obvious. Today, sanctions mean JEMA’s Russian holdings (which were worth more than £350mn at the end of 2021) and dividends accruing in a custody account in Moscow (worth £35.3mn and counting) are entirely notional. At one point last May, when Putin issued a decree to identify property that could be seized in the event of US confiscation of Russia’s sovereign, it seemed as though they might be gone forever. A separate (ongoing) attempt by Russian bank VTB to secure a freezing order over assets held by various JPMorgan entities, including JEMA, has looked similarly existential.
But at some point, possibly soon, this uncertainty might vanish. We know Trump wants a quick deal. And if the sanctions switch could be turned on in a matter of days, the reverse might also be true. At Tuesday’s summit in Riyadh, Russia’s foreign minister Sergei Lavrov said that US and Russian officials had agreed to overcome “the issue of the seizure of our property and banking transactions”. While few details are clear, a sanctions reprieve already appears to be on the table.
This takes us to our second explanation. Investors are bullish because they can be. In a recent update, JEMA’s board drily noted that the “premium arises due to a difference in the view of the valuation of the company’s net assets and should not be interpreted as an indication that investors are more likely to derive any value from the company’s Russian shareholdings”. Indeed, since the trust’s focus switched to the EMEA region, that value has barely budged within JEMA’s portfolio (see table).
Currently, these holdings are classed as ‘level 3’ assets under International Financial Reporting Standards’ fair value hierarchy, meaning they are based on ‘unobservable market data’. While most professional investors avoid this sort of opacity, regular investors can do what they want. Plus, just because Western firms won’t provide live feeds for Russian equities doesn’t mean they can’t be found online.
Third, like the guy trying to recover his bitcoin from a Newport landfill site, there have been just enough positive signs to keep investors’ hopes up. In October, JEMA was able to liquidate its stake in Nebius (formerly Yandex, often dubbed Russia’s Google) after it slipped outside of the sanctions net. Although the board warned shareholders to treat the sale as a “unique situation”, transactions have been known to happen. Last year, the Barings Emerging EMEA Opportunities (BEMO) trust – which itself has frozen holdings in seven Russian blue-chips, and £2mn in a custody account – managed to sell £2.3mn of nil-value Russian securities on its books. It, too, later netted a further £1mn when it sold its stake in Nebius.
What are the chances?
JEMA isn’t the only ‘play’ on the war’s end. Shares in FTSE 250 outfit Ferrexpo (FXPO), which mines and pelletizes iron ore from its facilities in central Ukraine, has often been seen as a proxy for peace (and a presumed beneficiary of the country’s eventual reconstruction). They are also up since November.
However, JEMA’s greater allure lies in the possibility of an instantaneous windfall. Even if the trust sticks with its revised mandate, an end to sanctions and the resumption of regular trading in Russian stocks could – in theory – allow it to realise a massive cash gain out of almost nothing. By contrast, the cash value in Ferrexpo, which will face many challenges even if peace breaks out, cannot be conjured so easily.
However, the binary nature of the situation doesn’t mean JEMA’s premium will ever be justified.
Last October, Russian civil courts granted VTB’s claims against JEMA in full. Next week, an appeal hearing could help determine whether the trust’s sub-custodian in Russia is made insolvent. And if this happens, it may not be able to service those holdings. Seen in this light, the writedowns make sense. Any investor claiming otherwise – or offering advanced insight into decisions made by Russia’s judiciary, or how these decisions might be impacted by geopolitical currents – are reaching.
Ultimately, JEMA’s rallying share price isn’t what it looks like: namely, cheerleading for the expedited carve-up of Ukraine. Between legal pitfalls and closed-door dealmaking, it still seems a blind bet on the favourable outcome of multiple coin flips. It might all come good. Or we might see sanctions lifted too late to impact the battle with VTB. Like 2022, the potential downside could again be 90 per cent.