THE RUSSIAN INVESTMENT story right now is one of stark opposites. In foreign direct investment all seems remarkably rosy. The government's 7% stake in LUKoil looks set to be bought by Conoco. In consumer finance, GE Capital, BNP Paribas and Société Générale have all made recent acquisitions. UBS also recently bought out Brunswick, its Russian brokerage partner.
The story is very different in portfolio equity investment where, despite Russia's having some of the strongest macroeconomic fundamentals in Europe, several large foreign institutions are scaling back their positions. Analysts at the Moscow brokerage houses have been wondering if the Yukos affair will affect investors' broader assessment of Russian risk. The answer seems to be yes.
Michael Reynal is portfolio manager at Principal Global Investors, which has over $500 million invested in emerging-market funds. He says: "All the negative news coming out of Russia has definitely affected our assessment of the country's risk. We actually started to pull back from Russia late last year, when the Yukos situation really began."
Reynal says the political risk he now sees in Russia has made Principal "turn back to markets with worse fundamentals, in Latin America and Asia, where there is less government interference in the markets". He adds: "Last year we were significantly overweight on Russia. Now we are underweight."
He is not alone. Angelika Millendorfer, a fund manager at Raiffeisen Capital Management who manages a e670 million emerging Europe fund, says: "The risk for equity investors is definitely higher than it used to be. We've tended to decrease our Russia allocation as a result."
She continues: "Since Putin came to power, everyone who followed Russia thought there had been a lot of improvement in legal and market
reform. Investors felt more secure about the market climate." The government's seizure of Yukos's key assets for sale came as a "nasty surprise", she says.
Now she is concerned that minority rights might not be observed in the sale of those assets. Raiffeisen Capital Management is one of a number of fund managers that wrote to the government expressing their concerns over the situation this July.
Another major equity investor in the region says: "We're now slightly underweight in Russia, having been very overweight. People are starting to reassess Russian risk."
It is not just foreign investors that are more bearish on the Russian economy. Domestic investors, which account for about 55% of portfolio investment in Russia, are also heading for the exit. Capital outflow is set to quadruple this year to between $8 billion and $12 billion according to the economic development and trade ministry.
The equity market has taken the brunt of the swing in sentiment. Sovereign bonds have not been seriously affected, although it is now much more difficult to sell Russian corporate bonds to US investors, because of concerns about Yukos.
In the loan market, too, anxiety over political risk is becoming evident. In August, Société Générale and ING backed out of the $600 million loan for TNK-BP because of concerns over the government's strategy in the energy sector.
In equity, however, valuations are down 30% over the past four months, while the MSCI Russia index has lost around 5% since the start of the year.
Why such bearishness, when GDP growth is set for 7% in an oil-dominated economy when oil prices are pushing towards $50 a barrel? To some degree, it is part of a wider shift in emerging-market capital allocation. Emerging-market equity funds have recorded outflows of capital of about $40 million a week over the summer, because of the changing US rate environment. As the Federal Reserve raises rates, some capital is being attracted back to developed markets from emerging markets.
But within emerging market funds, Russian funds have also seen bigger outflows than most. According to EmergingPortfolio.com, which tracks about 7,000 funds, capital is seeping out of emerging Europe equity funds at a rate of $19.7 million in a single week, in part because of negative sentiment over Yukos.
Yukos affair spooks investors
What particularly spooked investors was the government's seizure of Yuganskneftegaz, Yukos's key asset, which is worth perhaps $16 billion. The concern was that the government was about to sell it at a cut-price rate to a government-friendly company such as Surgutneftegaz or Rosneft, in disregard of the interests of foreign minority investors and of Russia's market image.
Elizabeth Eaton, fund manager of CSFB AM's emerging Europe fund, says: "Investors were feeling that they had successfully ring-fenced the risk from the Yukos case from the rest of the market. That changed when it became clear that Yukos's key asset would be sold."
The seizure of the company's key asset made some investors think the government was less interested in the company having evaded taxes, and more interested in redistributing property to government-friendly parties. Eaton says: "The worry is that the risk will go on to other oligarch-connected assets."
At the end of August it was still not clear how the sale of Yukos's assets would be handled, though investors are watching very closely. Leila Kardouche, fund manager of Schroders $500 million emerging Europe fund, says: "The single most important thing is that they deal with the sale in a way that is friendly to minority investors. A fire sale of the asset would be very bad. It would substantially change our assessment of Russian risk."
Equity investors' woes have not been confined to Yukos. Gazprom local shares were also badly hit in August when a Duma deputy wrote a letter to the head of the Russian securities market regulator complaining about what are known as grey-trading schemes.
The schemes, which are widely used by brokerage houses in Russia, allow foreign investors to invest in Gazprom local shares through offshore structures. Foreign investors were frightened by the accusations, and Gazprom lost about $6 billion in market capitalization in a single day.
Local brokerage UFG says that the deputy's accusations were prompted by a local legal battle between UFG and a hostile takeover specialist. Nevertheless, as Eaton of CSFB AM says: "The gigantic sell-off clearly exhibited how concerned people are about political risk in Russia."