Igor Danilenko would be the first to admit that touting the joys of Russian equities to foreign investors is no walk in Gorky Park.
But the money manager from St. Petersburg is eager to dispel some misconceptions that make the market seem even more hazardous, one-dimensional and less liquid than it actually is.
“It’s kind of unloved, so there’s not a lot of foreign money going in,” Mr. Danilenko, senior portfolio manager with TKB BNP Paribas Investment Partners, acknowledged during a recent visit to Montreal and Toronto.
“I would say that net new portfolio investment in Russia has been quite minimal for the last two years. It’s hard to get excited about the concept of Russia. Of course, when people look at valuations, they start to think that maybe it’s worth a second look, because it does seem significantly cheaper than other emerging markets.”
Most Canadians pay no attention whatsoever to the Russian market, regardless of price. After all, if they want oil and gas, which accounts for more than half the benchmark Moscow index, they can get all they need right at home without the perceived risks. And when investors do think beyond Russia’s vast energy assets, such confidence-crushers as widescale corruption, blatant political interference, murky insider dealings and a lack of transparency come to mind.
Just last week, Russian authorities accused William Browder, the American head of London-based Hermitage Capital Management, of fraud over the fund’s purchases of shares in state gas producer Gazprom a decade ago. In an interview with Bloomberg, Mr. Browder said the Gazprom share purchases were “entirely legal” and that the Russian move was political.
Mr. Browder suggests the Kremlin is flashing its anger over the Magnitsky Act, a piece of U.S. legislation aimed at barring and seizing U.S. bank accounts of Russian government officials linked to the prison death of a whistle-blowing lawyer named Sergei Magnitsky. (Despite being dead, Mr. Magnitsky, who, along with his client Mr. Browder, sought to expose corrupt tax officials, is also charged in the alleged share fraud.)
The U.S. law is no trivial gesture, as high-level Russians have moved large sums abroad. That includes the head of the parliamentary ethics committee, who resigned under pressure from President Vladimir Putin after it was revealed he owned an undeclared condo in Miami worth $1.3-million (U.S.).
Yet Mr. Danilenko says foreign investors are wrong to assume that corruption is more rampant and corporate governance much weaker than in other, more popular emerging markets. “They’re pretty much the same.”
The trick, he argues, is to use active managers who do a great deal of homework – just like him. Another hint: Steer clear of the big state-controlled enterprises.
“As a general approach, I would avoid companies that don’t have the same motivation as you do, which is to make money and deliver a return to shareholders. That will lead you to escape most [bad] situations. This pretty basic due diligence can be easily done. It’s not like these [misbehaving] companies tell you they’re doing everything well and then they surprise you. They’ve been doing this for years,” he says with a chuckle.
One easily avoided problem occurs when controlling shareholders transfer assets from public companies to their private holdings. “We watch out for that, because if a person owns more than one business, it’s hard to say where the profit centre is. Usually, we can see these red flags in advance.”
In other words, if someone owns 100 per cent of a private company and, say, 50 per cent of a publicly traded vehicle, it’s not hard to guess which interests will come first. “So we watch out for problems in ownership and problems in motivation of management, when, for example, they don’t have proper incentives” to safeguard the public company’s interests.
Another obvious red flag centres on government-controlled public companies like Gazprom.
“Oddly, people get very surprised when they invest in a state-owned company in Russia, and the company declares it will spend money not on economic projects but on social projects or regional development,” Mr. Danilenko says. “When a company like Gazprom spends $5-billion on the Sochi Olympics, you get zero economic return.”
Even those energy producers not under the state’s boot may not be as good investments as they appear on paper, not least because of the government’s 80 per cent tax bite of gains stemming from higher oil prices.
“Oil and gas is a low-growth sector. You really need to be selective” to find companies deploying capital efficiently, he says. “Because that’s the main differentiator of valuation in these companies – not the oil price.”
Investors in Lukoil and Gazprom – the energy stocks with the most liquidity and heftiest weightings in the index – have reaped a negative return over the past four years. “If you had invested in some other non-benchmark stocks with legitimate growth stories, you would have done up to 100 per cent better.”
His list includes banks and wireless telecom providers, which have benefited from strong consumer demand and rising incomes. He also likes utilities, which have completed mandatory capital spending imposed as a condition of their privatization and are now free to deploy their capital as they like.