Strategic Outlook for 2006: Castling. Second-Tiers Take the Limelight.
Throughout 2005 the Russian stock market outperformed investor expectations by breaking record after record. A case in point: the RTS index hit an all-time high in early August 2005, after which the market moved along an upward track and powered ahead more than 80% by the end of the year. Sustained demand for Russian stocks was driven by increasingly favorable conditions on primary commodity markets and a strong flow of Western funds into emerging markets further stoked investor enthusiasm. In another highlight, last year international rating agencies had their attention riveted to the Russian economy and continued to upgrade its credit ratings, which also added strength to domestic equities.
Our analysis of the macroeconomic situation and factors impacting the prospects of Russian securities shows that next year the stock market is poised to continue moving along an upward track. However, upside is expected to be moderate and we believe the benchmark RTS Index will hover within a range of 1,150-1,300 by year-end 2006. We see next year's primary upside potential in second-tier stocks and this research report will therefore devote special attention to the diversification of asset portfolios by classes of assets and economic sectors.
In line with our 2006 equity strategy, we advise investors to structure their portfolios as follows:
| | Conservative | Balanced | Aggressive |
| Bonds |
78,00% |
60,00% |
34,00% |
| Shares: |
22,00% |
40,00% |
66,00% |
| including blue chips |
10,00% |
17,00% |
26,00% |
| including second-tier stocks |
12,00% |
23,00% |
40,00% |
| |
100% |
100% |
100% |
Asset weightings in stock portfolios:
| | Conservative | Balanced | Aggressive |
| Gazprom |
9.1% |
8.5% |
7.9% |
| Gazprom pref |
9.1% |
8.5% |
7.9% |
| MTS |
9.1% |
8.5% |
7.9% |
| Lukoil |
9.1% |
8.5% |
7.9% |
| Surgutneftegaz pref |
9.1% |
8.5% |
7.9% |
| UralSib |
2.2% |
2.3% |
2.4% |
| Severstal-Avto |
3.3% |
3.5% |
3.6% |
| Irkut |
2.7% |
2.9% |
3.0% |
| Severstal |
4.9% |
5.2% |
5.5% |
| Murmansk Marine Shipping Company |
3.3% |
3.5% |
3.6% |
| Novoship pref |
3.3% |
3.5% |
3.6% |
| Siberia Telecom |
2.2% |
2.3% |
2.4% |
| Far East Telecom |
1.6% |
1.7% |
1.8% |
| Mikron |
2.7% |
2.9% |
3.0% |
| Magadanenergo |
4.4% |
4.6% |
4.8% |
| Samaraenergo pref |
4.4% |
4.6% |
4.8% |
| Zeyskaya HPP |
3.8% |
4.0% |
4.2% |
| UralKaliy |
4.4% |
4.6% |
4.8% |
| Cherepovetsky Azot |
3.3% |
3.5% |
3.6% |
| Salavatnefteorgsintez |
3.3% |
3.5% |
3.6% |
| Novosibirsk Chemical Component Plant pref |
3.3% |
3.5% |
3.6% |
| Pava |
1.6% |
1.7% |
1.8% |
| Total: |
100% |
100% |
100% |
We expect annual portfolio returns, which are calculated on the basis of fundamentals, to be 15% for the conservative portfolio, 20% for the balanced portfolio and 29% for the aggressive investment strategy. Equity weightage in the recommended portfolios varies from 22% to 66% depending on the risk tolerance level selected.
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