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Investing in Russia: Great Opportunities, But Tread Carefully

By Jim Fink on June 23, 2011

The Russian growth story lacks some of the glamour of China and India. But Russia is a good proxy for global economic growth because its market is overweight energy.

— Yiannis Mostrous, Global Investment Strategist

On October 1st, 1939 — at the very beginning of World War II — British Prime Minister Winston Churchill was asked why he thought the Soviet Union had agreed in August to join forces with Nazi Germany in a non-aggression pact. Stalin’s decision was curious given that Hitler hated communism and had often called Slavs “untermenschen” (i.e., subhuman) that would eventually be conquered by Germany. Churchill scratched his head and replied:

I cannot forecast to you the action of Russia. It is a riddle wrapped in a mystery inside an enigma: but perhaps there is a key. That key is Russian national interest.

The Soviet Union and communism are long gone, but the enigma that is the Russian psyche remains. For investors looking at Russia, the often-asked question is whether it is safe to invest there – i.e., are private property rights respected? Fear that the answer is “no” led investors to pull out $38 billion from Russia last year, after pulling out $57 billion in 2009 and $134 billion in 2008.

Russia Has a Risky and Unpredictable Investment Climate

The reasons for investor fear go back . . . forever, but recent events include the 1998 government debt default and the 2003-06 dismantling of Yukos, a private Russian oil company that had its CEO imprisoned and its assets confiscated on phony charges of tax evasion. Russian President Vladimir Putin had singled out Yukos for destruction because Yukos CEO Mikhail Khodorkovsky had challenged Putin’s United Russia political party by peacefully funding opposition political parties and newspapers. As I wrote last September in Russian Oil Company Lukoil is Cheap for a Reason, private businessmen in Russia are terrified of Putin and will consequently never contest confiscatory tax rates and will quickly dismiss any profit-maximizing project if there is any chance that it would offend Putin. Not a good business climate, to say the least.

Recent events have caused continued concern. Just yesterday (June 22nd), the Russian “Justice” Ministry refused to certify a new opposition political party – The People’s Freedom Party (PARNAS) – for inclusion in upcoming parliamentary and presidential elections. According to the co-chairman of PARNAS:

It is clear that Putin has decided not to admit out party to the elections. PARNAS’s participation in the elections would have involved serious risks for Putin’s vertical power structure. There is no point in appealing the decision. It is impossible to try to work with this regime within the bounds of the law.

This follows the monkey trial late last year where Mikhail Khodorkovsky was convicted yet again, keeping him behind bars for at least another six years, and the disturbing news in November 2009 that a lawyer defending a U.S. investment firm doing  business in Russia was allowed to die in a Russian prison without medical treatment. The impending death of his lawyer led Hermitage Capital Management fund manager Bill Browder to say that anyone investing in Russia long term “is out of their mind.” Similarly, a U.S. venture capitalist wrote in June 2010 that anyone thinking of investing in Russia needs to “hire bodyguards and hunker down.”

Among the foreign companies that have recently left Russia because of corruption and political issues include French retailer Carrefour, the South African diamond company De Beers, and British oil giant BP (NYSE: BP).

Russia’s Investment Climate May Be on the Verge of Improving

Despite these significant problems, there is hope for foreign investors.  Pepsico (NYSE: PEP) is expanding in Russia, having recently acquired the country’s largest food company, Wimm-Bill-Dann. Other foreign companies staying put are Coca-Cola (NYSE: KO), France’s Danone (Other OTC: DANOY.PK), and General Electric (NYSE: GE).

This past December, at the same time that he was putting Mikhail Khodorkovsky back into jail, Prime Minister Vladimir Putin tried to reassure foreign investors that Russia was open for business by proposing to ease foreign investor restrictions that had been put into place by Putin himself two years earlier in 2008.

Russian president Dmitry Medvedev has also made welcoming gestures to foreign investors, first at the World Economic Forum in Davos, Switzerland this past January and then again just this past week (June 19th) at the St. Petersburg International Economic Forum. One of Medvedev’s ideas is to establish a $10 billion private equity fund that would invest side-by-side with foreign investors, thus giving these investors some comfort that their investment will be protected with “big brother” on their side.

One U.S. believer is Goldman Sachs’ Jim O’Neill – the man who invented the world BRIC. O’Neill says recommends investing in Russia, arguing that concerns about Russia are “overblown.” But some doubt that Medvedev has any real power, so what he has to say about market liberalization is discounted by many. Is Putin going to run for President in 2012? Until that question is answered — hopefully in the negative — many investors may stay on the Russian sidelines.

Find the Best Russian Stocks with the Help of Global Investment Strategist

Yiannis Mostrous scours the globe for the foreign stocks with the highest return potential. They could be in Europe, the Far East, Latin America, or Africa.

Right now, Yiannis recommends several Russian stocks in his long-term growth portfolio. One Russian stock in particular is an exclusive member of his “Top 5 Stocks to Buy Now” list. He recently told Global Investment Strategist subscribers that he is cautiously optimistic about Russia because:

The country is seeing encouraging signs of growing domestic demand and while the Russian consumer has yet to take the world by storm, the economy is on the right track.

To find out the names of his favorite Russian plays — along with all the foreign markets and individual foreign stocks Yiannis likes best right now — give Global Investment Strategist a try today!

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