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. Last Updated: 07/27/2016

Big Competition for PIFs




Since their inception, Russia's unit investment funds have had a tough time getting off the ground. Exorbitant costs, seemingly excessive regulatory oversight and investor skepticism continue to thwart what could potentially be an industry with stellar growth. In fact, at first perusal it appears that these investment funds -- known in Russian as PIFs -- have been short on luck, and that their future is consigned to a lonely corner in an expanding mecca of investment opportunities unfolding in Russia's exciting capital markets.


To be sure, this is not entirely the case. PIFs have already shown, by surviving the first several months of existence, that they are worthy investment products and will be all the better for having overcome these trials. Equity funds have fared smartly during the market's boom. And this week aggregate assets of all PIFs (there are 11 actively selling their units) will cross the $30 million threshold. Granted, considering that the hypothetical size of stowed-away savings in Russia is some $30 billion, this is but a blade of grass in a fertile valley. But in May the industry only had $17 million, and 75 percent growth in four months is not to be knocked.


But the ride for PIFs is destined to get rougher. Ahead lies the ultimate challenge: funds created by Russian banks. To be known as General Funds of Banking Management, these new investment vehicles are sanctioned by the Central Bank, and will be regulated by it too. The first bank funds will be registered soon and will be belong to MFK (Uneximbank's investment banking branch) and Rossiisky Kredit.


Bank funds have a bright future. They will enjoy several tremendous advantages over their PIF cousins, which will result in reduced costs for the investor. Bank funds will not need to hire fund managers to make investment decisions, depositories to safeguard securities or specialized registrars to maintain shareholder lists. All these functions will be performed in-house. Also, banks, unlike the managers of PIFs, will not have to rent or buy property to conduct transactions with investors; they can use their existing branch network, thereby cutting the hefty distribution costs which have plagued PIFs. For example, CS First Boston was recently forced to close an expensive retail outlet.


In fact, the list of advantages bank funds will have is mesmerizing. To have a fund registered, any interested bank need meet only a minimum of requirements. And when commencing a bank fund, there is no minimal threshold that banks will have to meet so that the given fund may be recognized as valid -- whereas PIFs have three months to raise 2.5 billion rubles. Indeed, the requirements for establishing bank funds are so lax that it would appear that, while designing them, the Central Bank's ulterior motive was to eradicate PIFs.


But like life, the markets are never as simple as they seem. Many banks are under the impression that they have PIFs beat insofar as they are more experienced in managing client assets. Quite the contrary: Experience is precisely the area in which PIFs are certainly superior. PIF issuers such as Pioneer, CS First Boston and Troika Dialog house have some of the market's most qualified and outstanding asset managers, people who have distinguished themselves in more than one bear market. The average Russian bank has excelled where it is nearly impossible to fail -- on the domestic bond market.


No less important is the fact that bank funds will have far more leeway in investment options than do PIFs. They will not be restricted from investing client assets in junk bonds (promissory notes), futures, options, and gold and silver.


As a consequence, bank funds will carry more risk, and will be more likely to implode without warning.


After weighing the information available at this early stage, the scales are tipped in favor in bank funds. The only weapon PIFs have at their disposal in this confrontation with bank funds is experience.


Some would say that these are two types of investment vehicles which can coexist. But it is this analyst's opinion that PIFs had best regard GFBMs as a hostile competitor if they are not just to survive, but thrive.


Given the chance, they must outperform. If they fail, they will wither away into investment oblivion.


How will the Federal Securities Commission react to save its pet PIF industry? An even better question is whether the market can support two distinct legions of mutual funds. Chances are, it can. Total registered savings in the nation's banks equaled $24.8 billion as of Aug. 1, which is up 12.8 percent from the beginning of the year. Part of this money will drift to potentially more lucrative investment alternatives as interest rates decline.


Banks will create their funds to keep clients' money under one roof, while PIFs will use their wits to outperform their banking rivals in the brass tacks of asset management: choosing the best investments during markets both bullish and bearish.





Gary Peach is the editor of the weekly newsletter Capital Markets Russia