More investors are beginning to believe a critical milestone in Russia's development is passed.
With Communism having been the loser in this summer's election, they believe Russia will continue on its route toward greater capitalism and a strengthening democracy, regardless of ailing President Boris Yeltsin's fate.
Certainly, the stock market has voted this way. Through Oct. 7, Russia's equity market soared 88% this year in U.S. dollar terms; and for the three months ended Aug. 31, Russian funds were the top 10 performers out of 1,300 emerging markets funds, according to the Micropal Emerging Market Fund Monitor, Glen Allen, Va.
Adding to the interest, a number of Russia funds made their debuts this year; and in early November, Vimpel-communications will become the first Russian company to list its shares on the New York Stock Exchange.
Those aren't the only pluses Russia's market enjoys. On Sept. 30, the International Finance Corp., Washington, added Russia, along with Egypt and Morocco, to its daily index series; and in January, the IFC plans to take the additional step of including those three countries in its global composite index. At minimum, the move will ensure indexers using this IFC benchmark will be investing in Russia.
These and other factors are adding to investors' bullishness.
"Over the next three years, we expect this market will rise - not in a straight line - but in the order of 50% per annum in dollar terms," said Jeff Chowdhry, a director of Foreign & Colonial Emerging Markets Ltd., London. In June, his firm launched the now $12 million open-end Russian Investment Co. fund. Foreign & Colonial also has a $45 million Polish Investment Co. and a $20 million eastern Europe fund, called Hypo Osteuropa Fund, that has a 10% exposure to Russia - up from 5% at the beginning of the year, he said.
To its proponents, Russia has addressed the crucial political problem: it has the procedures for ensuring a smooth power transition if Mr. Yeltsin's health fails. And, with that problem seen as under control, investors who favor Russia's market can focus on the country's attractions. Cited David Tripple, chief investment officer of Pioneer Mutual Funds, Boston: not only are investment "valuations very cheap," they can be one-fifth of the valuations in comparable non-Russian companies, "but the economy is about to turn and provide underlying growth for segments of the economy."
Attesting to its commitment to Russia, Pioneer manages and owns 51% of the First Investment Voucher Fund in Moscow. The firm also is marketing a fund for direct stakes in Russian companies.
Earlier this year, the $89 million Pioneer Emerging Markets Fund brought its Russia exposure to a hefty 8%. That occurred during the market's downswing on concerns that Mr. Yeltsin would lose the election. Once Mr. Yeltsin's political fortunes improved, the market rallied and spurred Pioneer to cash in its Russia position. As Mr. Tripple pointed out, the stocks had surged 150% to 160%.
But Pioneer and others remain champions of Russia's long-term prospects.
Maintained Rory Landman, manager in London of the $150 million Baring Emerging Europe Trust, managed by Baring Asset Management, "the presidential election changed the agenda in Russia. Now we're not talking about (a choice between) Communism or reform. The agenda now focuses on the pace of reform and how to reform rather than whether to reform."
Although Mr. Yeltsin's health brings short-term uncertainty to the market, Mr. Landman said the country's economy is "on the brink of strong economic growth," making Russia's market a good long-term bet.
His fund began investing in Russia in 1994 and gradually moved to its current 19% market-weighted position. He likes companies in Russia's energy, utilities and telecommunications sectors.
Gratham, Mayo Van Otterloo has "a fairly large investment bet on Russia, of about 5% of emerging markets portfolios," said Arjun Divecha, a managing director in the Berkeley, Calif., office. The firm started its Russia investing about a year ago, then lifted the exposure from 2% when the market declined after this year's presidential elections. "In the short-term, I doubt we will do very much more buying," said Mr. Divecha. "But if Yeltsin died and the market fell 30% to 50%, we would certainly be buying," he said of the firm's "long-term strategic bet."
Franklin Templeton Group is "taking advantage of recent weakness due to uncertainty (surrounding) Yeltsin's health to buy into the Russian market right now," said Dorian Foyil, senior vice president and portfolio manager of the Templeton Greater European Fund and the Templeton Growth & Income Fund. Outside of Templeton's Russia fund, Templeton started building its Russia exposure at the end of August. Not only are "the values still there," but recent market weakness provided an entry point, said Mr. Foyil. He likes blue chip companies such as Mosenergo in energy and LUKoil in oil and gas.
But investors recognize significant problems remain.
Politics is one glaring example, as illustrated by Political Risk Services, East Syracuse, N.Y. In its September ratings of countries on political, financial and economic risk, Russia obtained the worst ranking out of 29 European countries for political risk. In Europe, it also ranked second worst for financial risk and fourth worst for economic risk.
According to PRS' International Country Risk Guide report on Russia: "while Yeltsin's election victory may well have avoided the unknown of a Communist victory," it has solved none of the country's fundamental problems and added more - "the frailty of the president's health, a new round of internecine fighting in the corridors of power and possibly a vacuum of authority at the very top."
In its assessment of Russia's economy the report said in part that "Russia is governed by what is little more than a criminal conspiracy. Bribery and corruption have become endemic . . . violence and fraud are part of the very fabric of society; poverty and despair afflict around one-third of the population; the economy is still contracting; and the country is drowning in debt."
Although some investors see conditions as less bleak, most agree that significant problems remain. As a result, market volatility should remain sharp. "One month swings of 40% to 50% won't be unheard of," said Ian Wilson, editor of the Micropal Emerging Market Fund Monitor. He believes it might take at least another couple of years before Russia's market "is in a state where institutional investors are comfortable with it." In his view, "a lot of pepole are too nervous about the political scene to be comfortable launching Russia subfunds to their umbrella family of funds." Thus far, there are only 20 to 25 mainstream Russia funds, he pointed out, compared with 101 China funds, excluding those for venture capital.
PanAgora Asset Management, Boston, is among those steering clear. Explained Kristine Lino, the emerging markets portfolio manager: PanAgora uses five criteria when evaluating a market to be included in its investible universe. When the assessment was last done early this year, Russia's market failed all five political/economic/market tests. And she doubts Russia's market will qualify next year.