Russia: 32 billion dollars in search of a manager

Relocating to Moscow might not be a top priority for investment bankers left adrift in the wake of the global financial crisis, but the Russian Finance Ministry may soon start issuing vacancy announcements. 

On Thursday, the ministry (known as MinFin) plans to issue a series of proposals to the Kremlin on how Russia should manage its nascent sovereign wealth fund (SWF).  Capable (and liberally-inclined) Finance Minister Aleksei Kudrin has said that Russia needs to attract top-flight talent to manage its oil and gas wealth, and the guidelines issued by his ministry will be key to understanding how Russia will develop its investment strategy.  MinFin does not have the in-house expertise properly to manage the fund, nor does the Central Bank.  Russia’s willingness to take on external managers would be a crucial step towards improving the transparency and professionalism of the fund, and could reassure the West that it does not intend to use its reserve of hydrocarbon wealth as a means of exercising undue political influence.

NWF debut

MinFin’s lack of investment expertise reflects not only Russia’s relatively recent embrace of state capitalism, but also the challenges inherent in developing a new SWF.  Russia’s fund, which has been christened the National Wealth Fund (NWF), grew out of the larger Stabilisation Fund (abbreviated in Russian as Stabfond), the total value of which is approximately 162 billion dollars.  This makes the Stabfond the ninth largest SWF in the world, according to the Sovereign Wealth Fund Institute, although MinFin has been reluctant to characterise the entire fund as an SWF.  The Stabfond has been a repository for much of Russia’s considerable oil and gas profits over the past four years, reducing the economy’s sensitivity to fluctuations in hydrocarbon prices. 

On January 31, then-President Vladimir Putin signed a decree splitting the fund into the NWF and the Reserve Fund, the latter of which is subject to strict guidelines about where and how it can be invested.  The 130 billion dollar Reserve Fund can only used to purchase fixed income, top-rated securities in the United States, United Kingdom, France, Germany, Italy and nine other European countries.  The Reserve Fund does not exist to make money, nor is its highly conservative investment strategy expected to change any time soon.

Profit motive

The 32 billion dollar NWF has been earmarked for higher-risk -- and, Moscow hopes, higher-return -- investments.  On September 11, Kudrin announced that the government was considering using the NWF to invest in Russia’s two main stock exchanges.  Less than a week after Kudrin’s statement, Russia’s markets recorded their worst one-day loss since the 1998 financial crisis as investors reeled from the US financial turmoil and perceptions of increased political risk in Moscow. 

President Dmitry Medvedev has since been trying to reassure investors that Russian companies are “seriously undervalued”, and following robust government intervention and a rapid upward correction on Friday, Russian stocks have begun to stabilise.  Nonetheless, the markets are still down 40-50% from their May peak.  Surplus budget funds will likely be earmarked to bolster the stocks of Russia’s energy and metals majors, increasing the chances that the NWF will also be used for this purpose.

However, any portfolio manager worth his or her salt would advise Kudrin to diversify the NWF’s holdings outside Russia’s borders.  Aside from the financial imperatives, the Kremlin would no doubt appreciate the symbolism of an oil-rich Russia investing in troubled US or European markets.  Patriotism may dictate that the NWF remains primarily a vehicle for Russian investment, but a token purchase of Western assets would fit well with the Kremlin’s aim of promoting Russia as a global economic power.