Russia's Warm Bear Hug for Private Equity

Moscow uses its new investment fund to woo foreign investors

While Russia has just met all the requirements for joining the World Trade Organization, foreign investors still view it as one of the worst places in the world to put their money. Even President Dmitry Medvedev, speaking at the APEC summit in Hawaii on Nov. 13, acknowledged complaints that Russia doesn’t always stick by the rules and said its judicial system is “still not as developed” as in many other countries. Now the government is using a new $10 billion sovereign wealth fund, its first, in a bid to attract foreign money.

The Russian Direct Investment Fund (RDIF) will start operating in early 2012 with an unusual mandate. It will only do deals in which foreign investors are also participating. “If we go to Western or Asian investors and they’re not interested in something, we can’t invest either,” says RDIF Chief Executive Officer Kirill Dmitriev. “We have this built-in protection mechanism to make sure we’re investing in things that make sense.”

What will draw foreigners into those deals, Dmitriev says, is that Moscow is using “state money to share in the risks and rewards of investing.” Also, RDIF’s partners will be putting money into specific deals, not a fund, he says, and won’t be forced to sell their positions even if the fund exits a deal.

To help establish credibility, the Russians have recruited a number of well-known investors to serve as advisors, including Blackstone CEO Stephen Schwarzman, TPG Capital’s Managing Partner David Bonderman, Apollo Global Management founder Leon Black, Kuwait Investment Authority Managing Director Bader M. Al Sa’ad, and China Investment Corp. Chairman Lou Jiwei. It’s also set to announce a supervisory board that will approve RDIF’s involvement in deals larger than $250 million. Half the board’s members will be independent, including former World Bank President James Wolfensohn and Harvard Business School professor Josh Lerner.

Already, Dmitriev says, “we’re working with seven U.S. and European private equity shops in looking at different areas such as health and logistics.” VEB Chairman Vladimir Dmitriev (no relation), whose state development bank may provide financing for deals, has said the fund is examining 20 potential projects worth $5 billion.

While Russia’s resources and growth potential seem like natural draws for private equity funds, the country’s reputation for corruption have chased many investors away. Russia was named the least attractive emerging market for three years running in surveys of investors conducted by the Emerging Markets Private Equity Assn. Russia drew $60 million in country-specific private equity funding in the first nine months of this year, down from $1.8 billion in 2007. China attracted $12.9 billion, while India received $2.9 billion, and Brazil drew $4.4 billion.

Hermitage Capital CEO William Browder, a prominent investor in Russia until the government revoked his visa in 2006, doubts that the advisers on RDIF’s board are in fact willing to commit funds to joint deals. “If something goes wrong, there’s huge reputational risk to having their names attached to this venture,” he says. None of the members of the RDIF’s advisory board were made available when their firms were asked for comment.

For Ed Verona, CEO of the U.S.-Russia Business Council, the fund sounds promising if the protections hold up in a dispute. “We need to see some test cases,” he says. Dmitriev says some of his advisers as well as other investors have expressed interest in specific deals the fund had identified. He’s also fielding calls from foreign officials who want to set up similar investment funds. “This is a new breed of sovereign wealth fund,” he says.

    BOTTOM LINE -

    The bottom line: Moscow hopes to woo private equity players through a fund that will invest in deals alongside them.

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