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Comment of Vladimir Potapov, Global Head of Portfolio Management Business at VTB Capital Investment Management to Financial Times


Tags: portfolio management

Sep 10, 2012
Russia is a bleak prospect for foreign managers

Reserve funds can invest in a wider range of assets, including foreign assets but, as Vladimir Potapov, Global Head of Portfolio Management Business at VTB Capital Investment Management, points out, investors see little point in diversifying into international securities.

While a small and vociferous number of fund managers have become cheerleaders for Russian equities, few believe they can make money by distributing their funds in Russia. The Russians’ long and deep distrust of foreign concepts, dating from Soviet days and before, militates against international fund managers. Thanks to 70 years of Soviet rule, there is no discernible investment culture either.

Cold and uninviting: for foreign fund managers at least
And despite Moscow’s stated ambition for Russia to become a major financial centre, it has so far failed to institute the kind of regulatory measures that attract large flows of capital. Even in China, where it is far from simple to distribute investment funds, the rules of engagement are considerably clearer.
Yet, Russia has a seriously wealthy top tier, a fast-growing mass affluent class and a burgeoning pensions industry. At some stage, say Russia observers, it will surely embrace the internationalisation of its savings industry.

For the moment though, the Russian landscape is bleak for international managers, particularly in the retail segment. “To widely circulate foreign securities to the Russian public is extremely cumbersome,” says Nicolas Fermaud, head of the Russia-Luxembourg desk in Allen & Overy’s Moscow office.
One of the reasons is that Russia refuses to allow the passporting of funds, so popular structures such as the Luxembourg Sicav are not recognised. “Unless you set up a local company you cannot distribute to retail,” says Mr Fermaud.

Retail market data is hardly compelling in any case. According to fund associations, just $15.5bn of retail money is invested in locally-domiciled funds, of which only $2.5bn is managed in open-ended funds. Last year, a paltry $230m of new retail money was invested.

Olle Olsson, a director of East Capital, a specialist emerging markets investment house, says: “Only 1-2 per cent of the Russian population invests at all in mutual funds, compared with nearly half of US households. The Russian equities market has been one of best performers in the last 10-15 years, but domestic investors have missed it.”
One of the reasons for this is the perennial volatility of the Russian market. It seems that every time mutual fund investors pluck up the courage to jump into the market, it crashes. Investors taking the plunge in Russian equities in 1998 or 2008, for instance, saw the vast majority of their capital wiped out. The few that stayed invested eventually enjoyed gains but required nerves of steel to do so.

“Russia is a fantastic investment case,” says Mr Olsson. “The country has no debt and growth is high. But volatility over the last 12 years has been more than three times greater than in other emerging markets. The problem is that pension funds have low amounts of money invested in equities so there are no local buyers to stabilise the market when there are economic headwinds.” By contrast, emerging markets with lower volatility, such as Poland, Chile and South Africa, are underpinned by strong domestic investor bases.

The institutional landscape is only a little more promising: the entire Russian pensions industry manages just $80bn, which is less than 5 per cent of GDP. This compares to about 70 per cent in developed markets and 15 per cent in Brazil, a comparable emerging market. Of the $80bn under management, just 4 per cent is invested in equities. As Mr Olsson notes: “Swedish pensioners probably hold more Russian equities than Russian pensioners.”

The biggest pensions savings pot is a state-administered scheme into which typically 6 per cent of most employees’ salaries is invested every month. At present, these pension assets are managed exclusively by local managers and invested predominantly in domestic fixed income assets. There is little opportunity for foreign managers to break in.

The second pillar is the pension reserve, into which employees can choose to move their retirement assets or make additional contributions. Around 200 companies offer reserve funds, of which the biggest one is Gazprom and the next largest is the railways pension scheme.

Reserve funds can invest in a wider range of assets, including foreign assets but, as Vladimir Potapov, Global Head of Portfolio Management Business at VTB Capital Investment Management, points out, investors see little point in diversifying into international securities. “Pension funds benchmark themselves to inflation in roubles,” he says. “So by nature they are focused on Russian securities.”

Mandates for institutional assets are awarded on a similar basis to elsewhere in the world. “It’s a very competitive process as there are more than 100 asset managers in Russia,” says Mr Potapov. However, competition is confined to domestic managers. “There is very little pension fund money invested with foreign groups,” he adds.
This situation is reversed when seeking mandates from the Russian super-rich. “In the high net worth channel, competition is purely from international fund managers, although the competition is really between the private banks rather than the fund managers,” says Mr Potapov.

But the real battle for the wealthy takes place offshore. Many rich Russians keep their wealth in Cyprus, Switzerland and Luxembourg.

Nevertheless, legislation permitting the use of derivatives may encourage the rich to stay onshore. “So you can have hedging strategies and that means you can also have hedge funds,” says Mr Potapov.

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