Russia: Deploys the big guns
Russia's two new sovereign wealth funds were instrumental in supporting the economy during the economic crisis. Martin Delaney reports
The creation of the Reserve Fund and the National Wealth Fund in February 2008 marked a new chapter in Russia's return to economic good health. Splitting the Oil Stabilisation Fund into these two separate vehicles meant that they could be targeted at different parts of the economy. The RUB2.2trn (€50bn) Reserve Fund was designed to aid the state budget, coming into effect - particularly over the last 18-24 months - at times of economic turmoil.
The RUB2.8trn (€62bn) National Wealth Fund - also known as the National Welfare or Future Generations Fund - is more forward-looking. Its stated aim is to fund a wholesale reform of the pensions systems in Russia.
According to the Russian ministry of finance, the Reserve Fund is "a part of the federal budget assets... dedicated to ensuring the financing of the federal budget expenses and maintaining federal budget balance in case oil and gas budget revenues decline".
The size of the fund is capped at 10% of the country's annual GDP. In essence, it has replaced the Oil Stabilisation Fund as a means to reduce inflationary pressure and insulate the national economy from the "volatility of earnings generated by export of non-renewable natural resources". Its remit has broadened, as the Reserve Fund not only draws revenue from the production and export of oil - as the Stabilisation fund did - but also from the production of natural gas and oil products. These "oil-related activities" - which can range to oil transportation as well as production - means there has been a certain amount of diversification, although the revenues raised are still dependent on any movement in the oil price.
"Both funds were used heavily last year to reduce the volatility of the exchange rate," explains Pavel Teplukhin, chairman of Troika Dialog Asset Management, a leading investment house. Indeed, as of 1 December 2009, RUB175bn was on deposit at Vnesheconombank, the state banking agent, for the express purpose of supporting the domestic stock market.
A total of RUB582.8bn - of the maximum RUB655bn permitted - has been allocated by the National Wealth fund to VEB. RUB387.79bn of this sum has been earmarked for subordinated loans to Russian banks and RUB20bn for loans to small and medium-sized enterprises. A further RUB40bn is available for loans to The Agency for Housing Mortgage Lending, but as of 1 December 2009 that had yet to be allocated to VEB.
The fund is managed by the ministry of finance, under the finance minister Alexei Kudrin, with an investment remit that stretches to riskier assets, such as corporate bonds and equities.
"The money is run in quite a conservative way," says David Smart, global head of sovereign funds and supranationals at Franklin Templeton. The split - which is detailed on the ministry's website - reveals diversification is at the centre of the investment strategy, even as far as ensuring assets in foreign currencies are split 45:45:10 between the US dollar, euro and sterling.
"Both funds have hidden agendas," says Jason Manolopolous, managing partner at Dromeus Capital Management who has lived in Russia for five years and runs an emerging market fund that invests in the CIS. "They are designed to prevent too much hard currency leading to inflation."
With this in mind, during the recent economic turmoil which affected many emerging markets, the funds were used to support the country's economy. It also experienced what could be described as one of the most successful trades of the decade: as the funds moved to invest in the Russian stock markets at massively deflated prices, they benefited to the tune of billion of dollars as the markets recovered by as much as 60%.
"It was a bit like the intervention by the Hong Kong Monetary Authority in the 1990s," says Smart. "That similarly resulted in some substantial gains."
Manolopolous adds: "They bought equities when the market cap was around 10% of GDP. The markets were down by about 70-80%, so to buy at that point was a very good thing to do."
Although the intervention was politically astute, it made good financial sense. "There were no politics in it," argues Teplukhin. "The idea came about because the prices were so depressed and it was a very good idea to use the Future Generations Fund to buy good, cheap companies."
Teplukhin compares the move with the US authorities' intervention in domestic financial institutions. "The point was to use the government resources to support the market and invest in the right way," he adds.
On the other side, monies were moved from the Reserve Fund to plug the country's first budget deficit in a decade. In March, the combined sovereign wealth funds fell to RUB7trn - and the Moscow Times reported that Kudrin warned the Reserve Fund would be "practically exhausted" in 2010. Spending will need to be cut in order to meet the estimated 7.4% deficit.
The other major threat to the Russian economy is population change. According to Rosstat, the government statistics agency, the population of working age will decline by 14m by 2025, making Russia's pension time bomb unique among developing nations. "Ironically, the demographic problem is closer to that of Italy, which faces similar issues," points out Smart.
Yet the establishment of the National Wealth Fund represents a step towards greater social and political maturity, argues Manolopolous. "You have to recognise it is intertwined with politics in terms of putting resources where the politicians think they should go, but Kudrin is keen for the money not to be spent on corrupt infrastructure projects."
He cites the events of 1991 and 1998 - that marked the collapse of the USSR and the Russia debt default crisis - as two determining factors underpinning the new economic resolve. "National pride was injured as one of the great superpowers became a shambles. GDP fell by so much and the Oil Stabilisation Fund was modelled on Norway's sovereign wealth fund to ensure it doesn't happen again."
The two new funds are not only the economic choice of last resort, but are becoming investors in their own rights. Rumours circulating in Moscow suggest that VEB is poised to take a 3% stake in Rusal, the world's largest aluminium producer owned by Oleg Deripaska, for between RUB14bn-18bn.
Teplukhin confirmed there was much interest in the National Wealth Fund's proposed purchase of Rusal stock. "Obviously the fund has a chance to participate in the IPO, or pre-IPO transaction, but I'm not sure whether that has been completed. But these types of investments are the exact purpose of the fund," he adds.