Taming the Russian bear

If you had said two years ago that Sberbank would become the biggest bank in Europe, nobody would have believed you,” said Florian Fenner, managing partner of Russian funds house UFG Asset Management, speaking at a wealth management summit in Moscow hosted by PWM in partnership with Deutsche Bank.

Scepticism of Russian high net worth (HNW) clients about their own banks is echoed by other Russian investment specialists, including Roland Nash, chief investment strategist at Verno Capital. “Many of my clients tell me they want to take money out of the country, but I tell them Sberbank is safer than the European banks,” he told the conference.

There is now a queue of Western institutions waiting to invest their money into a perennially undervalued tranche of Russian equities. Verno for instance, a fast-growing long-only and alternatives boutique created at the end of 2009, is already attracting large chunks of institutional money from the US and Middle East. Its managed assets have shot from a standing start two years ago to $160m (€120m) today.

But the need to convince sceptical Russian entrepreneurs about the safety of their own financial institutions remains an abiding theme. Moscow private bankers reckon only $10bn of the estimated $300bn of Russian HNW money is banked locally. “Yet the Russian banking system is more stable today than other countries’ financial systems,” said Vyacheslav Smolyaninov, head of investment strategy at Uralsib, echoing earlier speakers. The number one factor influencing the mood of investors and indeed the Russian macro-economic situation today is the crude oil price, he says.

When this plummeted by 70 per cent in 2008, $1,000bn was wiped off the country’s stocks, although the markets did bounce back quickly, achieving the type of modest, single digit growth which most European countries would currently accept without condition.

In these terms, it is foolish to believe the Russian market as a whole is anything but a commodity-fuelled, beta play. But that does not stop canny investors avoiding the mega-capitalised energy producers and focusing in on emerging market sector favourites of technology and consumer-driven stocks.

Most prefer fast gambles on local stocks, shunning funds and long-term holdings. They are put off both by a lack of faith in their financial system, a highly developed conspiracy-led view of the business world and first-hand experience of one of the world’s most primitive corporate governance systems.

“Russians understand direct investments in bonds,” says Michael Kunzi, head of the Moscow representative office of Swiss bank Lombard Odier. “What they hate is funds. When a bond goes up or down 10 per cent, they can see why it is happening. When there is somebody in between, managing the money for them, who can’t explain the performance, they are not happy.”

Russian fund managers are slowly breaking down the barrier to trust. Not only do they share some investment insights with potential clients but they offer them a much more valuable commodity: that of time.

Says Andrei Movchan, CEO of Third Rome, a growing Moscow-based funds house now supervising $350m: “We tell these entrepreneurs: ‘we don’t pretend we can manage money better than you. But unlike you, we have the time to do it.’”

A Russian client may wait one year following an initial introduction before investing. After this time, they may hand over a typical stake of $1m, says Mr Movchan. Yet if they lose out in the first six months, most will cut and run, never to return. “They will openly tell you they don’t like Russian business, banks or politics, but they will still invest in their own stocks [rather than foreign shares] because they understand them better,” believes Mr Movchan.

He sees no point in marketing large stock, beta-based funds to local clients, as there is no value to be added by an active manager. It is in the vast country’s small companies, which most investors don’t have access to, where he sees significant investing opportunities. “Each time you look at the market, you can see a dozen such opportunities. Forget about Gazprom and the other giants,” he warns.

Mr Movchan is also a keen bond investor, managing a personal fixed income portfolio currently yielding 13 per cent to maturity. This invests particularly in bonds issued by banks such as Rosbank, affiliated with Société Générale, and ATF, from the UniCredit group. “When you are getting such yields to maturity, the risk premium corresponds to a 30 per cent default rate, which looks more like the Great Depression than the current situation, where the actual default rate is only 3 per cent. This is almost nothing compared to the returns.”

The other opportunities these managers wish to present to clients are in the consumer, new technology and agriculture sectors. “Questions of food security are becoming more and more acute,” says Anton Rakhmanov, the CEO of Troika Dialog’s asset management operation. “There are 7 billion people on this planet and Russia is one of the very few countries in the world with an excess of arable land, with half of the country available for cultivation.”

But outside these limited opportunities, there are strong doubts among Russian portfolio managers such as Mr Rakhmanov, who believe equities remain cheap due to long-term structural and political problems, with a stimulus of real reform needed to give any serious boost to the stockmarket.

“Corporate governance issues in this country remain far from perfection,” he says, pointing to the recent merger between financial institutions VTB and the Bank of Moscow, which he says were “value destructive to minority shareholders”, not favoured by current legislation.

Management do not treat other shareholders as co-owners of a business, says Mr Rakhmanov. “If you compare Gazprom to BP over the last 10 years, there is a striking difference in the level of dividends returned to minority shareholders. That’s why it is relatively difficult to persuade our current client base to invest in the Russian stockmarket.”

Most portfolio managers do not expect things to improve in a hurry, with no incentive for the clique of narrow-minded ex KGB officers in their 50s, who currently run Russia, to change the style of their economic stewardship.

“The leadership does not understand how to deal with the problems and refuse to recognise that the problems are actually getting worse,” says Third Rome’s Mr Movchan. But this view is by no means universal and Verno’s Roland Nash believes the increased role which the government is playing in many areas of the economy can work to Russia’s benefit.

“A lot of people are sceptical about the current government and the future after the December [parliamentary] elections, but change will come,” says Mr Nash. “The growth profile Russia has had until today is unsustainable without change.”

His theory runs that economic success is the key to the government’s political popularity. This cannot be maintained without reforms once Russian Federation President Dmitry Medvedev hands over the leadership to Vladimir Putin.

Mr Nash pours cold water over popular criticism of the government somehow re-possessing private holdings in companies. Instead, he believes, many debt-burdened enterprises have actually approached the authorities for bailout subsidies. “There are strategic sectors of the Russian economy where the government feels it has to show some direction. But there are also large parts where government influence is very limited.” These, he believes, include stocks in the consumer, retail, banking, finance, telecoms, utilities and service sectors.

Moreover, says Mr Nash, Verno’s funds will look to government activity to provide a catalyst for the upward trajectory of certain shares. He cites fertiliser company Uralkali, which recently merged with rival Silvinit to create the second largest global potash producer, triggering a massive change in the make-up of its shareholders.

Verno is closely following reports that Uralkali may also acquire Belaruskali, a leading producer in neighbouring Belarus. Uralkali is reportedly getting strong Russian government support on the potential deal.

Such developments leave Mr Nash with a generally positive short and longer-term outlook, while being keenly aware of the risks. “I am very optimistic about 2012. I just need to get there alive,” smiles Mr Nash, leading to knowing laughter from conference delegates. In Russia, physical, political and investment risks are never too far away.