Why big guns back the new Russian revolution

Spend, spend, spend … on 2.5m new cars, designer shops and Mamma Mia! Patrick Collinson reports

Photograph: Franz-Marc Frei/Corbis

Its streets are gridlocked. Inflation is rampant. Decrepit “Khrushchevski” housing blocks blight the skyline. And right now it’s probably the most exciting city in Europe.

Moscow will confound you. Looking for bleak reminders of Stalinism? You’ll find them in spades. Looking for gangster capitalism? You’ll see that, too, with cartoon criminals in darkened Range Rovers accelerating along Tverskaya, Moscow’s Park Lane.

But the anarchy of Yeltsin’s failed 1990s experiment in shock capitalism is over. Ten years ago, half of Russia’s workers weren’t being paid, banks were bust and the rouble was collapsing. Today, Russians are Europe’s biggest consumer spenders. This year they will buy 2.5m cars – about the same number sold in Britain last year – and are on track to overtake Germany as Europe’s largest consumer market.

Gleaming new car dealerships are sprouting all along Moscow’s once-deserted highways. A giant Ikea store sits alongside a hypermarket run by Germany’s Metro chain. In the city centre, Zara and Canali shops parade near Red Square, while hoardings promote the latest entertainment sensation: Mamma Mia. This is no longer the grey, inhospitable city of Soviet times – although as Chelsea and Manchester United fans will testify, it’s eye-wateringly pricey.

I’m in Moscow, the guest of Robin Geffen, the chief executive of Neptune Investment Management and the man in charge of around £400m of British small investors’ money in his Russia fund. If you’d put £10,000 in the fund three years ago, today it would be worth £37,400. But Geffen says ignore the critics who say the gains are the result of an oil-based boom that could burst tomorrow. Shell and BP’s oil reserves are falling fast, but not so at Gazprom, now the world’s third largest stockmarket-quoted company. Other natural resources are in plentiful supply, and enjoying voracious demand from China and India. Meanwhile the service sector of the economy is making extraordinary productivity improvements as Russia continues to shake off the misallocation of labour under the Soviet system.

Geffen projects growth in Russia this year at 7.5%-8%, placing it in the same bracket as China. He is confident that even after a decade of gains, the stockmarket still has much further to run. The market’s overall price/earnings ratio is still just 11-12. What that tells us is that although share prices are up, they are being more than supported by profit growth in Russian companies.

Roland Nash, a Briton who has been living in Moscow since leaving university in 1994, is recognised as one of the top Russia analysts. He is a director of Russia’s leading investment bank, Renaissance Capital. He says: “The returns to be made in Russia are genuinely phenomenal. They have been in the past, and they will be in the future.” But he adds: “The risks are large, and the world can change very quickly.”

He should know: “I became a millionaire by the age of 25 [during the Yeltsin years] and bankrupt by the age of 26. Russia blew up spectacularly in 1998.”

At the Russo-British Chamber of Commerce, Neil Cooper says that today Russia is “possibly the strongest economy in the world. We are seeing a recovery that was inconceivable in 1998”. Despite the problems BP and Shell have encountered, Britain continues to be the leading foreign direct investor in Russia. But behind the figures it is believed that much of the money is from Russian exiles returning home.

There is widespread bewilderment at the picture painted of Russia in the British press – spies, polonium, Putin’s authoritarianism, mafia control and corruption.

But what the Russophiles do acknowledge is the challenges facing the country. Top of the list is inflation, currently at 11%, followed by bureaucracy. Perhaps because they are financiers, Russia’s depressing income inequality is barely mentioned. Regional inequality is also immense. Incomes in some parts of the country are just 5% of the typical Muscovite’s take-home pay.

President Putin was lucky. He saw oil rise from $10 to $100. Maybe President Medvedev will enjoy oil at $200 a barrel. If you think crude is heading that way, it is still a great time to buy Russia funds.

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How to invest

Five years ago they barely existed. But today, Russia funds are the darlings of the unit trust world, with outstanding performance figures attracting a wave of money from small British investors.

At fund advisers Hargreaves Lansdown, Mark Dampier says funds from Neptune and Jupiter (the asset management groups, not the planets) are among the hottest sellers. “They are more popular than some of the biggest UK funds. The money is pouring in,” he says.

The biggest, and to date the only unit trust that invests solely in Russia, is Neptune Russia & Greater Russia, launched in 2004 (neptune-im.co.uk). Over the past year it has given investors a gain of 38%, and over three years it is up 268%.

It focuses on big companies – its single biggest holding is oil giant Gazprom – but aims to cash in on the Russian consumer boom through holdings such as Wimm-Bill-Dann, featured below.

Other Russia-oriented funds spread their investments over all of the countries of the former Eastern Bloc, and usually throw in Turkey and Israel as well.

Jupiter’s fund is called Emerging European Opportunities (jupiteronline.co.uk). Managed by Elena Shaftan, it is currently 65% invested in Russia. The rest of the cash is split chiefly between Poland, Turkey, Croatia and the Czech Republic. It is bigger than the Neptune fund, with £720m under management, and has also enjoyed huge returns, although not quite on the scale of Neptune. It is up 22% over the past year and 152% over the last three years.

Credit Suisse European Frontiers, managed by Elizabeth Eaton, has 60% of its cash invested in Russia, and has chalked up similar returns to the Jupiter fund. Invesco has an Emerging Europe fund that was launched less than a year ago, while the Allianz fund, called BRIC All Stars, spreads its investments across Brazil, Russia, India and China. Do not ignore the specialist investment trusts in the region. JP Morgan Russian Securities has notched up an impressive 349% gain over the past three years.

The minimum investment in most of the funds is £1,000 as a lump sum or £50 a month into a regular savings plan. Avoid paying an initial charge of 5-6% by buying through a discount broker. Try h-l.co.uk or chelseafs.co.uk. Or go to a fund supermarket such as Fundsnetwork.co.uk (run by Fidelity) which will discount most funds to just 0-1.25% initial charge.

Golden days

The critics say Russia’s economic boom is down to one thing alone – the surge in oil prices. The country produces nearly as much oil as Saudi Arabia and has huge untapped reserves. But Russia is not just rich in oil – it also sits atop extraordinary reserves of other minerals.

It has a commanding position in many metals markets, such as nickel, platinum and palladium, and produces nearly a quarter of the world’s uranium. It is also about to catch up with South Africa in the league of world gold producers.

Polyus Gold is a name few western investors will be familiar with. Yet it is already the world’s fourth-largest gold producer and is hoping a pounds 1.2bn open-cast development of a huge new find in eastern Siberia will triple output and propel it to the top of the global rankings by 2015.

The company’s share price has gone from 981 to 1,545 roubles over the past year as the gold price jumped from $650 (pounds 328) to more than $1,000 an ounce, although in recent weeks it has traded lower. Unlike other producers, Polyus did not “hedge” its gold sales and has benefited directly from the price rise.

It is one of the largest holdings in Neptune’s Russia fund, and was spun out of Norilsk Nickel. Norilsk was a former slave labour camp, and once part of Stalin’s gulag. Like so many of today’s mammoth Russian companies, it was sold in the 1990s for a song by President Yeltsin to politically connected bankers.

Whether Polyus will continue to shine for investors is a matter of debate. Labour costs in Russia are soaring by 20% a year; the closest town to the new mine is 200km away; the gold is contained in low-grade ore; and power stations will have to be built. It is likely to make a profit only if the gold price stays above $600. And its billionaire oligarch controllers have fallen out. But if it does produce on time and on budget, this share could be, well, something of a gold mine.

Agriculture gets the juices flowing

It’s a country better-known for vodka and borscht than healthy living. Yet one of the fastest-growing companies on the Moscow stock exchange is Russia’s answer to Tropicana – juice producer Wimm-Bill-Dann.

Over the past year its share price has doubled, with sales of its J7 juices, milk, yoghurt and baby food products soaring. Investors reckon it will one day challenge global groups such as Danone and Nestle.

Some Russian companies have a murky past, controlled by gangster oligarchs who built giant enterprises based on the theft of former state assets. But Wimm-Bill-Dann is different: it was a start-up company that experts hail as a model of new Russian entrepreneurialism. If the name sounds like Wimbledon, that’s not a coincidence. Its founders reckoned that Russia’s emerging middle-class consumers would trust a western-sounding brand. Oddly, most Russians think it’s an American company.

Food quality is a serious issue in Russia. It is a vast country with crumbling post-Soviet infrastructure and appalling bureaucratic procedures. Getting food to stores on time while meeting quality standards is a major challenge, and perhaps explains why few western supermarket groups have entered the country. (Tesco considered it and walked away.)

Wimm-Bill-Dann acknowledges concerns over quality. In total, it has one-third of the milk and dairy products market in Russia, but says that “the quality of bulk milk in Russia is poor”. It prefers to source its milk from Canadian and US agribusiness groups which have begun buying up Russian dairy farms. It has also set up its own state-of-the-art dairy farm outside St Petersburg.

Agriculture and food production is likely to be one of Russia’s boom industries in the coming years. The vast collectivised farms of the Soviet era have barely modernised over the past decade. Some estimate that Russia has an untouched area of top-grade farmland equal to the entire ploughed acreage of Canada. With food prices on a secular upward trend, and with China and India on its doorstep, Russia could become Asia’s grain basket.

But unlocking Russia’s agricultural potential will be an enormous challenge. The country’s population is declining, and young adults are deserting the countryside. Road, rail and food distribution systems are decrepit. But that, according to Neptune’s Robin Geffen, presents an enormous opportunity. He has invested in domestic fertiliser producers, and companies engaged in upgrading Russia’s creaking rail network. “Agriculture is possibly the most underplayed reason why it’s a good time to buy Russia,” he says.

http://www.guardian.co.uk/money/2008/may/24/moneyinvestments.investmentfunds