Russia Behind the Headlines

The stereotypical picture often obscures the truth

Originally published in the December 2014 | January 2015 issue

“There is not much correlation between FT headlines and returns you get on the ground in Russia.” Russia is a very large market, with a populationof over 143 million people. It is the ninth largest consumer market in the world, and by 2020 it will be first in Europe and the fourth largest in the world. On the investment side, performance of Central and Eastern Europe (CEE) and Russia funds has beaten other emerging markets, developed markets and the S&P 500, according to statistics from EMPEA and Cambridge Associates.

However, given the recent developments, Russia is definitely not the first choice for conservative global investors today. Increased uncertainty and political risk make Russian markets unattractive, but on the flip side those factors bring opportunities for hedge fund managers who are able to take advantage of volatility, and long-term investors. The country is in a contradictory environment where people who were invested in Russia for years are getting out, and some new investors are trying to put fresh capital to work following the classic mantra of buying when there is blood on the streets, looking for liquid and high-yield assets. Russia has become rather heavily undervalued – as it has been for years – but now “it’s really screaming”. But, the future returns and future of the financial markets as a whole depend very much on politics. Still, this doesn’t keep large pools of assets, some of them family offices with a couple of hundred million dollars from around the globe, including America and Asia, taking on a contrarian view and going bottom fishing in Russia. Capital is very scarce, so they face much less competition and many choices.

Russia and alternative investments: unlocking domestic capital
The current regulation does not allow local institutions such as insurance companies or pension funds to invest directly in hedge funds or alternative investments, including private equity. The main audience for hedge funds in Russia is qualified high-net-worth individuals and family offices. And it looks like these investors’ perceptions about alternative investments are changing.

The days when long-only was the winning strategy in the Russian market are over. Historically, Russian investors associated actively managed strategies with enormous returns and excessive risk. Today the most sophisticated investors and their advisors consider alternative investments a source of diversification and portfolio risk reduction. They are also becoming more realistic about returns.

85% or 90% of private banking assets in the US, for example, are invested into some form of liquid securities, while that percentage in Russia is maybe 5% or 10% maximum. The growth potential is staggering.

The Opalesque 2014 Russia Roundtable took place on 22 September in Moscow with:

  • Stephen Lewis, Director of European Business Development, Maples Fund Services
  • Alexei Klaptsov, Director, SPRING Group
  • Christian Putz, Portfolio Manager, Kazimir Partners
  • Dmitry Malykhin, Chief Investment Adviser, Da Vinci CIS Opportunities Fund
  • Dmitry Schuetzle, Managing Director, VIY Management
  • Gregory Klumov, Portfolio Manager, SBD Global
  • Nadya Nesterova, Head of Investor Relations, VIY Management, Co-Head of Information Policy & Market Statistics committee, National Alternative Investment Management Association (NAIMA)
  • Olga Kokareva, Advisory Board Member, Moscow Hedge Fund Managers Club

The group also discussed:

  • What are some of the recommended ways to invest in Russia?
  • How has corporate governance developed since 2008?
  • What new products are Russia-based managers working on?
  • Opportunities in Russian CDS, fixed income, and currency: rouble one of the most attractive carry currencies

Matthias Knab


Matthias Knab: What is the situation you are currently facing as Russia-based alternative investment managers or investors? Also, can you share with us what your own clients, so the end investors, are doing?

Gregory Klumov: Unfortunately, the local investors are very pessimistic about us, the alternative investment providers. The reason is that 90% of the industry has had negative track records for the last couple years, primarily because most of the funds were focused on the local stock market. The result is that the most popular “alternatives” products here are dollar-denominated capital protected notes, issued by state-owned banks and real estate, sometimes levered.

A new demand trend that has picked up recently lies in a traditional asset: fixed income. The whole asset class experienced a sell-off after the political events we witnessed, so a lot of private banks are pushing clients to replace CDs with Eurobonds issued by the same institution, because the yield on the latter is higher, plus they are liquid.

While for the more risky assets, investors prefer structured notes, where principal loss is limited to 0-10% (zero coupon bonds, for example) with the cash flow stream invested into call options on assets like US stock indices, gold or some ETFs.

If we zoom out the most recent trends of the last few years, we’ll see that local investors are actually just waking up to the alternatives asset class. I can think of several reasons to explain the gap. First, the private equity business was generating healthy double-digit returns for the last 10-15 years and most of the capital owners were reinvesting their profits.

Second, there is a big gap in financial education across the country, as everybody was going through, literally, battlefield experience learning finance and capital markets here in Russia. And last but not the least, the legal framework and infrastructure were not ready to securitize assets and protect investors in the way it is happening in some other emerging markets, saying nothing about the developed ones. If you look at the US, for example, 85% or 90% of private banking assets are invested into some form of securities, while this percentage in Russia is maybe 5% or 10% at maximum. So while we definitely have very low base to grow from, there are still a lot of obstacles for the industry to take off.

Dmitry Schuetzle: The last six months in Russia have been turbulent – however, not so much from an economic perspective but rather from a political perspective. For private equity, for example, the past six months have not had much of an impact. It’s not enough time to feel impact, given that we pursue long-term strategies and the investment process alone can take several months to execute. So for us, the market fundamentals don’t look bad at all, which is why we continue active deal sourcing and are pleased that we have enough funds to continue investing for the next couple of years. So now is a time of great opportunity for us, not least because we don’t seem to have so many competitors these days.

Olga Kokareva: From the hedge funds perspective, the investors’ landscape in Russia is slightly different than that for private equity. The current regulation does not allow local institutions such as insurance companies or pension funds to invest directly in hedge funds. The main audience for hedge funds here are qualified high-net-worth individuals and family offices. And it looks like these investors’ perceptions about alternative investments are changing.

The days when long-only was the winning strategy in the Russian market are over. Recent political and economic developments made Russian investors rethink the concept of risk. Even fixed-income instruments or government-related bank deposits are not considered completely safe investments anymore. Now, more investors are actually starting to ask themselves, “What happens if?”

Historically, Russian investors associated actively managed strategies with enormous returns and excessive risk. Today the most sophisticated investors and their advisors consider alternative investments a source of diversification and portfolio risk reduction. They are also becoming more realistic about returns.

Of course, those investors are still very few in total, and therefore the demand is far from optimal. But we see increasing interest in education, investors want to know more about opportunities in alternative investment space.

That said, Russian private investors tend to invest in what they can understand and trust. They realize that apart from market risk with alternative investments they should also care about operational, liquidity and strategy complexity risks.

Stephen Lewis: I just want to add an optimistic note because we have a more global view in terms of our investors and external investors’ perceptions on this particular market. Earlier in the year, non-Russian investors took the view that the market was going to be tough when the Crimean issues arose. We have seen a fall in the AUM of several funds, but the market has recovered and is nearly at the level it was prior to the market downturn. The redemptions and recovery were primarily in funds with external investors.

We have also seen an increase in the number of new Russian funds, asset classes and structures. This growth has been fuelled by Russian investors looking to diversify their portfolio and spread their risk. We administer a variety of Cayman structures and have seen a great deal of interest in Irish structures. The asset classes range from the traditional global equity and fixed income, through real assets, private equity and real estate, to various hedge fund strategies.

Matthias Knab: Let’s add more colour and details regarding the respective environments of your individual strategies. For example, Dmitry can you share with us what you see in the CIS region?

Dmitry Malykhin: As you said, our fund has in it CIS abbreviation, but the CIS markets other than Russia are really, really pretty small. Luckily, we didn’t invest in Ukraine much. That’s good. I think that what we saw this year happening in Russia, we can add CIS to that story, also because Russia has a quite lot influence over CIS, as you may guess. So we have seen that the future returns and future of the financial markets as a whole depend very much on politics. While this may sound like very banal, nevertheless it’s really true and what we experience.

Just after Crimea, just about one month after that in April or May when we saw some steps of Mr Putin towards the West, a lot of people had also just started to look for Russian assets. They were asking whether it’s a good time to invest or not, because Russia is now rather heavily undervalued – as it has been for years – but now it’s really screaming. Just about two months after that, after the final round or the Western sanctions and after the very recent “Sistema” affair, which is still developing, I think this is just another sign how much the markets depend on politics. So probably we and the investors have to just be prepared for what may come next, and that is difficult to estimate. If the situation turns, if we see some indications for that, we will have a great time to invest.

Now, I looked at the transcript of the Opalesque Russia Roundtable from 2008, and there were a lot of bulls there and I remember myself being one in November 2008. Our timing and our positions were right then, but for now, I am not sure – we may have this situation for years. Maybe now it will turn around quickly, but we should be prepared for both scenarios.

Gregory Klumov: We also see that some investors are trying to bottom fish in Russia. Over the last few years, I have been doing some extensive traveling, attending a number of hedge fund conferences looking for managers to invest into. I met a significant number of foreign family offices that approached me as a Russian individual asking for an efficient way to buy some Russian exposure. We were even thinking about creating an offshore product with local Russian treasury debt before it started clearing like corporate Eurobonds.

Those were fairly large pools of assets, family offices with a couple of hundred million dollars from around the globe including America and Asia. Obviously, they have never invested in Russia, and now they feel valuations are attractive and want to put a couple of million dollars to work – maybe just 1% or 2% of their assets – in Russia. But as I said, that inflow is being negated by the outflow of people who were invested here for number of years. In some cases those investors have been exposed to Russia since the beginning of early 1990s. They were adding to their exposure in 2008, but then over the last couple of years they were bleeding out either in part of in whole, just because they couldn’t bear mark to market losses any more. If you talk to them, they will tell you they are fed up with the Russian government, inefficient legal system or the Russian corruption.

So in general we have a sort of contradictory environment where people who were invested in Russia for years are getting out and some new investors are trying to put fresh capital to work following the classic mantra of buying when there is blood on the streets and looking for liquid and high-yield assets here.

Again, I am kind of watching this from the outside, as for our own fund we follow a completely different strategy as we strive to basically diversify our shareholder out of Russia by investing in hedge funds, private and public equity companies in the US and Europe. However, we also have a separate team that manages our Russian exposure. They invest in second and third-tier companies for the dividend streams.

Matthias Knab: What do you recommend those family offices that are looking at Russia now?

Gregory Klumov: Russian treasury debt. It yields almost 10% now, in roubles, is very liquid and undervalued versus other emerging markets debt. Most of those family offices are pretty conservative. They wouldn’t dig for some third-tier companies to put themselves at risk to deal with the company management, possibly facing corporate governance issues like Pharmstandard – Google it if you have not heard about it – where the shareholder extorted some assets out of the company, and minorities couldn’t do a thing about it.

One famous hedge fund manager said that in emerging markets you have to invest in debt because this is something that’s well-regarded and is usually paid off. With EM equity, particularly Russian SOEs, investors don’t own the income statement but the balance sheet. The income statement is owned by government officials and oligarchs, who control the entity, while minorities just own the balance sheet and end up with restructured debt, at most, when s*** hits the fan.

Olga Kokareva: Russia is definitely not the first choice for conservative global investors today. Increased uncertainty and political risk make Russian market unattractive, but on the flip side those factors bring opportunities for hedge fund managers who are able to take advantage of volatility. There are less risk-averse and more opportunistic investors out there and they might be willing to consider getting in the emerging market play beyond investment-grade debt.

My advice to those investors would be to really focus on manager sourcing. Careful manager selection becomes much more important in today’s environment than it was back in the mid-2000s.

The key is to find the manager who knows the local market, who is in a position to ensure downside protection and get out of risky exposure as quickly and efficiently as possible if something goes wrong. And also it’s critical to explicitly understand how exactly the strategy works and more importantly in what circumstances it stops working.

Christian Putz: It is difficult to account for political uncertainties in a fundamental bottom-up investment approach. As a consequence, our firm, along with other Russian asset managers, decided to go global and offer products with a broader geographic focus than just Russia or CIS. This strategic change has been reinforced by the fact that global investors have subdued interest in Russia and local investors want to diversify away from Russia. And a global mandate allows me as a portfolio manager to find really great businesses which meet my investment criteria for the long book.

Coming back to the Russian stock market, it is hard to be bullish even if you disregard political uncertainties. Commodities play the crucial role, with approximately 60% of the Russian equity market being represented by oil and gas companies. In simple terms the underlying drivers for oil and gas companies are the oil price, production growth and the lifting costs. All of them do not look great. If you take a one or two-year view, the risk/return characteristics for the Russian oil and gas sector are unattractive. The oil price will probably stay at the current levels or maybe decrease given the shale oil boom and low global economic growth. Production growth is almost non-existent and can even turn negative due to the recent sanctions. In short, there is no significant growth driver, while the production and lifting costs are increasing. The weak rouble is only partly offsetting those increasing costs. Hence the low valuations reflect unattractive fundamentals and not really buying opportunities.

Before the financial crisis in 2008 the fundamentals were quite different, with the oil price increasing from $30 to almost $150 and annual production growth reaching 10-20%, Russia offered significant growth.

Alexey Klaptsov: Right, if Russia is considered as a big oil company, yes, it is probably not the place to be in. But luckily, Russia has also other sectors which are not so connected to oil. The problem with Russia is that Russian GDP has been decelerating for the last three years. In my view, consumption is really the place to look at. That is also why investors try to invest in retail, in real estate, or in medical or health-related businesses that are all private as of now.

But we have come to the point where internal consumption cannot support GDP growth any more, just because real income does not grow. The only thing which can boost GDP up is investment, and the big obstacle for that is cost of capital. In Russia, cost of capital is very, very high; it’s more than 10%. Now, it is very difficult to find good projects which could be profitable if you have to borrow at 10%. It is impossible if you have to pay 15%. It means that Russia will not be successful if companies can only operate at this relatively high cost of capital. But if an investor is able to raise capital at relatively low levels, investments in Russia will work. So probably going forward, in Russia we will only see those investors who have an opportunity to secure capital, and all others will leave.

That’s what we see. I don’t know who raised the capital in publicly traded companies this year – I think only a few firms, Russia-dedicated firms or funds. Probably many other companies have lost investors this year because of low GDP growth and the political tensions. But having said that, the best time to invest in Russia is when everybody is bearish. You should be quite brave to be in Russia.

Matthias Knab: Specifically, what do you recommend?

Alexey Klaptsov: We recommend investing in specific companies; we are not saying simply that someone should “go to Russia or to China”. Effectively, you should invest in a specific person. A well-known example is Magnit, the Russian retailer set up by Sergey Galitsky.

Christian Putz: It is hard to sell the Russian equity market as a long-term investment case. No one will probably buy into an investment pitch which says, “You should invest in Russia because in 10 years there will be a great diversified economy, there will be safe regulation and your return on investment will be outstanding.”

But I also think that there are different investment strategies, and in some cases the investment strategy of a Russia-focused manager has a very low correlation with the performance of the Russian equity market. For example, I am quite convinced that you can run certain trading and quant strategies in Russia and generate significant returns for your investors despite the Russian market being in a downward trend since March 2011.

Dmitry Schuetzle: I think we shouldn’t write off Russia completely. It is a very large market, with a population of over 143 million people. Russia is the ninth largest consumer market in the world, and by 2020 it will be first in Europe and the fourth largest in the world. I don’t think investors can ignore those facts.

Alexey Klaptsov: Russia is still undeveloped. You can find lots of sectors where Russia is extremely inefficient and where investors can make money on this inefficiency. The problem is, as we pointed out, the cost of capital. As long as cost of capital is that high, it’s very difficult to find projects that work at those levels. Any increase by 1% decreases the number of eligible projects significantly.

Dmitry Schuetzle: You are right that in a market that is underdeveloped such as Russia, there is opportunity. In terms of capital, our experience is that if you look outside of Russia into the global economy, you see that there is still plenty of money looking for such opportunities. Eventually, the current troubles will come to an end and more of this money will find its way into Russia.

Matthias Knab: What is the level of education within that investor base? Is there an understanding about alternative investments strategies and asset classes? Where do you need to start this education?

Olga Kokareva: This is a great question because, in fact, the lack of education and awareness is the main problem about internal demand for alternative investments in Russia. Even professional wealth advisors and institutional allocators’ staff oftentimes do not possess sufficient knowledge in the area of alternative investments to efficiently assist their clients in adding alternative exposure to the portfolio. At the same time there are quite a few alternative investment teams in Moscow with focused expertise, globally recognized certifications, years of practical experience and global community exposure. And those are the best people to ask about alternatives.
So earlier this year NAIMA and the Moscow Hedge Fund Manager Club have decided to join forces to create the industry initiative for raising awareness on alternatives among the Russian financial community. This summer we have organized an event in collaboration with CAIA Association where we announced our plans to launch the first educational programme in Moscow focusing entirely on alternative investments. The programme may serve as CAIA exam preparation for Moscow-based candidates, but its ultimate purpose will be to help financial professionals dive deeper in alternative investments to enhance their asset allocation skills.

Another project our associations are working on is the regular educational and networking events where alternative investment professionals get the opportunity to listen to guest speakers’ presentations, discuss particular alternative strategies, learn new concepts, ask questions, argue and share ideas.

The more investors and advisors know about alternative investments, the more competitive the industry will become. It may sound counterintuitive but that is in the interests of market participants because alternative investments is a global industry, and there should not be an “emerging market naivety discount”. Investors have to demand global-quality services and transparency, and the local industry should only consist of talented managers who are able to compete on a global level.

Gregory Klumov: Large macro funds all have sizeable books of credit derivatives in Russia. Companies like Brevan Howard, Bridgewater, etc., all trade Russian credit-default swaps, Russian fixed income, and Russian currency. As a matter of fact, rouble is one of the most attractive carry currencies adjusted by volatility and size of the market.

Also, you can do arbitrage by buying government-issued Eurobond and sovereign CDS. This spread is around 150 basis points right now. One reason for that is that the local investors underestimate and don’t understand the opportunities available in the derivatives and the global macro space, while foreign investors are not hedging their books enough. Another reason is possibly that it is hard to open a true prime brokerage account with a big global institution. You would need a very good track record of personnel and shareholders to establish this relationship in order to get access to cheap funding.

But once you have all that, you can get funding at maybe LIBOR plus 40, 50 basis points and then you could trade these Russia-exposed derivatives, the stuff that Russian people inside the country cannot do. As for the education, there are still big gaps as you mentioned in terms of understanding how financial markets work, even basics like what is equity, what is fixed income, what are credit derivative and things like that, but we are seeing some progress. I have another example of Russian education gap in alternatives. While I worked at Everest, I was raising money for a hedge fund that was trading global equities with a simple, fundamental value approach: define couple big trends, identify a basket of exposed global equities, analyse them to death and put capital to work. But people were not ready at all for global investing. They didn’t understand the point why to buy, say American, Philippine or Indonesian equities, because local politicians announced on state TV that Gazprom will have market cap of $1 trillion, so everybody was obsessed with that.

But now, having lost decent chunks of capital, people are looking at different asset classes, besides local equity markets. They are learning their way through some press, journals and magazines. As a matter of fact, some private banks are expanding their product offerings in alternatives asset class to start educating clients how regular high-net-worth individuals can diversify their portfolios out of Russian risk or at least add some uncorrelated performance components to it.

So, things are slowly progressing, and maybe it will take 10 to 20 years, and hopefully with the help of our government, it will be shorter. As a consequence of the current tensions and sanctions, there is also a certain rush of Russian capital flowing back to the domestic market which was previously managed offshore. I think it’s safe to assume that a part of this capital is looking for attractive investment opportunities.

Matthias Knab: Along with transparency, corporate governance is always important and a hot topic when it comes to emerging or underdeveloped markets. How did you see corporate governance developing since say our last Russia Roundtable in 2008?

Christian Putz: Well, I moved to Moscow in 2009, so I cannot really compare with the pre-financial crisis period. But having the recent corporate governance incidents in mind, it is hard to talk about improving standards. Minority investors suffered severe losses.

Everyone associates Russia with corruption, but the reality is that there are many other emerging markets which have the same or even worse levels of corruption and corporate governance. Obviously this does not mean that one should not fight corruption in Russia or that corruption is not an issue in Russia. However, corruption is not just a Russia-specific phenomenon but reality for countries which are at a certain development phase. As an investor in Russia, Brazil, China etc. you have to accept this reality and only invest if the expected returns are attractive enough taking low corporate governance standards into account.

Nadya Nesterova: If you look at the figures, Russia’s business climate has made notable strides over the past year, climbing up 19 positions in the World Bank’s Doing Business 2014 ranking. Russia keeps now the first place among BRIC countries; it is four places above China in the global list.

So it shows that considerable progress has been made. Of course one can’t overlook the impact of the current political situation, and no doubt this has an effect on the perceived business climate. But if you get beyond the current politics, headlines and noise, you see that the underlying analysis and figures are positive, and significantly improved from where they have been previously.

Stephen Lewis: To attract foreign investment it is going to be necessary to accept the required levels of corporate governance. As other markets have matured, they have educated the managers and investors to the point where the use of a board of directors with the necessary independence has become the norm. Our clients here in Russia have certainly accepted that point, putting the necessary boards in place with the appropriate documentation.

Dmitry Schuetzle: From our point of view we see a huge improvement in the corporate governance culture in Russia, because right now we can at least say that every entrepreneur we meet to talk on a potential deal has heard about the institute of a board of directors, and so on. Five years ago that would not have been the case. Now it’s not a problem and every one of our shareholder agreements includes policies on BoDs and corporate governance more broadly. Today, all of our investee companies have properly functioning boards of directors.

Matthias Knab: Is this done via shareholder agreements or different share classes?

Nadya Nesterova: Shareholder agreements.

Matthias Knab: I wonder why? What is the benefit versus having different share classes? In the US, for example, it is more common to use different share classes to segregate different rights and aspects.

Dmitry Schuetzle: From our point of view, shareholder agreements are more common and easier. You are right with your observation regarding the US, because there they often do different capital raising rounds, but typically it’s much simpler in our deals where there is basically one main founder, the entrepreneur, and VIYM representing financial investors.

Alexey Klaptsov: Coming back to corporate governance, I would think that corporate governance in Russia actually became better, much better than it used to be in 2009 or 2010. Let me give you two examples. The TNK-BP case actually questions corporate governance in British Petroleum, because you know that Rosneft was not obligated to buy out, but it would be obligated if TNK-BP did not vote for loans given to Rosneft, and Rosneft would have to vote for these loans. So it’s more a question to BP rather than to Rosneft in this particular case. In my view, the real question here is if British companies have good corporate governance?

If you look at Protek as a second example, I think this is a totally different story, because Protek and Russian Sea, these two companies actually misled investors, and that was why they declined significantly. I believe that happened in 2010. Last year we had an absolutely different situation with Tinkoff when the main shareholder provided full information and he did not mislead investors, but investors made up a story and they invested in the company, which was different than it is.

Christian Putz: I agree that TCS is a different story, but I would not say that that investors made up a story. The story was heavily pushed by the sell side and some of the brokerage firms might have had a certain conflict of interest given that they had private equity investments in TCS.

Alexey Klaptsov: Right, but still, while the situation is not pleasant, it’s much better than in 2010. And also, what I would like to mention is that the current market is different than it used to be, because Russia has had a problem with capital during last three or four years. As a result, now it’s clear that we have different types of companies in Russia: some which are traded at very high valuations and others which nobody wants to buy.

That situation has been forcing the majority shareholders to the conclusion: if they would like to see a high valuation, they have to be more pleasant to minority shareholders. Almost all companies started paying dividends, whereas five years ago, before the crisis, Russian companies tended not to pay dividends. Now, even companies in a high-growth mode like Magnit are paying some dividends, because they understand that investors would like to see dividends. They would like to see a simple story, transparency, a good cash flow, and with that a good performance, which is a big step forward compared to where things were a few years ago.

Christian Putz: As a general remark I would like to say that most investors probably have bad feelings with respect to Russian corporate governance, given that they have a long-only mandate and might have incurred significant losses. On the other side, for a long/short fund manager, bad corporate governance can offer great opportunities on the short side. Is there a better short than a badly managed company, with management stealing assets, especially in this environment where the economy is slowing and companies with high debt levels have issues refinancing their debt?

Dmitry Malykhin: I am not that sure that corporate governance has improved much since 2008. In my opinion, it hasn’t. Second, when it comes to companies starting to pay dividends, you could also argue that maybe the majority owners of these companies are afraid and now try go get some money out of the company and replace that with say debt finance, if they can. So, I think we have to look at this phenomenon case by case, and I am not sure that the big dividends, which in fact got bigger for some of the private companies, can generally be seen as a sign of significantly better corporate governance. Third, I would like to look at the bigger picture, and the bigger picture or the deeper question is why should corporate governance should get better at all?

Before the very recent events, we would have said “because we want more people to invest and do well in the markets”, but let me also point her to the famous huge poster on the wall of a house somewhere in the centre of Moscow that said “there are things more important than the stock market” – you get my point? I am not saying that something which happened yesterday will have a profound effect in the 10 years going forward, but view this as a negative process which started, I don’t know when, maybe in 2011… And as a result, the process of improving corporate governance, improving substance of the stock market, requires more than technicalities. In my view, the very substance of the corporate governance has no stimulus to evolve, except for several companies.

Alexey Klaptsov: Can you explain further what you mean by “substance” in that respect?

Dmitry Malykhin: That means, for example, having the right board of directors’ protocols. Letme give you an example with Rosneft. Maybe they did everything according to the legal requirements, but they still may not have followed good corporate governance. Following a good corporate governance not just by form, but by the substance, would have meant in Rosneft’s case to buy out minorities at a fair price, which would have been about two times higher than what it was.

Alexey Klaptsov: At the end of the day, even in Western countries, we know that people follow rules for various different reasons and one of those reasons is law. If they can be punished, they will try to avoid breaking the law. I have been on the market for nine years now, and again, because in the current environment it is so hard to get capital, people have to play fairly, because if you don’t, you tend to become bankrupt or you get in trouble and get caught by Interpol.

Christian Putz: I think all of us have different examples of bad corporate governance in mind. We need to differentiate incidents which involve private company owners versus those where you are dealing with state companies. It obviously might be difficult to enforce your rights with the latter.

Alexey Klaptsov: The best company from the perspective of a Western investor is privately owned, so no state-controlled company, where you deal with one majority shareholder who meets with people. Ideally he also acts as a manager to the company, a company with a good story and which at some point will start paying dividends. If it’s a state-controlled company, I can see some international investors do not want to invest. But coming back to Rosneft for a moment, which is a good example, we should also acknowledge that Rosneft could in fact do what they did because it was allowed by a Western company called BP. It was actually BP who wanted to get a good price, in the end BP did not play a fair game.

Christian Putz: I suppose, this is what Dmitry Malykhin meant with form versus substance.

Alexey Klaptsov: Correct, and what I find really awful here is that in fact a Western company behaved like this, showing the worst corporate governance.

Christian Putz: I think this is getting quite philosophical. Both cases are not very good, right? So justifying bad corporate governance by saying another side has bad corporate governance as well is probably not helpful. Let’s keep in mind that we are having this discussion because we are asking ourselves what should improve in Russia so that this country becomes more attractive for investors. Saying that BP is not better than Rosneft, will not increase Rosneft’s attractiveness for investors.

Gregory Klumov: I will add to Christian’s point. Bad governance, like corruption, is not just a Russian phenomenon, but a global issue. If you look at countries that export energy, I believe that out of 22, 17 or 18 have significant state presence or state ownership in the sector. As a proxy for those, you can look at publicly traded equities in China with and without state ownership, and you will see that the valuation gap has widened significantly in the last couple of years. Just make a basket on Bloomberg of state-owned enterprises in China and the ones without state ownership, both Hong Kong and A-shares. You will see how large that gap is and that it continues to widen.

So this not just a Russian phenomenon, but a global phenomenon of a very weak economic recovery and slow GDP growth. In a low-growth environment, efficiency and growth is something that gets a premium multiple. If you are competitive and efficient, your valuation is higher. This, I suppose, is the primary reason for the multiple premiums, enjoyed by efficiently run, growing companies like Magnit, VIPShop and others.

Alexey Klaptsov: Coming back to investing in Russia, I believe we as well as foreign investors are aware that political risks are quite significant in Russia, so we can spend time to find good companies etc., but all our good work can be destroyed by one political decision. However, when that risk will be mitigated, this will push the markets to very high levels.

Olga Kokareva: What is important to understand is that investing with a Russian alternative manager is not the same as taking pure passive exposure on Russia. As we all know, in alternative investments dispersion of results among different managers is much greater compared to passive investments, and thus management team talent and edge play a critical role. The industry is still emerging in Russia, but there are some talented managers here worth looking at.

However, overall country risk obviously does negatively impact alternative investment teams with local operations and makes them much less attractive for global investors. Those Russian managers looking to raise capital globally should probably also look at improving their set-up structure to minimize potential operational risk.

Dmitry Malykhin: We have spoken with a lot of foreign investors over the last five years. We typically find that the perceived risk regarding investing in Russian companies is much lower for investors who are present on the market already, compared to those investors who are just entering the economy. Of course, the view on the Russian market and local businesses is better from the inside than from the outside. There is no point trying to play down the tensions we are facing at the moment. These are challenging times without a doubt. But challenging times usually come with a lot of opportunities. And as some of prominent investors say, there is not much correlation between FT headlines and returns you get on the ground in Russia.