Investing in Russia: The Good News and the Bad

Russian shares have been extremely profitable for investors in recent years. Direct investment in Russian by oil companies have been more of a mixed story.

Russian policy toward foreign capital has been inviting in the past, but is it still so? Is the Russian stock market exposed to levels of uncertainty due to political event risks such that greater caution is warranted? … We think so.

The Good News:
The ride so far has been great. This chart of the daily closing prices for the Russian Stock Exchange since 1995 shows its phenomenal rise to approximately 20 times its initial value. [click to enlarge]

Over the past 5 years the Russian index and the Templeton Russia Fund (TRF) managed by the noted manager Mark Mobius has produced more than 5 times the gain of the Russell 3000 (proxy (IWV)), as shown in this chart.

Until recently over the past 3 years, Russia (proxy (TRF) or (RSX)) has outperformed China (proxy (FXI) or (GXC)), Brazil (proxy (EWZ)) and India (proxy (INP) or (IFN) or (IIF)), and has clobbered the U.S. Russell 3000 (proxy (IWV)).

In the recent 200-day history however, China has massively outperformed Russia, the other BRIC countries and the U.S. Only the U.S. market underperformed the Russia index.

The Bad News:
Russia is becoming hostile to both foreign investors and private capital. Putin has not gone to the length of Chavez in Venezuela to nationalize key industries, but he has leaned in that direction. Being more adept than Chavez, Putin has obscured his energy nationalization program with:

• Demands for unproven back taxes to destroy domestic companies (Yukos (YUKOY.PK) ), and
• Plans to revoke BP’s (BP) license on its $6 billion investment in TNK due to alleged production violations, and
• Alleged environmental violations by Shell (RDS.A) that will require license revocation for its Sakhalin project unless it transfers a large share to Gazprom (OGZPY.PK) the government controlled company – funny how the environmental problem goes away after Putin expropriates billions in value from a foreign investor

We have seen Russia use its gas supplies to threaten first a former satellite two winters ago, and again this past winter it effectively threatened Western Europe with freezing. Now it is talking about pointing missiles at Europe.

If Russia is already stealing assets from foreign direct investors, and bullying neighboring nations with energy policy and military threats, how long will it take for it to find ways to steal money from foreign stock market investors? It is already doing so to the extent that value is being expropriated from oil companies that are somewhere in most of you’re portfolios. Does this sound like a great place to put your hard earned money? Aren’t there other high growth options that do not have such extraordinary political risks?

Here are some recent press comments relevant to investment in Russia:

Investors will be asking if capitalism is a one-way ticket [money into Russian, but not back out] ... how far [is] Russia is prepared to embrace western capitalism. … it wants to seize back resource assets that had passed into control of foreign companies. ... A number of investment banks and western companies have set up shop in Russia, but they remain skeptical over their long-term prospects. Times Online [UK]

‘Everybody talks about what Hugo Chavez is doing in Venezuela but nobody makes the comparison with Putin. It is basically the same thing’ said Fadel Gheit, an analyst at Oppenheimer in New York. Petroleum World (Venezuela )

Analysts say that Russia’s stock market is on the threshold of the pre-election period. Drastic fluctuations of share quotations are typical for it, because of long-term investors’ apprehensions. Kommersant (Russia)

On a political and business level, deep distrust has grown among western countries – particularly in America – over the Kremlin’s creeping repatriation of some of its major resources. First with Shell and now with BP, President Vladimir Putin’s desire to put assets back under state control has understandably made investors nervous about their exposure to Russian resource stocks.” Times Online [UK]

President Vladimir Putin said Russia would go back to its Cold War stance of aiming its missiles at Europe if Washington went ahead with a plan to build a missile defence shield near Russia's borders. … [he] said Moscow would not be responsible for the consequences because Washington had started the escalation. The Age (Australia)

The big gains in the Russian stock market could well be more history than future. The political risks to your wealth in Russia are much greater now than they were perceived to be a few years ago. We think a touch of Russian exposure in a multi-country emerging economies fund such as (EEM) or (VWO) is OK, but we think discretion is the better part of valor when it come to significant investments in Russia.

Full Disclosure: Author owns VWO, EWZ and IWV