- Who Can Invest In Russia?
- A Brief History of Russian Stocks
- The Risks Involved
- Potential Investments in the Future
All things being equal, Russia is a tempting target for investors and businesses alike.
Going into 2022 with a $2.1 trillion nominal GDP, it is the fourth-largest economy in Europe and the ninth-largest worldwide. That puts it about on par with New York state or Texas.
It is a member of the “BRIC nations,” a handful of top-tier emerging markets, along with Brazil, India, and China.
It is also a commodity and export-heavy economy, with outsized market share in a list of critical materials, including oil, natural gas, fertilizers, wheat, and other grains, and too many metals – both base and precious – to list beyond major ones like steel, nickel, gold, copper, and aluminum.
However, all things are most certainly not equal.
Investing in Russian stocks, businesses that operate within the country, or even its currency – the ruble – was a risk even before war and sanctions came. It’s since become far more complicated.
Let’s look at the restrictions in place, go through an abbreviated history of the risks even in good times, and what kind of investments may be available in the future.
Who Can Invest In Russia?
To answer this question, it is more important to answer who cannot invest in Russia. The answer has evolved over time.
The first iterations of investment restrictions were established back in 2014, following the invasion of Crimea. They targeted individual Russians – both politicians and business leaders – with travel bans, frozen assets, and transaction restrictions. This escalated to sanctions on major Russian energy firms and banks. An arms embargo was also imposed on weapons, related materials, and dual-use technologies.
By the end of 2014, the first restrictions on investment funds flowing into Russia went into effect. A 90-day maturity limit for bonds, equity-based investments, or any other financial instruments was placed, then lowered to 30 days.
A litany of issues was well established, leading to the renewed Russian offensive in Ukraine and the new clamp-down in 2022. The details are complex, but the implications are simple.
Both the USA and EU have imposed new penalties for anyone transacting in rubles or with Russian companies. Since April 2022, this explicitly includes individual investors. The USA and EU are trying to cut off Russia from foreign assets, currency exchange markets, and new investments.
Outright bans on investing in Russian businesses or imports – while allowing assets to be sold, as long as those buyers aren’t banned from investing in Russian- or ruble-based assets themselves – are disingenuous. The sanctions don’t declare these assets to be worthless, Technically, it is not illegal to be invested in Russian companies. In the real world, they do. A market with no buyers and limits on sellers is practically infungible and insolvent.
Investing or facilitating trades in Russian stocks, currency swaps involving Russian rubles, and any equity or contractual swaps is illegal for virtually all exchanges and investors that participate in USA or EU markets. There is a distinction in there to note, “investors that participate in USA or EU markets”.
Russia is still selling oil and natural gas to Europe. China doesn't care about what the USA and EU are doing. India and Southeast Asia are still buying. The sanctions and restrictions are based on the so-called ‘western nations' and the financial institutions they can influence. Granted, that's a whole lot of them, but not all.
I’d be surprised if individual investors have access to Russian equities or currency. It's just too much risk for too little reward. Better to just deal with large companies with established relationships with governments and push transactions through central banks.
Even if there was access below the largest geopolitical scale, the history of investing in Russia makes this tenuous situation even worse.
A Brief History of Russian Stocks
Since the fall of the Soviet Union, there have been three avenues for public investing in Russia.
If you want to go down a Carrollian rabbit hole, the 30-some years between the dissolution of the Soviet Union and 2014 are covered by far more competent writers and historians. It was a fever dream of lofty, fanciful language masking very dark undertones.
Short version? “Russia” wanted foreign investment. It got it. The economy became globally integrated. Who counted as “Russia” became a very short list from a nepotist
The first investment avenue is through the kinds of exchanges we’re used to here in the “west,” which started as early as 1989 in Russia. Volume, market breadth, and capitalization were weak but quickly grew for lack of much else.
These are now consolidated into the Moscow Exchange, or MOEX, officially founded in 2011 after the last major merger. Equities, bonds, derivatives, forex, money markets, commodities, etc. It’s the go-to one-stop shop.
Second, which many investors found preferable, is exposure through major global conglomerates. Think of oil and mining companies that hold LLCs and joint ventures and only need to report division revenues and margins once a quarter, if that.
Finally, the third avenue was through secondary listing in foreign exchanges, especially the London Stock Exchange, and tight control on share issuance.
Remember that these are public investment platforms, though. Owners of major Russian companies only needed to list shares in exchanges to raise funds as much as they wanted, and the chaotic days in the 1990s allowed some to establish near-total ownership of companies in the once-socialized industry.
Following the collapse of the Soviet Union, a small number of oligarchs – almost exclusively with ties to new power-brokering politicians, freshly defunct government agencies, shadow economies, or preferably all of the above, quickly seized control over what were once state-owned operations. The most lucrative was tied to oil extraction and mining operations.
A veneer of legitimacy from sorting out questionable bookkeeping, plus some lobbying in the USA and Europe to globalists that wanted Russian inclusion – and to prevent what may have become a failed state – cleared the way for international investment.
Money flowed into long-neglected companies, provided a fantastic return, and spurred consistent production increases.
The structure still posed a risk. Once Russia was beyond its existential crisis, it could evolve on its own. And what it evolved from was an already established nepotistic oligarchy.
The Risks Involved
A lot of the early “status quo” work was not done by Putin. It was during the fragmented years under Boris Yeltsin. These newly empowered oligarchs guaranteed Putin’s rise to power, only to see him turn on them. At least in public discourse.
What actually panned out was a fundamental transformation from oligarchy to patriarchy. Russian leadership, consolidated under Putin, was newly empowered to choose which oligarchs remained in favor.
Once upon a time, in the year 2000, a couple of dozen of the richest men in Russia was summoned to the Kremlin to “bend the knee.”
According to the New York Times, this is what Putin said:
“I want to draw your attention to the fact that you built this state yourself, to a great degree, through the political or semi-political structures under your control. So there is no point in blaming the reflection in the mirror. So let us get down to the point and be open and do what is necessary to do to make our relationship in this field civilized and transparent.”
“Being open” and “doing what is necessary” was already clear, and this was a meeting designed to drop the facade and make it transparent.
Mikhail Khodorkovsky was the richest man in Russia. He built a $15 billion fortune through a terribly corrupt scheme called “Loans for Shares,” which has more history than we should get into here. A key move was buying 78% in a privatization deal for Yukos, once state-owned, for $310 million. In reality, it was worth an estimated $5 billion.
(Editor's Note: Beginning in 1995, Boris Yeltsin's government began privatizing state-owned shares in companies through a loans-for-shares scheme. The scheme helped with “fundraising” for Yeltsin's 1996 reelection campaign and restructuring freshly-sold companies at the same time.)
He publicly called out Putin for corruption. In 2003 he was ripped out of his private jet and charged with fraud and tax evasion.
While he was certainly not someone that, in biblical terms, should cast the first stone, this solidified a trend. He was imprisoned in Siberia for a decade. All shares he owned were seized. Trading was halted in Yukos after share prices collapsed.
Most importantly, a savor was crowned that would make sure the company didn’t fail. Virtually all of Khodorkovsky’s stake was passed to Igor Sechin, a close ally of Putin.
This set the terms of the paradigm to this day. It has been repeated time and time again. Political agitation results in disgrace, seizure, and reappropriation.
This is a classic political machine graft pushed to an extreme. An executive in power has police forces make an arrest. A subservient judicial branch convicts. Assets are seized. A ‘no bid’ deal is announced. Assets are transferred. The players in Tammany Hall would wish it could do it so easily.
The list of such machinations is long and continues beyond our need for detail, but here’s the latest.
In mid-October 2022, Russia seized a 30%, $4 billion, stake in a major oil project with no compensation. It is far from alone. BP, TotalEnergies, Equinor, and Shell have all transferred ownership of assets for ‘pennies on the dollar’ at best.
That’s just one disenfranchised oligarch in a long list and one from a long list of public companies that has no recourse.
A continuing risk, even beyond the normalization of relations and an end to sanctions, is a culture of ‘pay to play’ politics with no guarantee of quid pro quo.
Potential Investments in the Future
This is a dark picture of Russian investments. It should be.
That doesn’t mean there isn’t value in trade or continuing to watch Russia for a change in the investing paradigm and political climate.
And I cannot stress this enough. IT IS ALREADY HAPPENING.
China is trading with Russia and ignoring virtually all sanctions. India is as well but is a bit less bold about it. A wide swath of southeast Asia is as well, especially for food and energy, and I'd dare anyone to blame them as both are desperately needed to stave off economic and humanitarian disasters.
That's the reality. A majority of the world, mostly far away from Russian-Ukrainian War, is trying to navigate a middle course in this stand-off.
Investments and transactions are still happening. The question is, if and when relations thaw and Russian investment becomes possible again, What should we look for?
Here are three basic guidelines:
Big Companies With Relatively Small Exposure
Investing in Russia has been perilous but also lucrative for companies that provide capital for minority stakes.
Minority stakes in commodity projects are designed to provide capital with profit-sharing potential that does not exist elsewhere. At least for the select projects they choose.
For example, Exxon (NYSE: ZOM) and other energy sector companies have a long history of investment in what can generously be called problematic environments and a long history of making plenty of money off of them.
Risk is mitigated by spreading investments on a global scale.
Diverse emerging market investments
Individual emerging markets have large profit potential in small windows. Individual companies within a specific emerging market? Moreso.
Investments that mitigate geopolitical risk by spreading investments across a wider swath of the world can focus on the rate of return for investors.
This will inevitably reduce the rate of return for any single project, but compared to going all in on small companies with all-or-nothing stakes in individual projects, the advantage should be obvious.
If you use backward-looking data and regret a larger stake, you are ignoring the forward-looking risk that once existed. It’s a trap everyone needs to avoid for ALL investments, these more than any.
Passive Stakes Through Funds
This is the most hands-off approach, but once the Russian investment potential changes, we will see more passive funds that will increase exposure to the market. This is especially true for commodities.
ETFs, ETNs, and certain kinds of retirement funds do not play any role in company management in spite of their theoretical stakeholder voting power.
There is no particular need to move on these now, but emerging market funds will play a major role in recapitalizing Russian companies one day.
That may take a long time. It may not be particularly palatable. It will happen.
When it does, and then how it relates to geopolitics, to steal a quote from a classic cold war movie, “The only winning move is not to play.”
Instead, we should wait for the inevitable reorganization and recapitalization and see if it's right for us.
Take Care,
Adam English
The Profit Sector
