Morningstar Magazine - April/May 2018 - 29

receipts include the Dow Jones Russia GDR, the
MSCI Russia ADR/GDR, and the DAXGlobal Russia.
These indexes also apply caps to individual
holdings, ranging between 10% and 30%. That said,
the top three holdings usually account for more
than half of the index weight. The only exception
is the DAXGlobal Russia, which applies a firm 10%
cap on single stocks and thus limits the combined
weight of the top three holdings to 30%. The top
three holdings of all these indexes-Russia's
largest bank, Sberbank, and energy conglomerates
Gazprom and Lukoil-have been the same over the
past two decades, though their individual weights
have dramatically changed over that period.
Rated Russia active funds allocate less to their
top three holdings, partly because of the UCITS
diversification rules. These may prevent active
funds from potentially profiting from overweighting
the likes of Gazprom, Lukoil, and Sberbank.
Market-cap-weighted Russia equity indexes
suffer not only from single-stock concentration but also from heavy sector concentration,
with energy typically accounting for about
half of the index weight. Meanwhile,
industrials, consumer discretionary, healthcare,
information technology, and real estate are
not represented at all.
By contrast, active Russia equity funds have
underweighted their exposure to energy by 10%
and 20% relative to the MSCI Russia 10-40 and
MSCI Russia, respectively, during the past decade.
This may have partly shielded them from the
downside to Russian energy stocks when oil prices
tumbled in mid-2014. As of now, their average
exposure to the sector is 30%.
Corporate oversight may give active managers
an edge as well. According to Morningstar's
Sustainability Atlas, Russian companies receive
some of the lowest corporate governance
ratings in the world. By moving further down the
market-cap spectrum and screening for corporate
governance risks, active managers have been
able to add value.
Passive investing in Russian equities is clearly
cheaper, however. Most passive funds
have ongoing charges between 0.5% and 0.65%.

Active funds rated by Morningstar analysts
have ongoing charges for the clean share classes
between 1.05% and 2.46%. These funds have
hurdled their higher fees so far, generating higher
returns than cheaper passive offerings, but will
have to contend with that obstacle going forward.

with an internal rate of return of more than 8%.
This has created value, with returns above
the firm's cost of capital. The firm's overseas
expansion continues to drive solid earnings growth,
averaging 13% during the past 10 years. This
bodes well for the future, as opportunities remain.

Either way, investors considering exposure to
Russia equity funds will have to contend with the
effects of foreign exchange on returns. None
of the rated funds apply a currency hedge on the
Russian ruble. Most of them find a currency
hedge too expensive to have in place. A key reason
for the MSCI Russia's dismal returns relative
to developed-markets equities over the past five
years through January has been the rising
U.S. dollar. Without currency translation effects,
the MSCI Russia Index would have generated a
positive annualized return of 10.07% over the
period, instead of a 0.48% loss.

CapitaLand Mall Trust, or CMT, re-enters our
Pick List at an attractive fiscal 2018 distribution
yield of 5.5% and a 15% discount to its fair value
estimate. This is mainly due to the current
weak retail environment, increasing competition in
2018 from new retail space, and the repositioning
of some of its malls. While we believe the above
factors will result in negative rental revision
in 2018, we still expect CMT's medium-term growth
to be supported by the redevelopment of Funan.
Construction of Funan is progressing well,
and CMT has received strong leasing interest for
its retail and office components. Its existing
properties across Singapore are of high quality,
with most of them situated close to subway
stations and transport hubs, and within areas
of high population density. The trust has a strong
record of adding value to its portfolio by
redeveloping existing properties, which has
delivered solid rental and income growth.

Monika Dutt is a passive strategies analyst with
Morningstar, based in the United Kingdom.
Ronald van Genderen, CFA, is an active strategies analyst
with Morningstar, based in the Netherlands.

Asia-Pacific Equity
Pick List
ASIA

Hong Kong
As it was for most global equity markets,
February was a volatile month for Asia-Pacific
equity markets. While all of the Asia-Pacific
markets have recovered from their lows, most are
still down 5% for the month of February.
This pullback in the equity market has opened up
opportunities for the Asia-Pacific Pick List. We are
replacing DBS Group D05:SG and Westfield
Holdings WFD:AU with CK Infrastructure Holdings
01038:HK and CapitaLand Mall Trust C38U:SG.
CK Infrastructure Holdings has a business strategy
of building and expanding its operations by
acquiring utility assets with stable and predictable
income streams. The company has a good
record of overseas acquisitions, targeting assets

DBS Group entered our Pick List in September
2016, as we believed concern over its oil and
gas exposure was priced into the share price at
the time. Our thesis has largely played out,
as the exposure resulted in higher provisioning for
nonperforming assets, but the bank's strong
underlying earnings helped offset the increase in
nonperforming assets over the past two years.
The bank's shares last traded at HKD 29.63,
and while we remain positive on its prospects over
the long term, we believe the upside is priced
into its current share price. Westfield Holdings'
stay on the Pick List was shorter after it entered
the Pick List in February 2017. In December, the
company agreed to a takeover by Unibail-Rodamco
at a 17.8% premium to the last close price before
the bid.
Michael Wu, CAIA, is a senior financials analyst with
Morningstar, based in Hong Kong.
Lorraine Tan, CFA, is regional director of research, Asia,
with Morningstar.

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Table of Contents for the Digital Edition of Morningstar Magazine - April/May 2018
