Fund file: Bullish on Russia?

Financial Times

Investors should look before they leap into investing in Russia, according to a report in Monday’s FTfm, but it is very unlikely that many will do so.

On the face of it, huge strides that have been made in the last year or so will make Russia a more friendly place for overseas investors.

“Right now we’re going through a period of moderate liberalisation,” says Jan Dehn, chief strategist with Ashmore, an emerging markets specialist.

He can see evidence of this in recent measures to allow greater flexibility of the rouble and in moves to encourage foreign ownership of local currency bonds. Until recently, he explains, foreign ownership of rouble-denominated Russian sovereign debt was about 3 per cent. It is now 5.4 per cent and Dehn expects the proportion to rise to something closer to the emerging market average, which is 20 per cent.

There is also a ministry of finance proposal that will require any listed company with majority state ownership to pay out 25 per cent of its profits in dividends to shareholders from next year. By next year, also, Russian companies will have to follow IFRS international accounting standards.

Small wonder that Dehn, along with many other emerging market fund managers, reports being overweight Russia.

Bill Browder, founder and chief executive of Hermitage Capital Management, thinks they have either foolish optimism or very short memories, or both.

“In very simple terms, Russia is a country that is completely devoid of property rights,” says Browder.
Browder argues that managers who say they can see an opportunity are ignoring the fact that at any moment their assets are exposed to a high likelihood of expropriation. “It’s not getting any better,” he says.

Browder has experienced at the sharp end how a successful Russian investment tale can take an abrupt turn into a horror story. After making a lot of money for investors with Hermitage’s Russia fund, he was thrown out of the country in 2005. Browder’s lawyer, Sergei Magnitsky, subsequently discovered the authorities had perpetrated a tax fraud that effectively stole $230m from Hermitage. Magnitsky was arrested in 2008 and accused of stealing the money himself. After nearly a year’s detention during which time he was beaten and denied urgently required medical treatment he died in his cell.

Even for investors who are confident they can steer clear of trouble, Browder believes the risk reward balance is too strongly skewed towards risk.

“It’s different risks in different emerging markets, but in Russia you have a government that is basically operating as a criminal enterprise,” he says, adding that unlike when he first started investing in Russia in 1996 when there was a chance of making 10 or 20 times your money, assets are now more expensive.

“It’s all about risk reward. Purely from an economic and financial standpoint it is a bad trade in the current environment,” he says.

International Monetary Fund data, however, seem to show investors are not spooked by political and governance scares so long as it does not happen to them.

In the three years from 2004-2007, the years during which state-owned Rosneft was controversially gaining control of rival oil company Yukos, total portfolio investment in Russia jumped. It almost doubled from $58.5bn in 2004, to $101.6bn in 2005. By 2007 it had reached $222.9bn.

Investors who had the courage to ignore the alarming stories of Yukos founder Mikhail Khodorkovsky‘s arrest and incarceration – which cleared the way for its effective privatisation by the government – have been rewarded.

“Russia’s been a good trade for us,” explains Dehn.

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