The asset management industry in Russia is comparatively young and does not have a long history. The first civilised forms of regulating this market date back to 1995 when there appeared the Federal Commission for Securities Market (FCSM), licensing of asset management activities, and the first specialised money management companies. The first active mutual funds appeared in the beginning of 1997. Then the newly born industry had to go through the 1998 national financial crisis followed by initial steps of the financial market infrastructure and by rapidly developing legal framework.
Today, there are 235 asset management companies that have a license to manage mutual funds, investment and pension funds. At the same time there are 1,024 companies and banks with a broader license for individual asset management. The rapid market growth can be illustrated by the fact that at the end of 2004 the top 20 companies had RUB270bn (€7.8bn)under management, but by the end of 2005 this number grew to RUB595bn rubles.
The ‘old guard’ of the market consists of veterans such as Troika Dialog, Aton-Management, Nikoil (now called Uralsib), OFG Invest, and Alfa Capital. A new generation of companies - with local and foreign origins - entered the market later and included Kapital, Renaissance Capital, Allianz Rosno, Rosbank Asset Management, Raiffeisen Capital, and DWS Investment. Market leadership clearly belongs to companies with Russian ownership.
After the pioneers Templeton and Credit Swiss left the Russian asset management market there was a long period during which foreign resident companies were absent in the country. Only during the past two years major rankings recognised the progress achieved by companies belonging to Allianz, Raiffaisenbank or Deutsche Bank.
However, foreigners seem to have missed the momentum in many market segments, and now it is hard for them to catch up with local peers. One reason for this is that many competitions and tenders include a requirement of two to five years of successful presence in the Russian asset management market.
Russia’s mainstream market consists of individual asset management for legal entities and physical persons, management of mutual funds, and management of pension reserves of NPFs (non-state pension funds).
In 2003 private asset managers acquired the right to manage second pillar pension savings of citizens who chose to leave the state Pension Fund of Russia (55 asset managers were selected for this job through a competition). Starting 1 July, according to the new legislation, asset managers will be able to manage pension reserves of insurance companies. Besides, this year opened up a very promising market, which we call ‘management of macro funds’. This market includes the reserves of gigantic financial conglomerates that accumulate financial resources for various purposes, eg, the Stabilisation Fund of Russia, Bank Deposit Insurance Fund, funded mortgage system for the military, and pension savings of ‘silent’ citizens who have not chosen a private asset managers or an NPF. There has been a significant expansion in the variety of mutual funds; Real Estate Investment Funds (REITs), for example, are developing faster than any other type.
We look at the most promising market opportunities that are developing.

Insurance reserves
The Russian market has more than 900 active insurance companies. Their total assets (not including the assets channeled through so-called ‘grey’ schemes) are roughly RUB200bn. Today about 50% of these assets are invested in debt obligations (veksels) of businesses affiliated with insurance companies. Starting 1 July, the ministry of finance will enact a new set of investment rules, and insurance companies will be obligated to invest their reserves (independently or through asset managers) into a specific choice of assets, namely government securities, corporate stocks and bonds, shares of mutual funds, real estate, bank deposits, and mortgage securities. Even before this new regulation asset managers found ways to manage insurance reserves, but after July 1 this part of the business can grow on a massive scale.

Funded housing mortgage system for miliary personnel
Since 1 January 2005, Russia has a law according to which the federal budget contributes annually during three years 37,000 rubles to a special account of each professional military service person (today it is about 60,000 people). This money is accumulated toward an individual housing mortgage down payment.
In 2005 this total contribution was RUB1.03bn, after that it will be over RUB2bn every year (adjusted for inflation and the number of eligible military personnel). At the end of December last year the ministry of defence (the government body in charge) conducted a competition and selected 10 asset management companies (see table).
The reserves will be invested in government securities (up to 40%), corporate bonds (up to 60-80%) and stocks (up to 45-65%). The “military mortgage system” is very similar to the current system of investing pension reserves. Asset managers are allowed to form investment portfolios according to their own preferences but strictly within the imposed limitations. Today, several legislative amendments are being prepared regarding the investment rules of this military money, and, similarly to the pension system, it is planned to allow investment into foreign securities via index funds.

Bank deposit insurance agency
This agency was created in January 2004. It has accepted 900 banks, which pay 0.15% of their deposits into a special insurance fund as premium to guarantee deposits under 100 thousand rubles per one depositor of a bankrupt bank.
At the beginning of 2005 the fund had RUB4.623bn, and at the beginning of 2006 it was already RUB19bn, and it is forecasted to have about RUB40bn by 2007. In 2004 the agency invested these reserves on its own into government securities, starting from 2006 they can be invested in government securities, corporate bonds and stocks (up to 20%). In March a competition was conducted and eight asset management companies were selected (see table). These companies will be entrusted with managing about 10% of the agency’s insurance fund. During the first year of this experiment the agency intends to fine-tune the investment mechanism and evaluate its effectiveness. Starting from 2007 there is a plan to allow investment into shares of foreign index funds and securities of the OECD countries (up to 10%).

New types of mutual funds
Today Russia has more than 400 mutual funds of which 250 are traditional (stock, bonds and mixed). Total assets of Russian mutual funds amount to RUB280bn. 2005 demonstrated and 2006 will show continuing active growth among new and promising types of funds: direct investment, venture and mortgage. The fastest growing segment is real estate investment.
At the end of last year, there were about 60 real estate investment trusts (REITs) with total assets of about RUB15bn. These funds differ by the type of real estate and by the type of income (development, rent). There appeared funds that invest exclusively in land. It is very likely that soon Russia will see the arrival of hedge funds.

Pension market
Since 2003, 55 private asset managers and the State Asset Manager (Vnesheconombank) have been managing the reserves of the second pillar of the Russia pension system. Today, these reserves equal about RUB200bn, the forecast for 2012 is RUB1.trn. In other words, the second pillar is expected to grow almost
10-fold during the next seven years.
The size of the total annual contribution will reach roughly RUB400bn. Considering that 98% of these reserves are currently managed by Vnesheconombank and are invested in government securities, there is a clear danger of overheating in this market.
Now, proposals are being considered to allow private asset managers (not only Vnesheconombank) to handle the pension savings of ‘silent’ citizens and invest them in corporate stocks and bonds. Much preparatory work has already been done on this issue and new legislation is being drafted. There are technical discussions on how to select asset managers and how to distribute specific investment mandates among them – whether to follow the example of the Norwegian Petroleum Fund where mandates correspond to different types of assets, or to allow diversified/mixed investment portfolios. Another discussion issue is whether to allow investment of silent citizens’ pension reserves into stocks and shares of index funds abroad.

The Stabilisation Fund
This fund receives money from the federal budget when the price of oil rises above $20 per barrel ($27 in 2006). It started operations in 2004 and by 2006 accumulated RUB1.32trn. The StabilisationFund is used to pay Russia’s debts to the IMF and Paris Club, and to cover the deficit of the state Pension Fund of Russia. The fund’s assets, however, continue to grow – as of 1 March it already had RUB1.563trn. These reserves are not invested inside the country to avoid inflationary pressure.
In fact, during 2004-2005 no investment took place at all, the secure ruble accounts were held with the Treasury generating an inflation-related loss of about RUB23bn. In 2006 the portfolio is supposed to be held in hard currency (US dollars, euros and British pounds) and government securities of 14 countries (Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, UK and US). In order to qualify, a sovereign issuer of debt has to have the highest credit ratings from two of the three major rating agencies and outstanding debt of more than 1billion in the corresponding currency. The Russian ministry of finance will make investment decisions while the actual investments will be executed by the Central Bank.
As of today, however, no investments were made. First, there was a concern that these reserves might be claimed through courts by creditors of Yukos oil company. To alleviate this particular obstacle a special investment mechanism – through the Central Bank – was designed. Then the Russian Prime Minister expressed his dislike of the low yields on foreign government securities and there appeared a proposal to invest partially in the stocks and bonds of foreign blue chip companies (the amount under consideration is RUB700bn or one third of the fund’s projected value by the end of 2006) with expected return of about 5%. At the end of March the government decided to expedite the preparation of a mechanism for investing a part of the Stabilisation Fund into foreign government securities, corporate bonds and stocks. It is planned to select through competition a private asset manager for handling the portfolio of stocks and bonds. It is very likely that a foreign asset manager will be selected for this job, even though Russian-owned companies will fight for their right to manage that portfolio as well.

What’s next?
Russia’s industry of asset management shows impressive results and has good perspectives. So far, institutional investors have set the tone. A new boost will come from the reserves of macro funds. At the same time, experts believe that the Russian population still keeps about the equivalent of $25bn ‘under the mattress’.
Tapping into this particular niche has remained only a dream during the past ten years, but the growth of retail networks and of general financial education have to bear fruit some day. Russia will definitely grow more susceptible to the impacts of globalisation of financial markets. It is very likely that soon a lot of Russian capital will be granted access to foreign assets.
At the same time we can expect to see more foreign asset managers enter the local market. Recently, for example, the Russian media reported that this year Merrill Lynch investment bank plans to set up its own subsidiary asset management company in Russia in addition to a permanent representative office.
Alexander Kupriyanov and Vadim Loginov are at