How to get profitability above the market in Russia without guessing individual stocks

For those who prefer to read the findings straight away:

  • Sberbank shares are an alternative to stocks of an index fund (for example, ETF FINEX FXRL) on the RTSI (IMOEX) index in the Russian market, since they closely follow the index (correlation of 95% and higher);

  • If the amount of dividends on Sberbank shares is <7%, personal income tax will be less than or equal to the management fee for FINEX ETF FXRL (0.9%);

  • The risk (standard deviation) on Sberbank shares is 1.5-2 times higher than the risk of the IMOEX index and FXRL shares, but the yield is just as much higher (29% per year instead of 14%), and even more, taking into account dividends;

  • Sberbank shares can be recommended for a passive investor for inclusion in a portfolio as a replacement for an index BIF (ETF) for the Russian IMOEX Index (RTSI), subject to taking on an increased risk;

  • If you create an ETF on Sberbank shares, you can further reduce investor costs and increase profitability by replacing 13% of personal income tax from dividends with a small fund commission (0.1% -0.3%) – maybe FINEX will be interested?

Why does an investor need ETFs

Exchange-traded mutual funds (BPIF in Russia, Exchange-traded fund, or ETF in other countries) are the most popular tool for building a portfolio of assets of a passive investor. For those who do not want to play the lottery, trying to guess the individual stocks that will give profit and outperform broad market indices (S & P500, RTSI, etc.), the shares of these funds repeat the movement of entire indices, such as

o do not require significant amounts to purchase. For example, in order to compile a portfolio of shares in Russia, the market value of which would repeat the movement of the MICEX index (IMOEX) or its dollar counterpart RTS (RTSI), many dozens thousand rubles. At the same time, the value of one share of the FinEx exchange-traded fund, repeating the movement of this index (FXRL) – less than five thousand rubles. In order to compose a portfolio that repeats the movement of the S & P500 index, it will not even take tens of thousands of rubles, but thousands, if not tens, of dollars, and, at the same time, one share of the Vanguard S & P500 fund (VOO), repeating the S & P500 index costs $ 375 and can be bought from a Russian broker (for example, Finam).

Ah, these commissions and taxes!

But, for everything, including the simplicity and cheapness of shares of index funds, you have to pay. And here the Russian investor has a harder time than the Western one. The commissions of most Russian ETFs and BIFs are an order of magnitude or more higher than the commissions of Vanguard funds (the coefficient of total expenses VOO – 0.03%, and Russian – 0.35..0.99 %%). Popular fund FXRL company Finex, which tracks the RTS index – spends 0.9% of the investor’s assets on administrative expenses. On the one hand, this does not prevent the FXRL fund from showing good results in terms of profitability (see Table 1, 239% over 5 years, taking into account the reinvestment of dividends) compared to the benchmark (189% – the growth of the IMOEX index over 5 years from 2016 (Fig. 1), in addition, the investor who purchased the shares of the fund does not pay dividend tax, and the dividend yield of the IMOEX index is about 5%.

fig. 1.  Correlation and profitability of the IMOEX index and Sberbank shares for 5 years (03.2016-03.2021) (finam.ru data)
fig. 1. Correlation and profitability of the IMOEX index and Sberbank shares for 5 years (03.2016-03.2021) (finam.ru data)

Is there an alternative to ETFs?

Is there an opportunity to get the same thing that index ETFs (ETF) give, but with a lower commission, at least for Russian investors? It is hardly possible to bypass Vanguard funds in terms of overhead costs, but there are options for the Russian market. What does an investor want from ETF stocks or stocks replacing it? Exact adherence to your benchmark, that is, a high positive correlation of annual, monthly, and better – daily results, and low commissions – the money that the fund takes for its management. The correlation, or accuracy of the FXRL following the RTSI, is a very high 99.5%. But if we look (Table 1, data – from the website finam.ru) at the most large components index IMOEX (Gazprom (14%) and Sberbank (12%)) – then we will see that there are options for a Russian investor how to get a comparable result without buying the fund’s shares:

Table 1. Coefficients of correlation of the IMOEX index (RTSI) with its largest components (finam.ru data)
Table 1. Coefficients of correlation of the IMOEX index (RTSI) with its largest components (finam.ru data)

As can be seen from Table 1, not only the FXRL index fund (95% -99.5%) has a comparable correlation coefficient with the IMOEX index, but also Sberbank shares, common (93% -95%) and preferred (95% -96%) … Of course, this is slightly less than 99.5% of the daily correlation that FXRL shares show – but the investor pays for such a high accuracy of following the index, giving 0.9% of the value of assets invested in the FXRL fund. And here an option looks very interesting when an investor, buying shares of Sberbank, receives almost all the advantages of an index fund, without paying management fees and using a significantly higher level of liquidity of shares of locomotives of the Russian market. But there is also the issue of risks, profitability, dividends and taxation.

Taxes and dividends

If the investor does not pay tax on dividends that go directly to the fund and reinvested by it when buying shares of a BITF (ETF), then when buying shares of Sberbank, the dividends are transferred to the investor, and income tax from them will be automatically withheld by the broker. And there is no way to avoid it – neither by buying shares to an individual investment account, nor by holding the shares for three years. Received dividends – automatically 13% is sent to the state. But if the profitability of Sberbank shares is below 7%, the tax will just amount to 0.9% of the investment amount – that is, it will become equal to the fund’s commission, so the investor will not lose anything, and with an increase in the value of shares and / or a decrease in dividends, he will also reduce his expenses.

Risks and profitability

Now let’s evaluate the profitability and risks of investing in the FXRL fund in comparison with investing directly in Sberbank shares. Table 1 shows data for 5 years (since FinEx ETFs are relatively new). There are no special surprises here – yes, the risk of investing in individual stocks is one and a half times higher than the risk of investing in the index fund of the broad FXRL market, but the return on investments also increases even more – 29% per annum versus 19%, and this does not take into account dividends on preferred shares of Sberbank ! As they say, everyone can choose for themselves. If we want a higher profitability, we buy shares of Sber Prefs, lower – just Sber. And if you don’t want to be at all risky, we continue to invest in indexed exchange-traded funds, for example, FXRL.

Outcome

Brief conclusions are given at the beginning of the article. It would be nice for FinEx to create a separate index fund for Sberbank shares and set a commission for it less than for the FXRL fund (not 0.9%, but, for example, 0.1% -0.3%). Since dividends received by the ETF are not taxed, this would reduce the costs of investors, and the reduction in commissions and taxes, as you know, has a decisive effect on the return on the investment portfolio of a passive investor.

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