November 2nd, 2010

Become a Shareholder of Russian Economic Freedom

Our recent participation in the Global Macro Investing and Geopolitical Risk Forum in New York helped us focus attention on the challenges and potential rewards of investing in Russia. We are asking supporters of free markets, free ideas and free people to show support for the rule of law, transparency and secure profits by requesting a symbolic share in Russian Economic Freedom today.

By becoming a shareholder in Economic Freedom you will send a message to Russia’s leaders that direct foreign investment will increase only if they stem corruption, increase transparency and enhance corporate governance. Owning a share will cost you nothing more than the courage of your own convictions, yet it will yield tremendous social and financial rewards for asset managers and the Russian people alike. Hedge your position – short Russia’s current regime and go long Russia’s economic future.

As you know, hope for an improved investment climate in Russia surged after President Dmitry Medvedev’s tour of Silicon Valley in June and California Governor Arnold Schwarzenegger’s October visit to Skolkovo, the new business and research hub started by Medvedev to encourage high tech innovation. Despite intense words of support by the Russian political and business elite, it’s become even more apparent that incubating entrepreneurs in Russia face massive bureaucratic hurdles to success.

As part of President Medvedev’s push to diversify the economy, he has launched an anti-corruption campaign, but the results have demonstrated the systemic nature of corruption in Russian society. The Prosecutor General Yury Chaika announced that the average bribe increased 30 percent to 30,500 rubles ($1,015) from 23,100 rubles last year. At a meeting of the heads of the law enforcement agencies, Chaika exhorted his colleagues, “In 2008 and 2009, we saw a significant revival of work in this area, but the results of the activities of law enforcement agencies in the first half of this year confirm complacency and a decrease of effectiveness and quality of work.”

At the capital markets level, a disappointing performance for Russian IPOs this year reflects the lack of progress in strengthening enforceable contracts, scaling back government intervention in business and allowing greater political expression. So far, the Russian IPO market has totaled only $3 billion this year, of which $2.2 billion is made up of the Rusal IPO on the Hong Kong Stock Exchange in March. This is only a tenth of the $20 billion IPO market predicted earlier this year by sell-side analysts.

The Russian stock market is posting gains along with increases by other emerging powerhouses China and India. However, volatility reigns as valuations on the RTS Index are trading at an average multiple of seven times 2010 earnings while other emerging markets are changing hands at an average of 13 times earnings. This represents an inherent risk premium for Russian businesses as investors seek safer harbors for their assets.

Transparency International’s recently released 2010 Corruption Perceptions Index ranked Russia as the world’s most corrupt major economy, falling to 154th of 178 countries. (Russia placed 146th in the 2009 index of 180 countries.) Russians now pay bribes totaling $300 billion a year, equivalent to almost a quarter of the nation’s GDP, according to Kirill Kabanov, head of the National Anti-Corruption Committee.

Jailed Russian businessman Mikhail Khodorkovsky and Hermitage Capital’s Bill Browder know all about doing business in Russia and how successful businesses can be run aground by the capricious whims of government officials. Khodorkovsky’s second trial is approaching its end and despite the trappings of a functioning judicial system, the ultimate decision maker of his fate rests within the Kremlin.

“A guilty verdict would damage President Medvedev’s reputation and his drive for modernization,” Mark Urnov, a political scientist at the Higher School of Economics in Moscow, told Bloomberg News. “Though Medvedev has never said that he’d like Khodorkovsky to be freed, his acquittal would be seen by many as Medvedev’s achievement.”

James Beadle, a U.K.-based consultant for investors in Russia, echoed that “a negative outcome for Khodorkovsky is likely to reinforce investor skepticism toward the fairness of the Russian business climate … I don’t think that any foreign company is under any illusions that things have changed; they remain hesitant.”

Investors should also heed the fate of Sergey Magnitsky, Hermitage Capital’s attorney who refused to give in to corrupt tax officials only to pay with his life. Recently, both US houses of Congress introduced the “Justice for Sergei Magnitsky Act of 2010”, which is not only symbolic but hits his perpetrators in their pocketbooks. The bill prevents Russian officials implicated in Sergey’s murder from entering the United States and freezes their assets here.

When introducing the bill, US Senator Benjamin Cardin said,

Nearly a year after Sergei’s death, the leading figures in this scheme remain in power in Russia. It has become clear that if we expect any measure of justice in this case, we must act in the United States…At the least we can and should block these corrupt individuals from traveling and investing their ill-gotten money in our country.

Although Russia is a tempting place to invest in new business with their highly educated population and large reserves, you should be cautious about the exhortations offered by President Medvedev. He has promised much but delivered little during his term and with the 2012 presidential elections coming up, the winds are blowing against his direction and even his meager declarations of modernization, transparency and accountability may come to an end.

Email and become a shareholder of Russian Economic Freedom.

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