Research Notes

2006 has become another successful year for the Russian equity market, as investor demand for the Russian assets has soared to enormous levels over the past eleven months. The major drivers behind this growth were favorable conditions which prevailed on global commodity markets in 2006, continued investor interest in emerging market stocks and a healthy macroeconomic situation in Russia. In our 2006 strategy notes we recommended investors to buy into second-tier companies and focused on sector diversification of our model portfolios. This strategy has proved to be an effective one, since while the RTS Index gained 62% in January 1, 2006-December 14, 2006, shares from various segments in our model portfolios spike by some 82%–84% during the same period.

In our opinion, the coming year will be marked by high volatility of the Russian stock markets and investor interest in low liquidity companies will remain robust. Year-end 2006 capitalization of the first-tier companies holds significant upside potential, however, we expect that RTS-2 Index is likely to outstrip the RTS Index in 2007 and recommend increasing the share of second-tier stocks in aggressive model portfolios. We advise investors in 2007 to take a good look at companies from the Russian telecom, utilities and consumer sectors, as well as producers of thermal coal, since rising household incomes, real ruble appreciation and investment boom play into the hands of companies whose products are geared towards internal demand. Below is a breakdown of first-tier and second-tier stocks in our model portfolios by asset type.

The annual yield of our conservative, balanced and aggressive strategies is expected to be 17%, 24% and 33%, respectively, while a possible decline in their value is projected at 5%, 15% and 30%, respectively. Our long-term upside strategy envisages 42% growth and 100% risks.

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