Exclusive Analysis: Russia Exceeding Expectations in Markets – Paul Goncharoff

Russia is the lowest priced of the world class investment destinations. It is a very deep-value market with a vigorous energy sector, a limitless wealth of natural resources, a growing global agricultural footprint, well educated technically savvy labor force, an industrial base that is being reborn with the latest in 21st century digital technologies, and yes, a rather large number of state-controlled enterprises (SOE’s) to leaven the mix in keeping with tradition, I guess. Oh, by the way, these SOE’s are paying attractive dividends today – really. 

Hanging over the Russian markets seemingly forever are worries about “rule of law”, currency and inflation risks, sanctions, corporate governance, and the recurringly referred to bogeyman of unipolar leadership at the helm of state. Taking the short term view, since 2014, Russia has been subjected to a “Ukraine crisis”, with resulting western sanctions sending equity prices lower and western investors trashing any possibility of improved economic prospects given ever-increasing sanctions. If that was not enough, the oil price collapsed then as well, add a further sprinkling of other crises like election meddling, colluding with presidents, Syria, nerve toxin poisoning, having a killer as leader, and so on ad nauseam. Sounds like a perfect Hollywood feature storm, no?

Much to the chagrin of the many experts across our planet, the Russian market, as represented by the MOEX Russia Index is up more than 150% since its early 2014 bottom – yes, that is just 7 years. Programs to replace imports with “made in Russia” alternatives have played their protective anti-sanctions role and the recovering economy is feeding momentum. Unintended consequences are such that Russian indexes in general have collectively risen to such an extent that it is now arguably the second best-performing among more than 90 major markets focused on by Bloomberg.

In doing and analyzing business, I have followed one key principle, and that is simply “follow the money”. It may sound simple, but in a sanctioned world to truly follow money can be a camouflaged detective puzzle. Nonetheless, financial flows continue to Russia in many forms other than the traditionally expected US Dollar transfers, which now play a far less important role than in the very recent past, in fact ever.

Investors are interested in upgraded expanding Russian assets, lower interest rates, much higher dividends paid by state-run as well as public companies, and the abysmally under-reported improved corporate governance reality in place. One pedestrian way of gauging the quality of governance is by looking at retail investors, and between 2019 and 2020 the number of private investors on the Moscow exchange doubled to 3.85m, and it looks like this will continue for the foreseeable future. These are people who live in the Russian economic reality and know it well, not rubes to be hoodwinked.

As it happens, the other day in Moscow I bumped into Mikhail Kuznetsov, a good friend who has served with me on the boards of several Russian management and governance organizations. Among them were the Russian Association of Corporate Directors and Managers, and the Association of Independent Directors of the RF. He also was part of the IFC’s “Corporate Governance in Russia” project in the late 1990s/early 2000s where we first met. He is a well known champion of corporate governance in Russia.

Since 2015 when he founded TopCompetence, an analytical think tank focused on corporate governance in Russia, he heads up one effort (among many) which is actively monitoring the companies comprising the RUCGI Index. Since December 2019, the National Corporate Governance Index has become the official stock exchange index “RUCGI” which is recalculated and updated quarterly.

Back in 2015, Sergey’s TopCompetence team together with the Moscow Exchange and the Center for System Transformations of the Faculty of Economics of Lomonosov University launched a large-scale, comprehensive, independent study of corporate governance in Russia. The study was based on the 100 largest (in terms of capitalization) companies in Russia whose shares are publicly traded on the Moscow Stock Exchange.

The research was and continues to be based on open sources of information, which allows looking at Russian corporate governance practices from the perspective of an investor or any other stakeholder. The result was that in December 2019, the National Corporate Governance Index became the official stock exchange index (RUCGI), updated daily by the Moscow Exchange for the leading companies identified by TopCompetence on a quarterly basis.

The purpose of the RUCGI Index is to develop and promote best corporate governance practices in Russia. Having an open and transparent methodology that provides all interested parties with the opportunity to analyze the level of corporate governance of the largest public Russian companies is of immense value, especially in an informationally-biased world. The effort identifies features, trends and objective measurable characteristics of corporate governance in Russia, taking into account the timeline realities and dynamics of development. The index is a universal tool that allows any investor to assess the impact of corporate governance on the company’s value, and allows companies to compare their own corporate governance practices with leaders in this sphere.

Recurring among Russian executives are conversations on what constitutes “good” corporate governance. It is a moving, constantly changing concept usually inspired by re-examination after a corporate meltdown or similar sanguine event. For example, the Enron accounting scandal in America showed the chinks in a redesigned corporation that too aggressively chased after new opportunities and (logically) profits. Such examples show the importance of management attention on internal risk management and the potential liabilities of overly relying on gatekeepers like S&P, Moody’s and similar, whose interests may not be necessarily aligned with those of the corporation or its investors. The Siemens bribery scandal showed how when operating in the traditions of acceptable German corporate governance, became subject to foreign expectations of differing proper practices and accordingly had to create new “best practices”  to balance the company’s obligations to domestic as well as foreign jurisdictions.

The few front-page corporate scandals that erupted in the U.S. economy starting in 2001 like Enron, Kmart, Chiquita, WorldCom, Tyco, Arthur Andersen, Bernard L. Madoff Investment Securities, Adelphia, Refco, Bear Stearns, HealthSouth, Lehman Brothers, Theranos and quite a few others have tended to undermine confidence in the effectiveness of corporate governance in the United States. While some may see these scandals and the related financial irregularities, as simply the products of a few dishonest or unethical corporate managers caught up in the collapse of a stock market bubble or other serious event, the pervasiveness and extent of corporate misconduct suggests otherwise. Whatever the basis, it did not seem to affect the gusto with which investors have flocked to US, EU and similar exchanges to invest in rather high PE equities.

Meanwhile, Russian private and commercial investors are flocking to the Russian stock exchange, and foreign “smart money” has been quietly and consistently engaged, the view that doing business in Russia is somehow dirty or fraught with risk remains a supported narrative by western mainstream media, and as a consequence cause many people and companies to shy away. This is not to say that Russia is free of corruption, crime, greed, ambition and the usual bouquet of malodorous scents, but in objective comparison it is small change, and like anywhere else are being addressed as best they can be, which again, is unsurprisingly better than most.

Despite immense efforts within the fabric of Russian business to improve and diversify the physical aspects of production as well as the ethics and management standards within businesses, reputationally Russia remains under an accusatory cloud. The era of being typecast as the “highly likely” bad actor has left its prejudged and unproven stains. It is like a well worn pair of jeans, comfortable for the western markets to maintain this perceived image as it doesn’t require the effort to reimagine the vastly different actuality that exists in potentially competitive objective reality today.

The introduction of the Corporate Governance Code for Russia in 2014 has become an important incentive and a step towards unification with world best practices and in some cases has taken a leading role. Russia today is ranked 7th out of the top 25 countries in terms of clarity and completeness in the scope of Corporate Governance requirements. The broad-ranging corporate governance reforms are in fact significant, closing-off most weaknesses, based on corporate legislation, and are favorable to investors. Aside from Russian not being English, what’s not to like!?

Analyst Paul Goncharoff, Moscow 

Ru-Main, 19.03.2021 

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