These should be good times for Moscow-based asset managers. After all, affluent Russians’ pockets are bulging with cash again. Moscow regained the crown of city with the most billionaires in this year’s Forbes magazine ranking, edging out New York, with 79. The surge in wealth reflects a vigorous economic recovery from the 2008–’09 financial crisis. Growth is running at a healthy 4 percent, stoked by Brent oil prices that have remained above $100 a barrel even as the global economy has slowed. Privately administered pension funds are growing rapidly in Russia, promising the formation of a much-needed institutional capital base. Stocks and bonds are increasingly attractive to retail investors as bank deposit rates lag well behind inflation.
For now, though, those positive factors offer more potential than actual benefit to local fund managers. Oligarchs and the merely wealthy are managing their money through Western-based family offices or entrusting it to European private banks, engaging in what Russian financiers euphemistically call “geographical diversification.”
Ordinary savers, meanwhile, remain scarred by a number of violent market swings since the country’s mutual fund industry was born in the privatization wave of the mid-1990s. The stock and bond markets cratered after Russia defaulted on its debts in 1998, and it took nearly a decade of economic and market recovery to begin enticing retail investors back into funds. That tentative confidence suffered a fresh blow in 2008, when the financial crisis wiped out three quarters of the Russian Trading System’s market capitalization between May and October. The RTS index was just approaching its precrisis highs when the latest global economic jitters triggered a 30 percent correction between April and August.
Given that volatility, it’s little surprise that Russian mutual funds hold a derisory $4 billion in assets, a pittance compared with the country’s $150 billion in bank deposits, according to Troika Dialog Asset Management. “Russia has one of the most unfortunate mutual fund industries in the world,” says Anton Rakhmanov, Troika’s director of asset management. “We’ve been in existence for 15 years and had two crises.”
In contrast to the subdued domestic players, international investors are edging cautiously back into Russia, spurred by the general vogue for emerging markets. This trend is evident in the Russia 20 , Institutional Investor’s exclusive new ranking of the country’s largest money managers. Two Western-run asset managers top the list. Prosperity Capital Management, an independent firm that focuses exclusively on investments in Russia and the former Soviet Union, had $4.85 billion in Russian assets under management at the end of June. It is followed by TKB BNP Paribas Investment Partners, a joint venture between the French bank and TransCreditBank, a subsidiary of Russia’s state-owned VTB Bank. The outfit had $4.09 billion in assets.
Mattias Westman, the Swedish founding partner who runs Prosperity from London, says the firm’s investor base, traditionally dominated by European family offices and Scandinavian institutions, is becoming more diverse. Since the crisis the firm has attracted money from four sovereign wealth funds, including Norway’s deep-pocketed Government Pension Fund Global, and two U.S. pension funds, a class of investors that has typically been Russia-averse. “A lot of investors are willing to have a real look at Russia now rather than dismissing it out of hand,” Westman says.
UralSib Asset Management ranks third on the list, with $4.01 billion in assets, followed by Troika Dialog Asset Management ($3.33 billion) and Promsvyazbank ($2.41 billion), Russia’s tenth-largest bank, which is one quarter–owned by Germany’s Commerzbank and the European Bank for Reconstruction and Development.
Homegrown Russian asset managers would love to build a bridge to Western capitalists. Aton Asset Management Co., which ranks No. 12 on the list, will launch a hedge fund next year targeted at international investors and domiciled offshore, deputy CEO Pavel Nikonov says. (If it were registered in Russia, the government might tax all the fund’s gains, not just the manager’s earnings.)
Yet most Russian managers still place their biggest hopes on reviving the domestic retail business. Here the potential seems impressive. The same Russian wealth explosion that has produced the country’s fabled nouveau riche has trickled down to millions of middle-class families with considerable means to build a traditional bourgeois nest egg. Per capita GDP reached $15,900 on a purchasing power basis last year, according to the Central Intelligence Agency’s World Factbook. That’s 30 percent higher than Turkey’s income level and nearly 50 percent more than Brazil’s. The average mutual fund account at Aton is worth $70,000.
The securities markets are looking more attractive in light of the dismal returns that banks offer these days. Russian savers enjoyed positive real interest rates on deposits for most of the post-Soviet period as banks competed fiercely to attract their cash, but the financial crisis has changed that equation.
The central bank flooded the financial system with liquidity to ward off the threat of insolvency. Banks now find themselves with more cash on hand than attractive borrowers. Sberbank, the dominant state-owned retail franchise, offers rates of about 4.5 percent on one-year certificates of deposit, half the current rate of inflation. That dismal arithmetic is music to asset managers’ ears. “I am very optimistic about the mutual fund business because of the lack of alternatives,” says Florian Fenner, managing partner of UFG Asset Management, an offshoot of the former United Financial Group. The firm ranks eighth on the list, with $1.64 billion in assets.
The mutual fund industry is also primed for a marketing revolution thanks to Sberbank’s pending acquisition of Troika Dialog, which was agreed in May. Sberbank, which holds nearly half of Russians’ bank deposits, plans to start hawking Troika’s investment funds across its 20,000-plus branch network. “This business is all about distribution, and we expect to explode the market,” Troika’s Rakhmanov says.
Competitors welcome the prospect of Sberbank’s bringing mutual funds to the masses. “This could be a big plus for us by making the market bigger,” contends Anton Pugach, CEO of UralSib Asset Management.
In other areas, however, the industry continues to be hobbled by the state.
Consider the case of pension regulation. In Vladimir Putin’s first term as president, the government enacted a pension reform that gave workers a choice between funneling their payroll deductions to the traditional state retirement system or to private alternatives operated by large employers and financial companies. The arrangement was modeled on plans that have worked well in Poland and Chile. Today about 25 percent of the workforce are opting for the private pension schemes, swelling their coffers to about $32 billion, according to Troika Dialog.
Antimarket regulations limit fund managers’ ability to invest that money, though. Specifically, the law does not allow pension funds to lose money in any calendar year. That requirement effectively restricts most funds to the most short-term and conservative investments, such as government bonds and bank deposits. “The pool of capital is being invested in the most inefficient way because a few laws cannot be changed,” says UFG’s Fenner.
To add insult to injury, the government also forbids asset managers from charging pension funds management fees and caps performance fees at 10 percent. “If the regulations are not changed, eventually asset managers will just refuse to manage pension funds,” Rakhmanov says.
Other traditional sources of investment remain underdeveloped in Russia. The insurance industry is in a formative stage, with most Russians lacking home or life insurance. Corporate treasuries are still struggling to pay off debts accumulated before the crisis and have limited cash reserves to deploy. The billionaires and multimillionaires for which Russia is famous largely bypass the country’s asset managers. “Ultrahigh-net-worth individuals establish family offices that create their own structures offshore,” says UralSib’s Pugach.
Oligarch capital seems to have been leaving Russia in large quantities regardless of the economic upturn. The central bank reported that capital outflows reached $31 billion during the first half of this year, about 4 percent of GDP on an annualized basis. A survey of the Russian superrich released this summer by Swiss private banking giant UBS found that four out of five favored the beleaguered euro as a store of value, while less than one third trusted the ruble.
II’s ranking of Russian asset managers reflects one notable absence: Hermitage Capital Management, the firm run by U.S.-born financier William Browder. Hermitage was the largest Russia conduit for foreign investors until 2005, when the Kremlin refused to renew Browder’s visa, without explanation. Then a group of alleged creditors sued Hermitage in Russian courts for some $500 million in supposed debts. Browder maintained that the suits were a fraud orchestrated by the Russian Interior Ministry. The struggle climaxed in 2009 when Sergei Magnitsky, a Russian lawyer representing Hermitage, was detained for allegedly helping Hermitage to evade taxes. He died after nearly a year in prison, after having been refused medical treatment for pancreatitis.
Browder has characterized the government actions as retribution for various corporate governance battles waged by Hermitage. Yet Prosperity is an often contentious investor as well, having locked horns with powerful Russian companies like former utility monopoly Unified Energy System or No. 2 oil producer Lukoil Co.
Prosperity CIO Alexander Branis recently joined the government’s task force on making Moscow an international financial center, identified as a key goal by President Dmitry Medvedev. Moscow’s asset managers clearly think he has a ways to go.
