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The Russian bull

Winston Churchill famously described Russia as “a riddle wrapped ina mystery inside an enigma”.

However, there seems to be a market consensus that if there ever was a time to solve the puzzle, now may be it.

The likes of the US andthe UK have been hit bythe credit crunch but Russia continues to be a sourceof strong returns.

Is that enough to justify having more than typical exposure of 5-10 per cent to what is seen as an emerging, if not volatile, market?

Recent figures on Russia tend to support the belief that the signals for investment are positive. The International Monetary Fund’s recent World Economic Outlook projected the country’s rise in GDP at 6.5 per cent for 2008 down from 7 per cent in 2007, compared with the UK and US which have projections of 2.3 per cent and 1.9 per cent respectively.

The latest MSCI global emerging markets index shows that over three years, the Russia sector is upby 106.97 per cent.

Hargreaves Lansdown senior investment analyst Alex Davies says widespread distrust of Russia means that global demand for shares is low compared with other emerging markets despite the fact that the market has delivered positive returnsfor the last seven years.

Davies says: “Russia has two economies, which the world not only wants but cannot live without – gas and oil. Russia has also managed its economy far better than Gordon Brown managed in the UK. In Russia, they have kept a small proportion of the cash from the oil and gas they have sold to the rest of the world and now havea huge cash reserve fundof $160bn. The world’svoracious appetite for oil looks unlikely to abate sothis reserve is only likelyto grow further.”

Davies says the reserve has been used to fund wage increases of around 20 per cent in the past three years, which has meant the Russians are now spending.

He says: “The Russian economy is largely isolated from outside influences so any fall in the market could be viewed as a buying opportunity.

“Russian banks are highly unlikely to suffer the same problems affecting some in the West as they have little involvement with the sub-prime debacle. In fact, mortgage and loan business in Russia is tiny. It is the equivalent to just 8 per cent of the value of their total economic growth. Compare that with the UK where a figure of 98 per cent is circulated.”

The FTSE Russia index is down by 11.6 per cent so far this but Davies says it may represent an even greater opportunity. “The Russian market is already undervalued and still stands asa cheap market in thelong term,” he says.

Russian fund investmentis currently headlined by Neptune founder Robin Geffen’s Russia and Greater Russia fund which has shown staggering performance.It is top of the Investment Management Association specialist sector over five years, returning 230 percent compared with an average 66.5 per cent.

Success like this in almost any other fund would surely see the fund size in the billions, yet Geffen’s vehicle stands at only £200m, indicating investorcaution on Russia.

Bestinvest analyst Marcel Porcheron says that many see the main call on Russia as the commodities sector, which represents 50 per cent ofall Russian investment. However, he says: “The country’s cash reserve is also used to fund infrastructure and consumer spending across Russia. As for the eternal political concerns,we use both JPM Russian securities, managed byOleg Biryulyov and Jupiter’s Elena Shaftan, both of whom see the political climateas stable.”

Geffen says: “From a political perspective, a smooth transition of power when president Putin hands over the presidency in Marchhas been assured. In October 2007, Putin announced Dmitry Medvedev as his preferred successor in March’s election. In turn, Medvedev has stated that he will appoint Putin as prime minister. The news was widely supported by the general public, business leadersand the political elite.”

Geffen says the rise of the consumer and consumer-facing stocks were a success in the fund during 2007, with opportunities in consumer staples, telecoms and financials all looking significantly underpriced.

Neptune is forecasting global growth of 7.5 per cent for this year and says Russia has some of the best-run global companies intheir fields.

Geffen says: “We remain very confident on Russia, believing it will maintain its thriving and fast-growing economy, where average wages have risen by over20 per cent a year in each of the past three years.

“It is an environment with very low costs of transport, housing, subsidised fuel and gas costs and no traditionof mortgages or loans of that kind. Therefore, people’s spending is directly in line with their pay increases, hence the rise of theRussian consumer.”

Jupiter Emerging European opportunities manager Elena Shaftan says: “I have become increasingly positive on the outlook for Russia andhave recently increased exposure to in the fundto over 65 per cent. This position reflects my view that Russia presents a relatively defensive proposition in the current uncertain global environment.

“Russia is not significantly exposed to the globalslowdown, given that the economy is largely driven by domestic demand and has practically no exposure o sub-prime issues.

“It has a very strong financial position thanks to the combination of foreign exchange reserves, the stabilisation fund, plus budget and current account surpluses that makes it less vulnerable to swings in global investor risk appetite.”

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