Russia’s investment rewards carry risks

Financial Times

Mention investment and Russia in the same breath and responses are likely to vary from concerns over corruption and political intervention to the allure of cheap prices.

Russia has been the laggard of the Bric quartet [Brazil, Russia, India and China] that has attracted investors in the past two years. But while emerging market funds have seen $7bn of net outflows this year, according to EPFR, a global data provider, flows into Russia have been picking up. Inflows to Russia total $1.22bn in the year to date, against outflows of $2bn for China and $980m for India in the same period, EPFR data show.

“Foreign investor appetite is stronger for Russia right now than for most other emerging markets.

“This is due to rising oil prices and Russia’s exposure to the energy sector, and attractive valuation for the market as a whole,” says Brad Durham, EPFR managing director.

Hugo Bain, a Russia investment manager at Pictet Asset Management, agrees there is renewed appetite for Russia. “We have seen significant inflows into our Russia fund in the first six weeks of the year,” he says.

Pictet invests about $1.5bn in Russian equities between three funds, including the Russia Fund.

At Renaissance Asset Managers, part of Moscow-based Renaissance Group, Plamen Monovski, chief investment officer, says it is the right time to buy “emerging market laggards” such as Russia.

“People will be buying into things that are very cheap. And Russia is the cheapest large market out there,” he adds.

A specialist investor in Russia, with the majority of the group’s $2.5bn assets under management invested in the country, Mr Monovski believes an improving economic outlook where the “domestic cycle is accelerating”, re-opening of bank credit lines after the financial crisis and the prospect of “massive infrastructure stimulus, similar to what we have seen in China”, are reasons for gaining exposure.

The International Monetary Fund forecasts economic growth of 4.3 per cent this year but Mr Monovski is more optimistic, expecting it to be more like 5 to 6 per cent.

Opportunities for foreign investment are also likely to come from the need to improve the country’s deteriorating infrastructure, he says. The Russian government plans to spend $500bn on infrastructure in the next three years and “will have to raise 60-70 per cent of this [from foreign investors]”, he adds.

Privatisation plans are also afoot. Earlier this month the Russian government launched the biggest sell-off since the 1990s, raising $3.3bn from the sale of a 10 per cent stake in VTB, the country’s second largest bank.

However, none of these arguments convince Bill Browder, founder of Hermitage Capital Management, a specialist emerging fund manager and once one of Russia’s biggest portfolio investors. He believes the country is the riskiest of the emerging markets.

Mr Browder, who was banned from entering Russia in 2005 after alleging corruption at big Russian companies, is pressing the European Union and the US for visa bans on Russian officials he accuses of complicity in the death in prison of his lawyer, Sergei Magnitsky, two years ago.

He believes the main risk for investors in the stock market is lack of clarity on property rights. “In Russia, any company may lose its assets or cash flow at any time to criminals or competitors without any recourse,” he says.

London-based Mr Browder says this makes it difficult to estimate the future value of an equity investment. “You have to apply a large discount but what is the right discount?” He ranks Russia in the same risk category as Iran or Venezuela and would apply “similar big discounts”.

He argues the prospects of Russian companies are less promising than other emerging markets. “They currently trade at about 7.2 x earnings with property risk compared to Turkish companies trading at 10.3 with much less property risk,” he says.

On the infrastructure front, Mr Browder recognises the need for foreign investment in Russia’s infrastructure but is concerned that projects can be a “big source of graft”.

Overall the risks are high. “Maybe you make 50 per cent or lose 50 per cent but it is a total crap shoot,” he adds. He believes investing in Russia would “only be tempting if valuations were much lower”.

Mr Bain of Pictet Asset Management agrees there are risks. “Russia is clearly to the upper end of the risk scale”. But he believes “the cheap [stock] prices are better than anywhere else in emerging markets”.

While he acknowledges corruption remains an issue, he believes Russian companies are improving, suffering less political intervention than in the past. “Russian authorities are taking more care over capital markets”, which is good news from a stock market viewpoint, says Mr Bain. Stocks are less volatile, “not dropping so often”, he adds.

Another risk element is Russia’s dependence on natural resources, notably oil and minerals. There is “an enormous bias to resources. When you buy Russia you have to take a view on what commodities will do,” he adds.

Lack of liquidity is also a risk but Mr Bain hopes this will improve when the country’s two main stock exchanges, the Micex and RTS, merge. Plans to merge are part of the government’s push to improve Russia’s financial infrastructure, aiming to attract more foreign investors. There are also grand ambitions to become an international financial centre.

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