An ETF With All Russia's Benefits -- and Risks

As the largest country on the face of the planet, Russia has its fare share of natural resources. It also has an economy that continues to grow at a healthy clip as evidenced by its 8.5% expansion in the first quarter.

Last spring, Van Eck Global launched its Market Vectors-Russia ETF ( RSX) to give investors access to the country.

"The fund was developed from our understanding that Russia was being under-represented among the BRICs and deserved its own ETF," says Adam Phillips, Van Eck's Director of ETF Sales.

Harvey Hirsch, a senior vice president at Van Eck, acknowledges the fund's heavy exposure to commodities and to the oil and gas sectors.

"The Russian economy is being driven by the energy sector," he says. "This ETF is a good vehicle for investors to gain exposure to that part of the market as well as to other rapidly developing sectors."

A Rags to Riches Story

Russia has come a long way since its financial crisis of 1998.

"Within less than a decade, the country has gone from bankruptcy to prosperity," says Dr. Marshall Goldman, a professor of Russian economics at Wellesley College and author of Petrostate: Putin, Power, and the New Russia.

The Market Vectors-Russia ETF is weighted 41.9% in oil and gas, and 23.4% in iron and steel. Its top names include Rosneft, Gazprom ( OGZY.PK), Lukoil ( LUKOY.PK), Norilsk ( NILSY.PK) and Mechel ( MTL).

Alexander Kliment, an associate for Eurasia Group, a political risk advisory and consulting firm, expects Russia's metals and mining sectors to remain especially strong, but not without risk.

"The sheer volume of Russia's metals reserves, the political clout of Russia's metals tycoons, and the strong global demand for raw materials all suggest that the sector should continue to thrive in the years ahead," he says. "But this will depend, in part, on whether the movement towards consolidation in the sector is successful. This is clearly the direction in which the often-bewilderingly complex Norilsk story is moving, though the denouement of the story will not be clear for several years."

However, Kliment has some words of caution about business conditions in Russia, where successful companies are often penalized -- or sometimes even taken over -- by the government.

"Business interest and activity in Russia continues to grow apace, irrespective of the presidential succession," he says. "President Dmitry Medvedev has repeatedly pledged to improve the business climate, reinvigorate judicial reforms, and battle Russia's pervasive corruption. But these are long-term projects that will require sustained political will to overcome entrenched interests."

Telecom

Russia's telecom sector has also been bustling. The Market Vectors ETF is 12.5% weighted in telecom and includes holdings such as Mobile TeleSystems ( MBT) and Vimpel-Communications ( VIP). As the two largest mobile phone operators, Mobile and Vimpel have seen their respective stock prices appreciate 400% and 800% over the past five years.

David Weissman, a telecom analyst for Zacks Investment Research, continues to see unique growth opportunities for these two heavy-hitters that sets them apart from their U.S. counterparts.

"Since penetration levels of potential users are near saturation levels in the U.S., companies such as Verizon ( VZ), Sprint ( S) and AT&T ( T) may facilitate subscriber growth levels with consolidation among regional carriers," he says. "This is not necessarily the catalyst needed for growth in Russia and Eastern Europe as it is much more apparent that growth can be fostered by prospecting to a significant untapped user base independent of consolidation efforts."

The shift away from landlines is one trend that Weismann finds to be particularly attractive about an investment in Russian telecom stocks.

"Cellular infrastructure for Russia and surrounding countries, in many cases, serve as the communications network of choice and often replace the need for landline telephones," he says. "The mobile penetration levels remain intriguing as more users are opting for this solution."

Professor Goldman has experienced the transformation of the Russian cellular industry first-hand. "A few years ago we took a group from Moscow to St. Petersburg and there were very long stretches along the way with no signal," he says. "More recently when we went, there were very few stretches that didn't have a signal."

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