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. Last Updated: 07/27/2016

Global Interest Grows in RTS

The nation's young stock market has been more a casino than a place to invest since its inception seven years ago. Last year, the market's performance was second only to China's, but in 1998, it was the worst performing emerging market in the world.

But as Russia enters its fourth consecutive year of economic growth and the private sector bubbles to life, analysts are saying this market may be ready for investors, not just gamblers.

"This place has been a speculation, sometimes opportune and sometimes dreadful," said Bernard Sucher, a managing director at the investment bank Troika Dialog, who moved to Russia in 1993 after nine years on Wall Street. "I've refused to use the word investment for most of the time I've been here. But now Russia is threatening to become a capital market."

For the individual American investor, the options are still limited. The easiest way into the market is through a mutual fund listed in the United States. Eight funds at least partly dedicated to Russia are traded on the New York Stock Exchange, according to Lipper Inc. Of these, two are closed-end funds. In addition, shares of four Russian companies -- the telephone companies Vimpel-Communications, Mobile TeleSystems and Rostelekom; and the oil company Tatneft -- can be bought as American depository receipts on the New York exchange. More than 50 other companies trade over-the-counter as American depository receipts, according to the Bank of New York. Offshore funds, not covered by American regulations, offer higher-risk investments, including bets against the market.

A boom in Russia's oil industry has propelled the market. The Russian Trading System, or RTS, has quadrupled in value since it hit a low in 1998, the year the government defaulted on its domestic debts and let the ruble float. Bond prices have risen even more.

Despite an 80 percent jump in the value of the Russian market last year, stocks are still relatively cheap, said Peter Boone, head of research at Brunswick UBS Warburg, an investment bank and subsidiary of UBS Warburg.

This is partly because the market fell so far in 1998: The RTS index fell 96 percent from October 1997 to October 1998, and has yet to climb back to its level of fall 1997. The riskiness of investing in Russia, Boone said, has also kept valuations down.

"Russia is still the cheapest of all the major emerging markets," Boone said. "In 1999 there were a lot of people who absolutely didn't want to talk about Russia and met you out of friendship more than anything else. Now Russia is the flavor of the day."

In past years, Russian stocks traded in tandem far more than shares in developed markets. Recently, some companies have begun to break out of the market's overall trading pattern, making stock-picking important, said Sylvie Armand-Delille, director of international sales at NIKoil, a brokerage.

For example, while shares of Yukos, the nation's second-largest oil company, rose 191 percent last year -- in part because of a campaign to improve relations with investors -- LUKoil, the largest oil company, was a relative laggard, with an increase of 32 percent. LUKoil trailed the market at least in part because it was slow to release internationally audited versions of its financial accounts.

Poor treatment of minority shareholders was common in the 1990s, when new capitalists were grabbing assets from the government. Since then, big shareholders, their fortunes in hand, have begun repairing relations with investors, especially as they try to access international markets. Yukos has sold a bond issue internationally, while LUKoil is seeking a stock listing in London.

Russia's stock market is small. Only about 10 stocks are traded actively, out of 235 companies listed, and the average daily volumes on the RTS range from $15 million to $50 million, with another $400 million traded abroad and on another Russian exchange that trades only in rubles, MICEX. That limits choices for Russia-dedicated mutual funds, which typically stick to the most liquid stocks, like oil companies and mobile phone operators.

The Pilgrim Russia Fund was the best performing U.S.-based emerging market mutual fund over the last three years, with an annual return of 56 percent a year, Lipper reported. The fund was managed by Troika Dialog until early in 2001, when ING Barings, which bought it the year before, brought in its own managers.

"Few other markets have as much going for them as the Russian market," said Samuel Oubadia, senior investment manager at ING Investment Management in the Netherlands. This was not always the case. Despite last year's performance, the fund was the worst in its category in 1998.

About 40 percent of the fund's assets are held in oil companies, led by Surgutneftegaz, Russia's third-biggest oil company. Other large holdings include Norilsk Nickel, the giant metal producer, at 5.2 percent of assets at the end of last year, and Vimpelcom, the mobile phone company, at 4.1 percent.

Wealthier individuals may be interested in offshore funds, which are not regulated by American authorities. The $425 million Hermitage Fund, registered in the Channel Islands, requires a minimum $1 million investment for Americans. It returned an average 71.94 percent each year over the last three years, but lost 92.9 percent in the year ended October 1998.

Investors have streamed into Russia's stock and bond markets before, with disastrous results. In 1997, heavy buying drove the RTS up 184 percent before a financial crisis in Asia dampened enthusiasm for emerging markets. Half a year later, Russia, without warning, defaulted on $40 billion in government bonds.

While much has changed since then, the market is not yet mature and some fund managers are cautious.

"Everyone talks about Russian oil companies, saying they are undervalued," said Oleg Biryulyov, a portfolio manager at J.P. Morgan Fleming Asset Management, which oversees a fund, registered in Dublin, with about $500 million in Russia. "Fine, I can accept this. But we need to remember that the Western companies have management resources and track records."

Still, there is reason for optimism. In contrast to the unchecked borrowing and spending of the 1990s, the Russian government now pays its debts on time and runs budget surpluses. The economy is expanding -- last year by 5 percent, this year by an expected 3.5 percent. The country is running a trade surplus of more than $50 billion.

Chris Weafer, head of research at Troika Dialog, said that the turbulent politics of Boris Yeltsin had given way to the steady hand of President Vladimir Putin.

"They have a plan several years ahead," Weafer said, "rather than just dealing week to week."

Russia also has the beginnings of a bustling private sector. Supermarket chains have sprung up, advertisements flash from billboards and cafes line streets in Moscow, if not in many provincial cities. A corporate bond market has come alive in the last year. Oil companies carry less debt than three years ago, and they have reduced staff and modernized operations and drilling.

"Russia is in better shape and is better posed for economic growth than it ever has been over the last 10 years," Christof Ruehl, the World Bank's economist in Russia, said.

"Ask the majority of the Russian population about their plans for 10 years down the road -- no one will have an answer," Biryulyov said. "Ask the same question in any Western country and people will answer with far more certainty. That's a major difference. It's the same in the market."