LAST MONTH INVESTORS put aside fears that the Kremlin was on the verge of renationalizing Russia Inc and drove the RTS (Russian Trading System) index to a new high of 700. However, talk of bubbles, first heard in October, has reappeared.
Investors have been jittery over the past six months, in particular as a result of Mikhail Khodorkovsky being thrown in jail. The worries have been fed by president Vladimir Putin's landslide election victory, which has given him almost total control of the Russian state.
Local brokers are divided over what comes next. Some believe that Russia's strong growth means that the RTS is still a good punt; others say enthusiasm is become over-exuberant.
"We have marked everything down to at least hold, except Gazprom local shares and [pipeline monopoly] Transneft. The whole market is overvalued," says Oleg Maximov, an oil and gas analyst with Troika Dialog.
Most analysts agree that Russia's days of triple-digit gains are over. Many point to the flood of money pouring in on the back of $30-plus oil prices as being the main driving force on the market and warn that riding the wave of liquidity is a risky game.
"In January, the Central Bank of Russia announced that reserves in the previous week had risen by $3.6 billion ? and that was despite a $320 million Eurobond coupon payment. To put that into perspective, it represents 7% of the outstanding monetary base," says Roland Nash, head of strategy at Renaissance Capital.
"Money has never been so cheap," says Nash. "And when the money supply is growing so rapidly, it tends to push all asset prices higher. Domestic demand remains the single biggest driver and with so much liquidity there is still tremendous pressure on asset prices to keep going up."
Timing was all
Picking Russian stocks used to be simply about timing. Any investor brave enough to buy Russian equities in the months after the 1998 financial crisis, when the RTS was a mere 36, would be 2,000% up now. But over the past two years Russia has ceased to be a plain-vanilla product.
In the atmosphere of confusion, where the fate of the oligarch-controlled companies remains unsure, analysts recommend a retreat to sure things: state-owned gas monopoly Gazprom remains the only substantially undervalued company, by international standards, on the RTS and state-owned pipeline monopoly Transneft is a popular second choice. But some are arguing that this defensive strategy overlooks a fundamental change.
"In the past Russia has been an asset play. Investors argued that Russian assets were cheap compared with the rest of the world and would rise as Russia re-rates," says Anton Khmelnitsky, head of equities at Brunswick Asset Management. "Now the economy is growing by 9% and Russia has become a growth story."
Khmelnitsky says that while the oil sector is mature, other sectors, such as Russia's five big steel companies, are just beginning the process of consolidation and investment that the oil companies have almost completed. Other sectors, such as food processing, are further down the line but will also go through the process. There is no consensus on where Russia goes from here, but most agree the tempo will slow.
"It has grown, but it is still possible to put together a portfolio that will return 50% a year," says Khmelnitsky. "You need to take the long-term view and look for companies and sectors with growth potential. It is not going to be homogenous."
Investors looking for the big gains that Russia has traditionally offered the courageous are going into the second tier of companies ? what bullish equity sales people have dubbed the "emerging blue chips", and more sceptical observers call "the great unpronounceables".
"Locals are getting panicky because they are only used to Russian valuations. You have to look across the board and Russia still looks cheap compared with the other emerging markets," says Eric Kraus, head of strategy at Sovlink, a second-tier specialist.
"The second tier represents the buying opportunity that the first tier did in 1991 [when the Soviet Union collapsed]," Kraus says. "There are some very good companies that trade at price to earnings ratios of two or four. These are the ?emerging' companies of the Russian economy."
Kraus argues that Putin's crackdown on tax scams and dodgy practices is driving the valuation growth of these companies and forcing them to adopt better business practices. Some of their owners are even hoping to repeat Khodorkovsky's trick of rebranding their companies as investment friendly and watching share prices soar.
"The tax man has become the investor's friend," says Kraus. "Before the crisis everyone booked their profits offshore but over the past few years companies have been bringing their trading arms home. It began with the likes of Norilsk Nickel and now that these companies have come clean the taxman is turning to the rest of the country. Investors are getting a free ride."
And second-tier companies are doing significantly better than the RTS. Sovlink's Russia Small Cap (SRSC) index has gained 155% since the start of 2003, while the RTS has risen by 74%.
All of the stocks on the SRSC rose in 2003 and several tripled in value.
The risks are still huge, though. "You still have to pick very carefully. There are some very very cheap companies that are worth every penny," says Kraus sarcastically. "Some of the owners of these companies get it, some don't and some never will."
Another way to tap into Russia's growth is through private-equity funds, which have been making heady returns but remain small and are dominated by Russian capital. "There are a number of attractive opportunities out there that are just as attractive as they were five years ago," says Michael Calvey, managing director of Barings Vostok, one of the first private investment funds in Russia. "But there are not thousands of them. The risks are going down and the quality is going up but that means the prices are also going up."
Barings Vostok has already doubled the capital in the first funds set up in 1994 and Calvey says that the returns from the second, launched in 2000, are likely to be even higher. But despite the good returns, private equity has yet to catch on.