From Russia, With Malice

Global investment can be a risky venture on a number of fronts. In addition to the typical market risk equity investors face anywhere in the world, the emerging markets can pose some unique political risks as well. Given that concern, I’m often asked if there are any countries I would avoid outright.

I consider myself an opportunistic investor and I’m generally willing to venture into any market where the risk-reward trade-off seems to be stacked in my favor. With enough due diligence I can get comfortable just about anywhere in the world—with the exception of Russia.

Russia is widely acknowledged as one of the most corrupt nations on earth, ranking 133th out of 174 in Transparency International’s Corruption Perception Index last year. The higher the rank, the worse the problem and corruption rackets in Russia are estimated to be a USD250 billion industry. By comparison, the US ranked 19th and Finland, Denmark and New Zealand were tied for least corrupt nation in the world.

A developing scandal in Russia that began this past Wednesday is an excellent example of this state of affairs.

Russia has developed a reputation in the technology sector, but it isn’t one that it likes to have spread around. For years, it has been claimed that Russian security services have engaged in or sponsored cyber attacks on Georgia, Estonia, South Ossetia and NATO. US intelligence services also believe that Russians have engaged in widespread high-tech espionage, systematically stealing data on sensitive economic issues and technology.

Russia has never confirmed responsibility for any of the attacks attributed to it, but usually doesn’t deny it either. That’s not terribly unusual when it comes to geopolitics; Israel has never openly admitted to possessing nuclear capability, but the rest of the world operates on the assumption that it does. It’s simply good strategy to keep potential enemies guessing.

But while Russia won’t admit to what seems to be its likely involvement in cyber warfare and espionage, its government did want put a legitimate face on its technology industry.
In 2009, then President Dmitry Medvedev—a protégé of Vladimir Putin who was then serving as prime minister after his own term as president and is who is now president again—proposed the creation of Skolkovo, the Russian equivalent of Silicon Valley.

The USD4 billion program, which involved partnerships with Western firms such as Microsoft (NSDQ: MSFT) and Google (NSDQ: GOOG), would create a technical university similar to our own Massachusetts Institute of Technology to train the next generation of technology entrepreneurs and an incubator area for high-tech startups.

Unfortunately for the Skolkovo program, Mr. Medvedev has made some enemies over the course of his career and in Russia the game of politics is played for keeps.

When politicians here in the US make enemies, it’s not unusual for damaging information to suddenly materialize in the press and high profile Congressional hearings to ensue. Reputations can be ruined and careers ended, but all of the parties involved ultimately walk away while suffering no real consequences.

In Russia, though, political score settling often involves criminal inquires by federal authorities, investigations by national intelligence services and lengthy prison sentences.

Skolkovo seems to be caught up in just such a web of investigations, as allegations have surfaced that more than RBL1 billion in funds earmarked for the project were misused and about RBL25 million was embezzled. So far, the charges have resulted in criminal investigations of two of the projects highest-ranking financial executives and there are whispers that the chairman of Skolkovo, Viktor Vekselberg, might soon have to answer some questions himself.

Mr. Vekselberg has been heavily involved in Russia’s natural resources sector for nearly 20 years. He owns the main controlling interest in Russia’s Renova Group, a conglomerate that’s active in Russia’s energy patch, aluminum production and a variety of other businesses. He was also instrumental in bringing together Russia’s TNK and BP (NYSE: BP) in a 50-50 joint venture that was the largest private business transaction in Russian history.

At this point, he is estimated to be the richest man in Russia and is often named as one of the country’s last oligarchs.

I’m not asserting that the Russian government is making an asset grab. However, given its history particularly with regards to Mikhail Khodorkovsky and Yukos, it’s not out of the question. And Mr. Vekselberg isn’t a stranger to scandal; he’s been dogged by allegations of shady land deals, banks driven into bankruptcy and fleecing the government in property transactions over the years. If anyone has enemies, he does.

This is a dangerous time for Skolkovo, as well as an interesting development for Mr. Medvedev. The pet projects of Russian political heavyweights are typically sacrosanct and Mr. Medvedev has been closely associated with Vladimir Putin who is THE political force to be reckoned with in Russia. The fact that Skolkovo is being targeted for investigations is an indication that the political winds are probably shifting on the Russian steppe.

Skolkovo has the potential to begin the process of dramatically reshaping the Russian economy, helping it to transition away from its dependence on natural resources. The fact that such a program can be attacked for what essentially amounts to political reasons is what makes Russia a daunting area for investing.

Those shifting winds are precisely why I often have third and even fourth thoughts when it comes to Russia.

1 Comment So Far

1. 

   Reply MICHAEL .C February 16, 2013 at 11:20 AM EDT

   FINANCIAL TERRORISM,GREED,CORRUPTION AND THE END OF TIMES.READ THE BOOK THE ARROGANCE OF EVIL,AND COME BACK AND COMMENT.