April 2008

Russian roulette

Russia has never been the easiest country to get your head around, as Churchill's famous quote suggests: "A riddle wrapped in a mystery inside an enigma'; which is probably why many people don't even bother trying! Furthermore, during 2007 the emerging market story focused its attention on the Brazilian, Chinese and Indian markets; drawing investors in in droves and grabbing all of the headlines. In comparison, the fourth member of the so called BRIC countries, Russia, remains understated and quite often, underweighted.

In fairness, the cynicism surrounding Russia can be justified, particularly when one looks at the geopolitical history and the seeming lack of transparency with company executives who have been known to have interests outside of adding value to their shareholders. Over the years, managers of Russian companies have honed their techniques in negating the influence of minority shareholders. One of the most commonly used tricks is in the election of members of the board of the company which involves proposing countless candidates with limited information on them. The aim is to divide the smaller shareholders so that a minority consortium who have decided on a candidate in advance to push their choice through.

During the run-up to the recent presidential election the political picture has been hugely scrutinised. The election resulted in an overwhelming victory to ruling party, United Russia with President Putin handing over the reins to his heir apparent Dmitry Medvedev. Despite this, Mr Putin will remain a significant player in Russian politics following his announcement to take up the role of prime minister.

With all this in mind, Russia is the largest country in the world with the highest level reserves of natural resources. Investment opportunities are potentially plentiful and have also been aided by the increasing importance of domestic consumer demand. Domestic consumption has helped fund a retail boom across Russia which has accelerated the diversification of the economy. Wealth has filtered right down through the Russian economy and no longer sits only with the super rich. The emerging Russian middle class is increasingly driving the economy, fuelled by 20% per annum increases in the average wage in each of the past three years. Although much of the growth has been on the back of huge demand for oil, a reduction in prices from current levels would have minimal impact. Indeed, commentators are suggesting that oil would have to fall to the $18-19 a barrel region for economic growth in Russia to stall.

The symptom of strong domestic demand is the possible acceleration in inflation.However, with the Russian market still currently trading at a discount in most sectors to its emerging market peers and given the fact that the Russian economy is well insulated from outside economic shocks, coupled with its financial institutions having no exposure to subprime problems and no tradition of mortgages or loans continues to allow the consumer to drive the economy.

At Origen, we believe that having exposure to some of the more esoteric markets can have a significant positive impact within a well diversified portfolio, however, clearly the position should be within the investor risk tolerance.

John Monaghan
Investment Manager
Origen