With economic grow undoubtedly slowing in the traditional major economies, has the time come for investors look at Russia?
The second half of 2007 was difficult to say the least for most investors. And 2008 has been the worst start to a year for several equity markets for many a year. With inflationary pressures here in the UK - and no doubt still more banks to announce further substantial write downs following the US sub-prime mortgage saga - is it all doom and gloom, or is there some room for optimism?
One area, other than cash, which has performed in recent times has been Emerging Markets - namely areas of Asia including India and China. These are higher risk regions however and even China saw large negative returns as recently as last month. So-called BRIC funds have been launched on the emerging powerhouses of Brazil, Russia, India and China. I would like to focus on one of these - Russia.
Why Russia? Firstly, it is necessary to look at the political background. The move towards a free market started under Mikhail Gorbachev and accelerated more rapidly under his successor, Boris Yeltsin. Arguably, the privatisation program that Yeltsin oversaw yielded spectacular riches for a very privileged minority.
In Britain, Chelsea Football Club owner Roman Abramovich has given an insight into the staggering amounts of money some individuals have accumulated since the end of communism.
But what has really pushed Russia’s place in the international community has been a post-Yeltsin regime under Vladimir Putin. Russia’s influential standing in the international community is really a direct result of Mr Putin’s free market reforms.
In the same way as the Norwegians built up their petroleum revenue fund, so too have the Russians. This is Mr Putin’s legacy to the Russian people. Russia has been using high oil prices to impose a windfall tax to create a stabilisation fund of $200 billion to ensure continued stable growth in the Russian economy.
This fund is being used to improve infrastructure and the continued upgrading of Russia’s debt by the international rating agencies, such as Moody’s, underlines the huge advances the economy has made.
Russia is rich in natural resources, especially oil and gas. Russian energy companies are well-run, conservative companies that Robin Geffen, manager of the excellent Neptune Russia and Greater Russia funds, thinks "are not going to get caught in the classic 'boom to bust’ oil cycle that we have seen at least twice over the last 25 years".
Other than gas and oil, Russia is also one of the world’s largest producers of platinum and palladium. Both are important metals for needs as wide-ranging as fuel cell production, microchips and, of course, jewellery. Russia is also a large and growing producer of gold. It is one of the two key global producers of diamonds and this should be beneficial given the increasing demand of diamonds in Asia, particularly China.
The rise of the Russian consumer is probably the most significant development in this market. Average wages have increased by over 20 per cent per annum in recent years in a relatively low inflationary environment. A recent Goldman Sachs study stated that over the next 20 years we will see a middle-class spread across Brazil, Russia, India and China of no fewer than 800 million people, which is larger numerically than the current combined total population of the US, Europe and Japan.
While this may seem encouraging news, it is a little misguided to view Russia in the same terms as a Western democracy with similar economic values. According to recent surveys, almost 70 per cent of Russians have no savings at all and you can hardly expect to find a significant pensions industry when the life expectancy of the Russian male has been estimated as low as 59, a year before pension age.
The average Russian’s distrust of banks is understandable if you look back to the 1990s. Millions lost their rouble savings when the Soviet Union collapsed in 1991 and in the financial crisis of 1988, the rouble’s value against the dollar fell fourfold.
Mr Putin’s recent tirades against the West and the recent forced closure of the British Council offices in his country owe more to the old Cold War regime than a bright new dawn of democracy. Evidence that Russia should not be regarded as a happy ally searching for Western values came last month with a somewhat chilling warning from a high-ranking official: "If you continue to preach to us, we will become your enemies."
In May, Mr Putin hands over the presidency to his hand-picked successor Dmitry Medvedev, but few doubt he will remain the guiding light behind his country’s policies. Perhaps St Petersburg University professor Stanislav Tkachenko best illustrated the often confusing messages coming out of the new Russia when he summed up Mr Putin’s character saying: "You can’t say he is a Slavophile or a Westerner because he is both, but above all he stands for a great Russian state."
These considerations aside, there have been high rewards for investors turning to Russia. Funds like the Neptune Russia and Greater Russia Fund offering 215.2 per cent growth since launch on December 31, 2004, will look attractive to many investors.
With high returns come higher risk and volatility. We all know by now that there is no 'easy money’ or 'easy ride’ when it comes to equity investing. However, in these changing world dynamics, Russia will play a very key role as a resource-rich country with a well-educated and strongly motivated workforce so a sensible exposure within your portfolio may prove beneficial.
*Trevor Law is a director with Montpelier Group (Europe) Ltd, the privately-owned independent financial advisers located at Barston near Solihull. TILaw@montpeliergroup.com
