#5
The Times (UK)
12 January 2002
INVESTMENT
High risks and rewards in Russia
Mark Atherton seeks the safest method to explore the Moscow markets potential

RUSSIA has long held a fascination for European investors, but only the brave should venture to its stock market — no matter how tempting the prospects may seem. After years of deprivation, when public sector workers went unpaid and the elderly did not receive pensions, Russians are at last beginning to see a rise in their standard of living. The economy grew by 5 per cent last year following an 8 per cent expansion in 2000. This has fed through to the stock market.

Moscow was one of the best performing stock markets in 2001. With a rise of 56 per cent, it was beaten only by Zimbabwe. But the market is still off its peak in the late summer of 1997 — before the Russian Government defaulted on its debt payments and foreign investors fled. They are returning, although gingerly. The lure is the vast mineral and oil resources in this enormous country, which is spread across two continents. If Russian companies can exploit these resources, the nation could prosper again.

Douglas Helfer, a director of Foreign & Colonial’s emerging markets team, says: “Russia is a country where the potential risks and rewards for investors are both very great. Shares are still very cheap, selling on under four times earnings, which is half the average for emerging markets.”

However, investors should be in no doubt about the risks of investing in Russia. Mr Helfer says: “The economy and the stock market are heavily dependent on the performance of oil companies, so if the oil price falls below 14 dollars a barrel, that could cause serious problems.

“The stock market is very volatile. There are not many shares traded and the ones that are tend to go up and down very steeply. The market may have risen by more than 50 per cent in 2001 but it fell by more than 70 per cent in 1998 and lost 90 per cent of its value between October 1997 and September 1998. Currency risk also has to be taken into account. In 1998 the rouble was devalued, causing a collapse of confidence among investors. The possibility of another devaluation has to be considered, though the Russian Central Bank now has significant reserves and oil revenues provide a steady source of foreign exchange.

“Although President Putin has ushered in an unprecedented period of political stability, the outlook remains uncertain. On top of that, there are still concerns about the level of corruption and the lack of a proper legal framework for businesses.”

Partly because of these negative factors and partly because they are wary of recommending a single country fund, financial advisers tend to suggest gaining exposure to Russia through a more geographically diverse fund.

James Calder, of Bestinvest, the independent financial adviser (IFA), says that investors wanting direct exposure to Russia are going to struggle to find a suitable fund. “There aren’t many to choose from. Brunswick runs a Russian growth fund based in the Cayman Islands; Barings has a New Russia fund based in Luxembourg, while Flemings runs two Russian funds based in Luxembourg and Jersey. British investors tend to steer clear of offshore funds because they usually have less regulatory protection.”

As a safer bet he picks out Baring Emerging Europe investment trust, a UK-regulated, broadly based Eastern European fund that has 35 per cent of its money invested in Russia. It also has about 22 per cent invested in both Poland and Hungary and 9 per cent in the Czech Republic, all of which are poised to join the European Union within the next three to five years.

Klaus Bockstaller, who heads the team running it, says: “The fund offers a broad exposure to the markets of Eastern Europe. We still believe Russia offers a lot of potential, even after its strong performance last year.

“In the case of Poland, Hungary and the Czech Republic, the key theme is convergence with the economies of Western Europe and likely membership of the EU within three to five years.”

The fund’s performance has been good — but volatile. In the year to December 1 it rose by 18.2 per cent, while over three and five years it has risen by 77.1 per cent and 107.2 per cent respectively.