Russia Isn't Siberia For Investors Anymore

Back in January, most international investors had soured on Russia--with good reason. President Boris Yeltsin had stumbled into a dirty war. Inflation was soaring, the ruble was tanking, and Mexico was giving emerging markets everywhere a bad name. Just the time to pour money into Russia, thought Brom Keifetz, whose Caribbean-based Firebird Fund beat the market last year by snapping up Russian shares when they were cheapest--at privatization auctions. Now, Firebird is busy raising money for a second Russia fund.

Like many others, Keifetz believes the market is poised for recovery. After hitting a low in February, when the war in Chechnya began to be more fully reported, Russian stocks are headed north again. But the market is still down 40% from its peak in early September. Says Keifetz: "We think stocks have much, much further to move."

Better economic fundamentals are one reason for optimism. Monthly inflation is down to 8.9%, the lowest since mid-August, and interest rates on one-year Treasury bills have fallen from 291% a month ago to 146%. Yeltsin is likely to try to help his reelection prospects by holding firm to his anti-inflation course.

But apart from economic improvement, there's another incentive to participate in the market: Its infrastructure is finally being built. Big players such as Chase Manhattan Bank International, Citibank, and Morgan Stanley are combining with Russian partners to help upgrade the nation's stock market operations. The U.S. banks' big institutional clients are pushing hard for change. The reason: Under U.S. Securities & Exchange Commission rules, pension and mutual funds can't buy stocks until well-capitalized custodians and independent registrars are in place. These custody banks hold securities for clients, buy or sell when instructed, and collect dividends.

The market isn't about to turn completely efficient or fair overnight. Just last month, Gazprom, which controls most of Russia's vast natural-gas resources, was charging foreign investors up to 100 times more than Russians pay for its newly privatized shares. Russian companies still have an unpleasant habit of splitting or diluting their shares outstanding without telling current stockholders, as oil company Komineft and Primorsky Shipping both recently did. And local individual investors still mistrust the stock market. When Red October Chocolate Factory launched its stock offering in December, foreigners and institutions supplied most of the $10 million raised.

The new changes will make Russia a very different place for investors--and certainly less prone to fraud. Businesses are increasingly handing over their shareholder registers to independent companies, and banks are starting to compete to offer rudimentary custodial services. Brokers are becoming better capitalized and more professional. And an electronic trading system that links Moscow brokers will be expanded to other regions this summer.

PRIVATE DEALS. Local entrepreneurs and international financial players are shaping the new system. One of Russia's biggest and most actively traded companies, Unified Energy System (UES), registers its share transactions at the Moscow Central Depository, newly created by two 31-year-old former Soviet Navy officers to manage the lists of stockholders. Chase Manhattan Bank International has linked up with UES to provide other shareholder services. And Merrill Lynch's Global Securities Research group publishes research reports on UES providing information that meets Western standards.

As Russia's stock markets gradually remake themselves, some foreigners are pushing ahead with private equity deals. Unable to put together a Russian mutual fund, as it has in India and Poland, Pioneer plans to raise up to $150 million for new Russian ventures. And Kohlberg Kravis Roberts & Co. has said it would raise some $3 billion from strategic investors over five to seven years for Russia's Kamaz truck plant. Says Charles H. van Horne, managing director of Creditanstalt International Advisers Inc. in New York, which raised $350 million in institutional capital for private placements in Russia last year: "It's the tip of the iceberg. This is the time in the market when the smart money deploys."

Smart is the key word, since investing in Russia will remain a risky business until the market is completely regulated. But the low valuations of Russian companies mean that investors with the stomach to ride out the highs and lows could see a big payoff down the road.

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