Foreign Investors Bullish, With Caveats

Managers of a new wave of emerging-markets funds said they are set to provide a $1 billion boost to Russia's ailing economy, despite the war in Chechnya, uncertainty over the future of privatization and low levels of direct foreign investment.

Foreign investors have virtually stopped buying shares in privatized companies on the secondary market since the Chechen crisis began and former privatization chief, Vladimir Polevanov, urged the renationalization of key industries.

While many of the new emerging-market funds buy and sell on Russia's stock markets, most said they are also committed to longer-term, direct investments. Many said they are in Russia for the long haul and are prepared to wait as long as five to 15 years to see a return on their equity in Russia's newly privatized companies. At the same time, they are urging caution in the short term as they expect a number of crises.

"We're following events very closely and we're taking a very cautious approach," said Richard Sobel of Baring International Investment Management in London, which jointly manages the $180 million First NIS Regional Fund. "The opportunities are particularly attractive over the medium and long term and we're trying to invest in things that will get over short-term bumps."

"We think it's going to be a highly volatile five to 10 years, but in the long view we're very optimistic about the prospects of the companies we invest in," said Mike Calvey of the SovLink-American Corporation, Sobel's Moscow partner.

More than $50 billion has poured into emerging markets worldwide over the past couple of years as international financiers have sought the high returns offered by Asian, Latin American and East European economies, analysts said. Recently, however, these markets have been severely hit by fallout from a deepening financial crisis in Mexico, once the darling of emerging-markets investors.

In an indication that some investors are rethinking their plans for Russia because of perceived instability, the U.S. investment bankers Lehman Brothers announced last month that they had abandoned plans to manage a $300 million Russia fund.

Nevertheless, a stream of unperturbed funds is still targeting the countries of the former Soviet Union. This is creating a pool of Western investment capital in Russia that exceeds $1 billion and which could leverage considerably more. Emerging markets giant Templeton is currently registering a fund of as much as $400 million. This would be the largest dedicated to Russia. Others have already begun investing.

The fund's capital would provide a major boost to direct investment in Russia. While foreign portfolio investment reached as much as $500 million per month in August and September, direct foreign investment lagged well behind, closing the year at just $1.2 billion. Per capita, this is well behind other emerging markets.

Direct investment -- providing funds for equipment and training -- is a much faster way of effecting change in privatized firms than portfolio investment, which primarily benefits the sellers of shares rather than the companies that issue them.

"The focus of our investment is venture capital," says Connell Gallagher of Framlington Investment, whose $66 million fund has been operating in Russia since 1993. "The comments of the privatization minister won't fall under our remit and events in Chechnya, although of concern, are taking place in a very small part of Russia."

Many are also banking on Russia's reformers to bounce back from what has been seen as a period of major political setbacks. They were encouraged when Polevanov was replaced by Pyotr Mostovoi, who is seen as closely allied with reformist First Deputy Prime Minister Anatoly Chubais.

"If those forces continue, I would be extremely optimistic," said Beth Hebert of Fleming Investment. Her company has "substantially invested" its $55 million securities fund after fully investing a small pilot fund launched 3 1/2 years ago. "Provided the economic reform process continues as it has successfully done to date." she said. Fleming also has plans for a much larger fund to be listed on the New York stock exchange.

Indeed, it is the risky nature of the Russian economy that makes it such an attractive opportunity to some pioneering investors. "We recognize it's very risky compared to other emerging markets, but we think the potential gains are commensurate to the risk," said Sobel.

The untapped nature of the market, where companies with high potential can be snapped up at competitive prices, makes it virgin territory for venture capitalists. "For the moment there's still a lot of room for people who want to make a quick buck before the giants arrive," said one fund manager who declined to be named. "But it's still very risky."

The relative economic stability achieved last fall, however, encouraged a new wave of funds to view Russia as a less hazardous destination for their investors' cash. While Chechnya has tarnished that image to some extent, managers like Orhan Sadik-Khan of Paine Webber's new $155 million Russia Partners Fund still see Russia as a good bet.

"Direct investment is still at a relatively early stage and the (Paine Webber) fund is basically a direct-investment vehicle looking for high-risk, high return," he said.

One factor helping to make investors like Sadik-Khan bullish about the future of investment in Russia is financing from semi-governmental organizations like the U.S. government's Overseas Private Investment Corporation, the European Bank for Reconstruction and Development and the International Finance Corporation, a branch of the World Bank.

"If you're an investor in an OPIC-supported fund, the worst you can do is get your money back at the end of 10 years," OPIC President Ruth Harkin said in a recent interview.

OPIC has provided loan guarantees for the Auburndale, Baring and Paine Webber funds, plus a $100 million agribusiness fund managed by the Agribusiness Management Co. Harkin says OPIC involvement is expected to leverage up to 10 times the funds' face values in private investment for Russia.

Lou Naumovski, the EBRD's resident representative in Moscow, says his bank's involvement in a project can be expected to leverage significant amounts of private capital.

The EBRD has invested in the Framlington fund, Barings fund, Capital International's $130 million New Europe East Investment Fund and the Helsinki-based $22.3 million Alliance ScanEast Fund.

"There will always be some appetite for Russian risk," Naumovski said. "I don't think there'll be any single event that will prevent Russia from being an attractive emerging market."