Russia's soaring stock market -up 62% in this year's first two months - is just beginning its bull phase, according to its proponents.
Thus far, foreign institutional buying has been propelling this hot market. but with the improving political and economic landscape - and somewhat better investment infrastructure - more domestic and foreign interest should materialize, experts believe.
"This is just the beginning" of investment in Russia, said Gavin Rankin, research director of Troika Dialog Asset Management in Moscow.
The volatile Russian market is still fraught with risks. But as memories of Russia's 1996 rocky political year - and its market effects - begin to fade, some investors see growing attractions to that stock market. Carrots include: the apparently improved health of President Boris Yeltsin, last year's plunge in interest rates and the inclusion of Russia's market in emerging market indexes.
This year, Russia was added to the International Finance Corp.'s emerging markets global composite index, and it's expected to be included in the IFC's composite investible emerging markets index. According to Mr. Rankin, when Russia's market becomes part of the investible composite index, "it would receive no less than a 3% weighting" and draw yet more money into that arena.
A recent report by Moscow-based Brunswick Brokerage adds to the list of Russian market attractions. Among the important developments:
14 Russian companies now have American depository receipts, with more planned to be launched this year.
Three custodians - Chase Manhattan Bank International, Credit Suisse (Moscow) Ltd. and ABN AMRO Bank (Moscow) Ltd. - have qualified to offer both global custody and subcustody services in Russia to U.S. regulated investment funds.
Improved shareholder registries in Moscow have helped cut the time it takes to settle trades.
The electronic Russian Trading System has been improved and expanded.
In addition, expected growth of investment vehicles should spur retail interest in Russia. According to officials of Troika Dialog, there are eight mutual funds for the domestic investors in Russia. But with 14 investment management companies already operating in that country, close observers expect more funds for the domestic market to emerge over time. (Excluding funds for the domestic Russian market, Micropal Emerging Market Fund Monitor also counts 30 equity funds for Russia and the Commonwealth of Independent States and three Russian debt funds.)
Some might question whether the red-hot Russian market will soon run out of steam. And even market proponents see corrections coming. But for those taking a longer term perspective, the market still is looking undervalued.
For example, Troika Dialog officials point to continued low valuations - including the market's price-earnings ratio of about six times 1996 earnings. Indeed, the market's approximately $50 billion capitalization seems minuscule compared with Russia's overall $500 billion official economy, said Nancy Herring, managing director of Troika Dialog Asset Management. (The firm is the subadviser for the $35 million SEC- registered Lexington Troika Dialog Russia Fund.) Ms. Herring believes market caps per Russian company could reach $50 billion to $70 billion in "our lifetime" for the largest Russian companies.
She cited the example of Gazprom, whose market cap is now about $11 billion. In time, Ms. Herring expects Gazprom to become the world's largest company in revenue.
Another example cited by Troika Dialog officials: LUKoil Holding, whose oil reserves are valued around 70 cents to 80 cents a barrel of proven reserves. That compares with an average valuation of $6 to $7 by other major oil companies outside of Russia. If LUKoil's 14 billion barrels of reserves become valued at average international standards, its market cap, now $10 billion, would rise to $85 billion, said Ms. Herring.
Of course, investors can find ample reasons to be leery of Russia's volatile market and what at least was its tumultuous political situation. Indeed, its economy appears just now to be headed back into positive territory after what has been described as a depression.
Furthermore, taxes in Russia appear to be a deterrent to investing. According to Brunswick Brokerage, Russia "taxes returns on investments by individuals at a rate of 12% to 35% and allows no deduction for capital losses. For mutual and pension funds to be successful, tax breaks are necessary."
But to Brunswick, the coming of the first domestic Russian mutual fund was a large step forward in encouraging domestic investing.
In general, the firm believes the past year has brought major improvements in the market's infrastructure.
As the brokerage firm said in its report, "significant progress has been made on these problems in the past year, and it's now possible for most foreign investors to enter the Russian market."
