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In accordance with US SEC Regulation AC, analyst certification can be found on the last page of this report.
[email protected], www.troika.ru
RUSSIA | STRATEGY
DECEMBER 2010
End sources of financial capital inRussia, $ bln
0
150
300450
600
750
D e p o s i t s
S y n d i c a t e d
d e b t
F o r e i g n
e q u i t y
F o r e i g n
b o n d
P e n s i o n
f u n d s
R e t a i l
h o l d i n g s
M u t u a l
f u n d s
I n s u r a n c e
s e c t o r
Source: Central Bank, Lionshares, Cbonds, Investfunds.ru,Troika estimates for 3Q10
Increase in domestic capital, $ bln
0
30
60
90
120
Deposits State pension
fund
Private
pension fund
Mutual funds Insurance
funds
Growth in 2010 Growth in 2011 Source: Central Bank, Investfunds,ru, Troika estimates
Equity market ownership
30%
29%
15%
14%
6%6%
Free float
Government
Oligarch
ManagementOther company
Foreigners
Source: Companies, Troika estimates
Capital raising in Russia, $ bln
0
50
100
150
200
250
2005 2006 2007 2008 2009 2010 2011 2012 2013
Loc al d eb t Forei gn d eb t T ot al equit y Source: Cbonds, Central Bank, Dealogic, Troika estimates
Kingsmill Bond, CFA +44 (207) 822 0771
Andrey Kuznetsov +7 (495) 933 9844
Sources of Capital in RussiaShow Me the MoneyWe summarize assets and liabilities for households, companies, the
government, banks, institutions and foreigners, and examine the nature
of the debt and equity markets to identify unusual aspects of the Russian
capital markets.
█ Foreigners are the key source of longterm capital. Foreign investors are
the providers of financial capital for the equity (75%), Eurobond (70%) and
syndicated loan (100%) markets, and provide 44% of the total financial
capital in Russia. Foreign perception is therefore arguably as important for the
equity market as local reality.
█ The principal source of domestic capital is deposits. Deposits make up82% of identifiable domestic financial capital, and are intermediated by the
banks into domestic loans, with little available for longterm investment.
█ Russia has limited institutional capital. The total size of the Russian
pension system is 3% of GDP, mutual funds are 1%, and insurance funds are
1%, a fraction of what we see in Eastern Europe. If Moscow is to develop as a
financial center, it will be necessary to stimulate the growth of this capital, a
financial deepening process we have seen elsewhere.
█ Corporate debt is already high. Given the lack of depth elsewhere in the
markets, investors should be relatively cautious about corporate debt, which
amounts to 48% of GDP.
█ Foreigners will be key to new capital provision. As most deposits are
recycled by the banks into loans, and institutional capital growth is low,
foreigners will be the principal source of capital for the coming wave of debt
and equity issuance. As the current account is shrinking, and debt capital is
not so easy to attract as before, this should lead to better corporate
governance and higher rates.
█ Beware the money illusion. In theory the government, the oligarchs and
homeowners control assets with tremendous value. However, the lack of
domestic capital means that valuations are suspect, and these assets cannotbe realized easily. Investors should thus avoid capital raisings that are not
accompanied by very clear standards of corporate governance.
█ Who owns the equity market? Of the free float of around $250 bln, we can
identify $120 bln in assets held by foreign longonly funds, but only $4 bln held
by Russian mutual funds, $19 bln by the banks, $10 bln by pension funds, and
perhaps $25 bln by retail. The rest is held by oligarchs or hedge funds.
█ Where is household wealth? We calculate that 84% of household wealth is
in property, 12% in deposits, and just 4% in all other financial assets.
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2 TROIKA DIALOG
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Contents
Assets and Liabilities of Key Players..................................................................................................4 Households.................................................................................................................................4 Corporates..................................................................................................................................6 Government ............................................................................................................................... 7 Banks..........................................................................................................................................7 Oligarchs .................................................................................................................................... 8 Foreign capital ............................................................................................................................ 9 Pension system .........................................................................................................................10 Mutual funds ............................................................................................................................10 Insurance..................................................................................................................................10 Summary ..................................................................................................................................11 Growth in domestic capital .......................................................................................................11 Liabilities...................................................................................................................................14
Capital Markets..............................................................................................................................15 Summary ..................................................................................................................................15 Equity market ...........................................................................................................................15 Government bond market.........................................................................................................18 Corporate bond market ............................................................................................................19 Bank bond market ....................................................................................................................19
Capital Raising Plans ......................................................................................................................20 What is planned? ......................................................................................................................20 How feasible are these plans?...................................................................................................20 Russia as a financial center........................................................................................................21
Appendix 1: How Russia’s Pension System Works..........................................................................22 The payasyougo system .......................................................................................................22 Savings part: government linked...............................................................................................23 Savings part: private .................................................................................................................24
Appendix 2: Russian Capital Flows .................................................................................................25
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Assets and Liabilities of Key Players
We set out below a summary of where we are able to identify financial assets and liabilities in the
Russian market. Although the best comparable markets lie in BRIC or Eastern Europe, we
benchmark against the US, as this has good data, and we bring in other points of comparison where
available.
It is clear that there will always be double counting involved in any analysis of financial assets and
liabilities, and we have concluded, following the methodology of the US Federal Reserve, that it is
impossible to net this out. Rather, we look at each piece separately, and then seek to add up the
totals insofar as it makes sense to do so.
We look therefore at households, corporates, the banks, the government, foreigners and oligarchs,
and then at the main areas of institutional money – pensions, mutual funds and insurance companies.
We then seek to summarize the nature of assets and liabilities, and where growth can be expected.
Households
ASSETS
The gross financial assets of households in Russia make up 26% of GDP compared with 279% in
the US. The only area in which Russian households have comparable financial assets is in deposits,
while all other longterm capital is tiny.
Household assets/GDP
0%
15%
30%
45%
60%
75%
Deposits Bonds Equities Mutual
funds
Insurance Private
pensions
Government
pensions
US Russia
Source: Central Bank, Rosstrakhnadzor, State Statistics Service, US Federal Reserve, Troika
estimates
LIABILITIES
Equally, Russian household liabilities are relatively limited.
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TROIKA DIALOG 5
Household liabilities/GDP
0%
20%
40%
60%
80%
Mortgages Other mortgage Consumer credit Other
US Russia
Source: Central Bank, US Federal Reserve, Troika estimates
NET FINANCIAL ASSETS
And on a net basis, the US household sector is still well ahead of its Russian counterpart. The US
household sector’s net financial assets are 147% of GDP, compared with just 18% in Russia.
HOUSING
The last issue to consider is housing, where the data is not perfect. According to Freddie Mac, the
total value of US housing stock is $17 trln, or some 117% of GDP, and a little lower than net
financial assets. It is worth noting that this implies a value per m2 of housing of under $1,000/m2
for the 20 bln m2 of US housing.
Data from Russia’s State Statistics Service on the value of Russian housing is mixed. The total
amount of housing is 3.2 bln m2; the average secondary market price is $2,000/m2 (nearly twice
the level of the US); and the total value is thus, in theory, over $6 trln, or four times the level of
Russian GDP. However, one comes to the inevitable conclusion that the values in the secondary
market are not a fair reflection of reality. If we assume that 20% of the housing has no value, and
then ascribe a value of $4,000/m2 to Moscow housing and $500/m2 to the rest of the country,
then the total value of the housing stock is around $2 bln, with an implied value of $800/m2. This
gives a value as a percentage of GDP of 132%, higher than in the US.
Given that on the whole we believe Russian housing is not of such a high standard as in the US, this
is a somewhat counterintuitive conclusion, and we do not set too much store by it. However, it is
interesting only insofar as it shows that in Russia housing is relatively expensive, and the main
source of household wealth is property, making up 84% of the total. The reason for this is pretty
clear – for the vast majority of people, housing, and not financial assets, has been able to hold value
over the course of the last 20 tumultuous years; money therefore shifts into housing. The other
reason is the fact that few people had to buy their own houses, so the market is very thin. However,
as Russia increases its transparency, as people are able to build more homes and as other
investment opportunities open up, it seems likely that the real price of houses should fall over time.
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Household sector net wealth, % of GDP
0%
50%
100%
150%
200%
250%
300%
US Russia
Net financial Housing
Source: Central Bank, State Statistics Service, US Federal Reserve, Freddie Mac, Troika estimates
Corporates
ASSETS
We do not have comprehensive data on corporate assets, but do know some part of what they
have: deposits are $330 bln, or 21% of GDP, which is higher than in the US, where corporate
deposits are only 17% of GDP. We believe that the main reason for this is the lack of alternative
opportunities for corporates to put their capital to work.
LIABILITIES
Russian corporates are surprisingly highly indebted, with some $725 bln in debt. The majority of
this is to Russian banks, with another large amount in syndicated debt to Western banks.
Corporate debt in Russia, $ bln
0
100
200
300
400
500
Bank debt Dollar syndicate Dollar bonds Ruble bonds
Source: State Statistics Service, Cbonds, Central Bank
US corporate debt as a percentage of GDP is only twice the level of Russia, which gives us some
cause for concern given how much smaller most Russian financial instruments are. Most interesting
is the fact that in Russia the domestic bond market for corporates is tiny, meaning that corporations
are obliged to borrow disproportionately from banks and foreigners.
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Corporate debt/GDP
0%
20%
40%
60%
80%
100%
120%
US Russia
Domestic bond market Domestic bank loansForeign bank loans and bonds
Source: State Statistics Service, Cbonds, Central Bank, US Federal Reserve
Government
ASSETS
The Russian government has assets of $500 bln, held mainly in foreign bonds, with a value of
around 33% of GDP.
In addition, the government owns $298 bln in listed equity market assets, according to our
calculations, or some 20% of GDP. This is also surprisingly high. While the two are not strictly
comparable, the Federal Reserve data from the US on equity ownership by the government shows
this to be around $200 bln, just 1% of GDP, and less even in total than in Russia.
LIABILITIES
Liabilities are low at just 10% of GDP in Russia, versus well over 100% in the US.
Government debt/GDP
0%
30%
60%
90%
120%
150%
US Russia
Bonds Government agencies/ banks
Source: US Federal Reserve, Central Bank
Banks
ASSETS
Russian banks have $1 trln in assets, or 70% of GDP. This is comparable with the US, where
commercial banks have assets equal to 100% of GDP. The reason why the two are comparable in
size in spite of the smaller amount of assets in Russia is that in the US, there are many alternatives to
banks, but in Russia (as in many other emerging markets) the banking sector acts as the key
financial intermediary to the economy. In Russia, there are far fewer consumer loans than in the US,
and the corporate sector is disproportionately important.
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Bank assets/GDP
0%
20%
40%
60%
80%
100%
US Russia
Consumer loans and mortgages OtherCorporate loans Cash and reserves
Source: US Federal Reserve, Central Bank
LIABILITIES
Both banking systems are largely funded by deposits. The Russian banks have a far smaller share ofbonds outstanding, however, as well as a relatively large amount of syndicated debt, which we
estimate at $95 bln.
Bank liabilities/GDP
0%
20%
40%
60%
80%
100%
US Russia
Deposits Other Bonds Government
Source: US Federal Reserve, Central Bank
Oligarchs
We do not have detailed data on the assets and liabilities of the Russian oligarchs. However, we do
have some inferred numbers.
ASSETS
We calculate that oligarchs and management teams own $299 bln in equity in declared stakes in
listed Russian corporates, as well as around $73 bln in what we assume to be closely held stakes.
This is a total of 25% of GDP, which is relatively large, being more than four times the size of the
total institutional money. However, because of the lack of institutional money, these stakes are hard
to monetize, and we believe that this gives rise to an interesting conundrum: Russian oligarchs have
enormous paper wealth, but that wealth is dependent on relatively small free floats of shares largely
owned by foreigners. So, it should be in their interest to ensure that foreign minority investors are
well treated and that dividend streams are high. However, minority shareholders are for the most
part not especially well treated, and dividends are low. It is this dynamic that makes the Russian
market so volatile and dependent on foreign perception, and that drove it to such low levels in thedark days of 200809.
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TROIKA DIALOG 9
LIABILITIES
As we found to our cost in the crisis of 2008, we are unable to measure the level of oligarchs’ debts.
However, we believe that some of this is captured in the data on Russian corporate debt, which is
higher than what is implied by our bottomup company analysis.
Foreign capital
EQUITY MARKET ASSETS
There is remarkably good data on the amount of foreign capital in the equity market. Lionshares tracks
$120 bln of foreign equity assets in Russia, by far the largest single source of assets in the market. We
estimate that foreign investors own around three quarters of the total real free float.
DEBT MARKET ASSETS
We estimate that foreigners own $20 bln of ruble debt, some 13% of the market, as well as $97 bln
of hard currency debt, some 70% of the market, and almost all of the $291 bln in syndicated debt (toboth corporates and banks). There is a separate question, of course, as to how much of this foreign
money is in fact Russian investors recycling their money back into the market, but this issue is beyond
the scope of this report.
Foreign investor financial claims on Russia, $ bln
0
50
100
150
200
250
300
Syndicated
loans
Long only
fund equity
Dollartraded
debt
Hedge fund
equity
Ruble debt
Source: Cbonds, Central Bank, Lionshares, Troika estimates
BENCHMARKED TO US
Foreigners therefore own 39% of Russia’s total GDP through syndicated debt, traded debt and
equity. While this is lower than in the US, it is a much larger share of the total amount of capital
available as a result of the lack of domestic capital.
Foreign ownership of debt and equity, % of GDP
0%
20%
40%
60%
80%
US Russia
Equity Debt
Source: Federal Reserve, Central Bank, Cbonds, Troika estimates
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Pension system
SIZE
The Russian pension system has a total of $48 bln in assets, half in the government fund, VEB,$4 bln in managed government funds and $20 bln in private funds. This is a total of just 3% of GDP.
This is very small in the global context. The US pension system has 52% of GDP in private schemes
and 28% in public schemes. Moreover, there are some markets like Chile, where assets in the
pension system are as high as 65% of GDP. It is nevertheless worth noting that there are other
markets like Germany or France which have yet to grasp the nettle of moving from a pay as you go
system, and which also have very small amounts of longterm pension assets.
Pension assets/GDP, 2009
0%
15%
30%
45%
60%
75%
C h i l e
S o u t h A f r i c a
U S
M a l a y s i a
B r a z i l
P o l a n d
G e r m a n y
I n d i a
R u s s i a
T u r k e y
Source: Towers Watson, OECD
Mutual funds
Data from investfunds.ru imply that the total size of the Russian mutual fund industry is no more
than $14 bln, less than 1% of GDP. Of this, $3 bln is in openended PIF funds (the main source of
pooled equity investment) and $7 bln is in property funds, which are often used as a vehicle for
private property investment.
Size of Russian mutual funds, $ bln
0
2
4
6
8
Property Equity Debt Other
Source: Investfunds.ru. Troika estimates
In contrast, the US has mutual fund assets of 66% of GDP, in Poland it is 8% of GDP, and many
other markets have mutual funds of well over 10% of GDP.
InsuranceAccording to the insurance regulator, the insurance sector runs $12 bln of funds, less than 1% of
GDP. Of these, just $2 bln are in equities, In contrast, the US system has 34% of GDP.
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TROIKA DIALOG 11
Summary
We summarize below the various different sources of capital in total.
Total sources of assets/GDP
C o m m e r c i a l b a n k s
F o r e i g n e r s
M u t u a l f u n d s
H o u s e h o l d d e p o s i t s
P r i v a t e p e n s i o n f u n d s
H o u s e h o l d e q u i t y
I n s u r a n c e f u n d s
S t a t e p e n s i o n f u n d s
C o r p o r a t e d e p o s i t s
G o v e r n m e n t
O l i g a r c h s / m a n a g e m e n t
0%
20%
40%
60%
80%
100%
US Russia
Source: Central Bank, US Federal Reserve
However, there is a large amount of double counting here. For example, the majority of the liabilities
of the commercial banks are deposits, and arguably the oligarch and government money is hard to
realize. So, if we look simply at the end sources of liquid financial capital, the picture emerges as
below, dominated by deposits and foreign capital.
End sources of capital in Russia, 3Q10
0
150
300
450
600
750
D e p o s i t s
S y n d i c a t e d
d e b t
F o r e i g n
e q u i t y
F o r e i g n
b o n d
h o l d i n g s
P e n s i o n
f u n d s
R e t a i l
h o l d i n g s
o f e q u i t y
M u t u a l
f u n d s
I n s u r a n c e
s e c t o r
Source: Central Bank, Lionshares, Cbonds, Investfunds.ru, Troika estimates
Growth in domestic capital
There are two main factors driving domestic liquid capital formation in Russia: the speed at which
deposits grow and the amount of capital that is invested in places other than deposits. We believe
that the main driver will continue to be deposits.
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Increase in domestic capital, $ bln
0
30
60
90
120
Deposits State pension
fund
Private
pension fund
Mutual funds Insurance
funds
Growth in 2010 Growth in 2011
Source: Central Bank, Investfunds,ru, Troika estimates
DEPOSIT GROWTH
Before the crisis, deposits were linked to M2, and M2 was simply a function of the increase in forexreserves, which in turn was the consequence of Russia’s large current account and capital account
surplus. As the government built up its foreign reserves, so M2 grew, and so the size of the banking
sector swelled.
Russian gross international reserves and M2, $ bln
0
200
400
600
800
2005 2006 2007 2008 2009 2010 2011
Gross international reserves M2
Source: Central Bank, Troika estimates
Domestic deposits and M2, $ bln
0
150
300
450
600
750
2000 2002 2004 2006 2008 2010
M2 Deposits
Source: Central Bank
Since the crisis, the government has largely allowed the ruble to float, and the driver for M2 growth
has been the fiscal deficit, as well as nominal GDP growth. We expect M2 to grow at around 25% in
2011 in ruble terms as a result of these factors and as the monetization of the Russian economy
moves closer to that of Eastern Europe. We expect deposit growth of a little less than this, driven by
household savings and corporate cash f low generation.
East European M2/GDP
0%
20%
40%
60%
80%
Russia Latvia Ukraine Poland Hungary Bulgaria CzechRepublic
Source: IMF
Russian M2/GDP
0%
10%
20%
30%
40%
50%
1995 1997 1999 2001 2003 2005 2007 2009
Source: Central Bank
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PENSION FUNDS
Pension funds have been growing quite fast from a low base, to reach some 3% of GDP; the
widespread belief is that they will continue to increase in the same way as we have seen in Poland,
where they are now 16% of GDP.
Size of Russian pension funds, $ bln
0
5
10
15
20
25
30
2002 2003 2004 2005 2006 2007 2008 2009 2010
State Private
Source: Investfunds.ru
However, as we detail in the appendix, the current plan is to curtail the shift of capital into the state
fund, leaving only private capital as the driver of growth. Unless there is legislation to encourage this
further, we do not believe that it is likely to exceed $4 bln a year, which is a relatively small amount.
MUTUAL FUNDS
The experience of Poland, where mutual funds have risen to some 8% of GDP, once more indicates
that there is tremendous potential for growth if people could be persuaded to invest their money
accordingly. However, total mutual funds in Russia are still less than 1% of GDP, and equity mutual
funds are the same size as they were five years ago. The checkered history of financial investments
in Russia, inflation and the recent financial crisis have clearly taken their toll, and we believe it will
take some time before the sector is able to grow rapidly.
Russian mutual funds AUM, $ mln
0
5,000
10,000
15,000
20,000
25,000
2005 2006 2007 2008 2009 2010
equity real estate bonds balanced other
Source: Investfunds.ru
Polish mutual funds, % of GDP
0%
2%
4%
6%
8%
10%
12%
1995 1997 1999 2001 2003 2005 2007 2009
Source: Polish Central Bank
INSURANCE SECTOR
Conditions in the insurance sector remain uncertain, so we believe that growth will be limited to no
more than 10%. This would imply an annual increase in total funds of only around $1 bln.
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Liabilities
SUMMARY
As we have seen, Russia has but a small number of liabilities outside the corporate sector. The
financial sector is pretty much just a passthough for local deposits at present. We believe that the
government and household sectors should be able to increase their liabilities, but that the corporate
sector will struggle to take on large amounts of additional foreign debt, as leverage is already
relatively high.
Liabilities/GDP
0%
30%
60%
90%
120%
150%
Government Corporate Financial sector Household
US Russia
Source: US Federal Reserve, Central Bank, Cbonds
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TROIKA DIALOG 15
Capital Markets
Summary
If we look at the four big markets of traded equity, corporate bonds, bank bonds and government
debt, they are all small in Russia as a percentage of GDP.
Traded markets, % of GDP
0%
20%
40%
60%
80%
100%
120%
Traded domestic
equity
Government
debt
Corporate
bonds
Bank bonds
US Russia
Source: US Federal Reserve, Cbonds, Bloomberg, Troika estimates
Equity market
HOW BIG IS IT?
The equity market is quite large in the global context, with a market cap of some 70% of GDP.
Market cap/GDP
0%
30%
60%
90%
120%
150%
China Russia Brazil US India
Source: Bloomberg
WHO OWNS WHAT?
We have detailed bottomup estimates from our analyst teams on the ownership of most of the
market. From these, we are able to estimate that the government owns 29%, oligarchs and
management another 29%, foreigners and other companies some 12%, and the free float is 30%.
Given that we will not be aware of all closely held stakes, the real free float is likely to be lower than
this, perhaps closer to 2025%, or around $250 bln.
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Equity market ownership
30%
29%
15%
14%
6%6%
Free float
GovernmentOligarch
Management
Other company
Foreigners
Source: Companies, Troika estimates
We believe that this is a relatively low free float, compared with other markets, and that a relatively
high proportion of the market is held by the government and oligarchs.
WHO OWNS FREE FLOAT?
We are able to determine with a reasonable degree of accuracy the ownership of over half the free
float. We know from public filings via Lionshares that foreign institutional shareholders own $120 bln,
we know from Russia’s Central Bank that Russian banks own $19 bln, from investfunds.ru that
Russian mutual funds own $4 bln, and from the insurance regulator that insurance companies have
$2 bln of stock. We assume a maximum of 40% of private pension assets ($10 bln) in the equity
market, and around 10% of the market, or $25 bln, held by retail investors.
The remaining $68 bln (28% of the adjusted free float) we assign to local and international hedge
funds and other organizations whose assets are not fully captured by Lionshares, such as Prosperity
and the various hedge funds of London or New York.
Ownership of equity free float
0%
10%
20%
30%
40%
50%
F o r e i g n
l o
n g o n l y
H e d g e
f u n d s
R e t a i l
B a n k s
P e n s i o n
f u n d s
M u t u a l
f u n d s
I n
s u r a n c e
f u n d s
Source: Central Bank, Lionshares, Troika estimates
Within the foreign longonly funds, data from Lionshares are able to identify the largest holders of
stocks as below. The largest foreign fund, JPMorgan, has twice as much capital in the equity market
in Russia as the entire Russian equity mutual fund sector.
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SOURCES OF CAPITAL IN RUSSIA – SHOW ME THE MONEY DECEMBER 2010
TROIKA DIALOG 17
Foreign equity investors in Russia, $ mln
0
2000
4000
6000
8000
10000
J P M o r g a n
A s s e t
M a n a g e m e n t
V a n g u a r d
G r o u p , I n c .
N o r g e s B a n k
I n v e s t m e n t
M a n a g e m e n t
V a n E c k
G l o b a l
B l a c k R o c k
F u n d
A d v i s o r s
B a r i n g A s s e t
M a n a g e m e n t
L t d . ( U K )
B l a c k r o c k
I n v e s t m e n t
M a n a g e m e n t
S w e d b a n k
R o b u r F o n d e r
A B
T e m p l e t o n
A s s e t
M a n a g e m e n t
A P G A s s e t
M a n a g e m e n t
E a s t C a p i t a l
A s s e t
M a n a g e m e n t
D W S
I n v e s t m e n t
G m b H
Source: Lionshares
Russian mutual fund managers are relatively small in comparison.
Russian mutual funds, $ mln
0
100
200
300
400
500
600
T r o i k a
D i a l o g
U r a l S i b
A l f a
C a p i t a l
R a
i f f e i s e n
C
a p i t a l
D e u t s c
h e U F G
B
a n k o f
M
o s c o w
A t o n
M a n a g e m e n t
T
K B B N P
P a r i b a s
K a p i t a l
G a z p r o
m b a n k
Source: Investfunds.ru
BENCHMARKING TO US
While the data from the US is excellent, it does not give the amount of equity owned by the
government or other corporates. Benchmarking to Russia thus becomes a little difficult, but we can
still give a sense of how the two compare.
Equity market size and owners, % of GDP
0%
30%
60%
90%
120%
150%
T o t a l
T o t a l t r a d e d
s t o c k s
H o u s e h o l d s
M u t u a l
f u n d s
P e n s i o n s
F o r e i g n e r s
L i f e
i n s u r a n c e
O l i g a r c h s /
c o r p o r a t e s
S t a t e
US Russia
Source: US Federal Reserve, Central Bank, Troika estimates
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18 TROIKA DIALOG
What is notable about Russia is that the total traded sector as a percent of GDP is low and the
amount of institutional money is also low, but the amount owned by the state and by oligarchs and
corporates is relatively high.
WHAT DO THEY OWN?
The contrast between what foreign investors own and what is owned by retail investors is very
instructive. Local investors tend to be much more heavily weighted to reform stories such as utilities
(MRSK Holding, OGK2, MRSK Urals and RusHydro) and Rostelecom. And foreign investors are
more heavily weighted to growth stories such as Sberbank, MTS, Magnit and NOVATEK.
Split of foreign holdings
0%
4%
8%
12%
16%
G a z p r o m
S b e r b a n k
L U K o i l
M T S
M a g n i t
N o r i l s k N i c k e l
N O V A T E K
R o s n e f t
K a z a k h m y s
V i m p e l C o m L t d
P e t r o p a v l o v s k
M e c h e l
S u r g u t n e f t e g a z
X 5 R e t a i l
G r o u p
S i s t e m a
Source: Lionshares
Split of local holdings
0%
3%
6%
9%
12%
15%
G a z p r o m
V i m p e l C o m L t d
N o r i l s k N i c k e l
S b e r b a n k
L U K o i l
R o s n e f t
R u s H y d r o
M R S K H o l d i n g
S b e r b a n k p r e f
R o s t e l e c o m
O G K 2
S u r g u t n e f t e g a z
p r e f
M T S
V T B
T r a n s n e f t p r e f
Source: Troika data for retail portfolios
WHY IS TRADING SO HIGH?
One anomalous aspect of the Russian equity market is that trading is so remarkably high (over
$5 bln a day) given the lack of domestic money. We believe the answer to this, as we argued in our
report on the issue, is that domestic investors trade with alarming frequency. We calculated, for
example, that the free float of Sberbank turns over nearly once a week.
Government bond market
HOW BIG IS IT?
As is well known, the Russian government bond market is rather small. The total size of government
debt is $64 bln in ruble bonds and $25 bln in Eurobonds. This is tiny compared with the mighty debt
of the US, where the Treasury bond market is $8.6 trln and the municipal bond market is $2.8 trln.
Traded government debt/GDP
0%
20%
40%
60%
80%
Russia US
Ru ss ia domestic Ru ss ia int l US feder al US stat e
Source: US Federal Reserve, Cbonds
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TROIKA DIALOG 19
WHO OWNS IT?
The majority of the Russian government ruble bond market is owned by local investors; we estimate that
banks own over half, and pension funds around a quarter. Very little is owned directly by individuals.
We estimate that almost all of the syndicated debt is owned by foreigners, as well as some 70% ofthe foreigntraded debt.
Ownership of Russian government bond market
0%
20%
40%
60%
80%
100%
Ruble debt Dollar debt
Locals For eigners
Source: Troika estimates
Corporate bond market
HOW BIG IS IT?
Russian corporates have $58 bln in listed ruble debt and $60 bln in listed forex debt. This is small in the
context of the $4.3 trln US corporate bond market and the corporate mortgage market of a similar size.
Corporate bonds, % of GDP
0%
10%
20%
30%
40%
50%
60%
Russia US
Russia: ruble Russia: $ US corporate bond US corporate mortgage
Source: US Federal Reserve, Cbonds
WHO OWNS IT?
In a similar manner to the government bond market, we believe the majority of the local corporate
bond market is owned by local investors (61% by banks) and the majority of the Eurobond market
is owned by foreigners.
Bank bond market
Russian banks have $28 bln in ruble bonds outstanding and $45 bln in Eurobonds, a total of 5% ofGDP. This is small in the context of the 38% of US GDP in bank bonds.
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Capital Raising Plans
What is planned?
SUMMARY
We estimate that the government and Russian companies would like to raise over $90 bln a year for
the next few years via borrowings, privatizations and capital raisings.
Net capital raising in Russia, $ bln
0
50
100
150
200
250
2005 2006 2007 2008 2009 2010 2011 2012 2013
Local debt Foreign debt Total equity
Source: Cbonds, Central Bank, Dealogic, Troika estimates
This level of capital raising is not dramatically more than has been raised in the past, though it is
likely to prove more difficult, as foreign capital is not as readily available as before.
PRIVATIZATIONS
The government plans up to $60 bln in privatizations over the next three or so years, as detailed in
our 2011 strategy.
IPOS
In our 2011 strategy we identified over $20 bln of IPOs planned, although it should be pointed out
that there is usually a significant gap between the plan and what materializes.
GOVERNMENT BORROWING
The government plans to borrow around $20 bln annually, mainly in the bond markets. While theplan is to raise this money mostly in ruble bonds, we assume that the government will need to tap
the Eurobond market in order to avoid crowding out the domestic market excessively.
CORPORATE BORROWING
We believe that each year corporations will seek to borrow around $20 bln net in rubles and a
further $20 bln in forex.
How feasible are these plans?
EQUITY
A total of $30 bln of equity capital raising does not sound like much in the context of a market that
is around $1.0 trln in size. However, it is large in the context of the history of the Russian market,
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TROIKA DIALOG 21
given that real free float is not much more than $200 bln, the total raised in the past has never
reached $40 bln and, in the context of other BRIC markets.
Equity capital raising in BRIC, $ bln
0
40
80
120
160
2007 2008 2009 2010
China Brazil India Russia
Source: Dealogic
LOCAL DEBT
Net issuance of a little over $30 bln is quite large in the context of a domestic market that has never
raised more than $30 bln.
FOREIGN DEBT
Net issuance of $25 bln is feasible in the context of past borrowing by Russia from abroad, although
we are concerned by the relatively high indebtedness of the corporate sector.
Russia as a financial center
As we have noted in previous research, a commission under Alexander Voloshin is currently seekingto encourage the emergence of a financial center in Moscow. However, we believe that this will be
difficult until Russia is able to put into place a number of measures to encourage foreign
participation and the formation of longterm domestic capital in debt or equity. From our
perspective, key issues include the following.
█ The solution to the various technical issues preventing foreign institutional money from investing in
the country. At present, for example, Capital Research, one of the world’s largest managers of
emerging market money, recently noted that only 30% of their funds under management are able
to be invested in Russia. The point at issue is that certain technical standards (mainly centered on the
depository system) that are required by US regulation (the SEC’s Reg 17F7) are not met in Russia.
█ The improvement of corporate governance so that minority shareholders receive the same rightsas others. This will take not merely legislation, but also significant action by the government to
correct some of the more highprofile abuses.
█ The formation of longterm domestic money through capital deepening. As we have seen above,
capital exists in the banking sector as deposits; the issue is to persuade investors to extend its
duration and to enter the financial markets. Moves that would encourage this (apart from time and
financial stability, of course) are lower inflation and legislation to improve the pension system.
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22 TROIKA DIALOG
Appendix 1: How Russia’s PensionSystem Works
There are three main parts to the Russian pension system, as encapsulated in the (slightly
simplified) chart below, where the boxes represent assets and the lines represent flows in 2010.
The main part is a payasyougo system, and this has been supplemented in recent years by
some state and private asset accumulation, although these are still relatively small. The total
pension assets under management are $48 bln, or 3% of GDP, compared with current annual
expenditures in the payasyougo system of $152 bln, or 10% of GDP.
Russia’s pension system
Employers
PFR
VEB pension
fund, $24 bln
Pensioners
NPF,
$20 bln
Mandatory
pension
insurance
Mandatory
accumulative
pension
Employer
sponsored
pensions
Federal budget
NPF,
$4 bln
$12 bln
$152 bln
$93 bln
6% payroll for
born after 1967
$13bln
20% payroll
$72 bln
NPF,
$4 bln
$1 bln $2 bln
$152 bln 0 $1 bln0
Discretionary
$ 2 bln
Note: Arrows represent annual money flows. All flow amounts are estimated for 2010.Numbers in the boxes represent assets accumulated by the entities.
Source: State Pension Fund, Investfunds.ru, Troika estimates
The payasyougo system
How it works
The main foundation of the Russian pension system is a payasyougo system. Each year
employers make mandatory payments of 20% of salary (up to a $14,000 salary cap) into a
government fund. In 2010, this will raise $59 bln. The government then adds $93 bln to this, and
pays out $152 bln directly to pensioners.
Clearly, then, in this system there is no saving or room for the accumulation of longterm money.
History
The increase in pension payouts has been enormous, rising from 6% of GDP in 2007 to 10% today.
Only recently has the state needed to fund it to such a degree, with the pension deficit rising from
$24 bln in 2007 to $80 bln in 2010.
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SOURCES OF CAPITAL IN RUSSIA – SHOW ME THE MONEY DECEMBER 2010
TROIKA DIALOG 23
Income and expenditure for the payasyougo pensionsystem, $ bln
0
50
100
150
200
2007 2008 2009 2010E 2011E
Raised by taxes Total payout
Source: Central Bank, Troika estimates
Global context
The payasyougo system will pay out $152 bln in 2010, or 10% of Russian GDP, which is high inthe international context.
Pension payments, % of GDP
0%
4%
8%
12%
16%
Canada US UK Spain Russia Germany Italy
Source: Peterson Institute
Future plans
In 2011, the mandatory payment by employers will rise to 26% of capped salary, meaning that the
pension taxes should raise just under $100 bln.
Meanwhile, the total pension payment is scheduled to rise 9% in ruble terms to around $159 bln in
2011. The gap will again be made up by the government.
Savings part: government linkedHow it works
For those who were born after 1967, 6% of the payroll goes to individual accumulation accounts,
where the plan is that they will be used after 2020.
An individual may choose where to put this money, with the choice to select either one of the 164
nongovernment pension funds or the state asset management company controlled by VEB. If a
person makes no choice, the money is left with VEB. As with most systems like this, most people
choose the default option, and VEB ends up with most of the money.
History
The VEB funds have accumulated $24 bln, while the nongovernment pension funds have $4 bln.
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24 TROIKA DIALOG
Annual flows
The flow to these funds is $13 bln a year at present, a l ittle under 1% of GDP.
Where is this money?
We believe that the VEB funds are all in government bonds, as are at least 60% of funds held by the
nongovernment sector.
Future plans
At present, the government has proposed that this accumulation system be shut down and
resources are diverted into the payment of current expenditures. However, a final decision on this
has yet to be made.
Savings part: private
How it works
There are two aspects to private pension funding in Russia.█ Employers may sponsor their own plans.
█ Employees may pay money into their own funds directly. An employee can pay up to R12,000
($400) a year, which is matched by the government up to the same amount. One slightly confusing
aspect is that this money actually goes into the same system as the governmentmandated savings,
although this is merely a technical issue that need not concern investors.
Annual flows
Annual flows at present are around $2 bln from employers, and we believe that they are very low
from employees.
How much is there?
The large Russian employersponsored funds have $20 bln of money. The employee funds are still
very small.
Who runs this?
The Gazprom pension fund is by far the largest, controlling 46% of the sector.
Sponsors of Russian employer pension funds
0
2
4
6
8
10
G a z p r o m
R u s s i a n
R a i l w a y s
T r a n s n e f t
K h a n t y M a n s i i s k
R e g i o n
U E S
L U K o i l
S v y a z i n v e s t ,
R o s t e l e c o m
R o s n e f t
N o r i l s k N i c k e l
T a t n e f t
O t h e r
Source: Investfunds.ru
Where is it invested?
We estimate that perhaps 40% of this money is invested in equities.
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SOURCES OF CAPITAL IN RUSSIA – SHOW ME THE MONEY DECEMBER 2010
TROIKA DIALOG 25
Appendix 2: Russian Capital Flows
We present below the summarized current and capital account of Russia since the start of reforms.
Money flows in Russia, 19942010, $ bln
E
x p o r t s
I m p o r t s
I n c o m e s r e
c e i v e d
I n c o m e s p a i d
F D I i n
R u s s i a
O t h e r i n v e s t m
e n t i n
R u s s i a
F D I a b r o a d
C a p i t a l o u t f l o
w
a n d
o t h e r i n v e s t m e n t s
a b r o a d
F o r e x r e
s e r v e s
a c c u m u l a t i o n
0
500
1,000
1,500
2,000
2,500
3,000
3,500
Source: Central Bank
It is possible to simplify these flows to just three main drivers: the current account, foreign
borrowing, and capital flight; the balance of these three is foreign reserves accumulation. While
capital outflow has been a constant backdrop, it was overwhelmed by the current account surplus
and foreign borrowing from 2006 to mid2008. Thus, foreign capital seemed so easy to attract
during the boom years.
However, looking forward, we expect the current account to shrink markedly, and we expect
foreign borrowing to be much constrained. This is likely to reduce the flow of “easy” foreign capital
into the country, and make Russia more dependent on capital markets.
Quarterly capital flows, $ bln
150
100
50
0
50
100
1 9 9 4
1 9 9 5
1 9 9 6
1 9 9 7
1 9 9 8
1 9 9 9
2 0 0 0
2 0 0 1
2 0 0 2
2 0 0 3
2 0 0 4
2 0 0 5
2 0 0 6
2 0 0 7
2 0 0 8
2 0 0 9
2 0 1 0
Current account Foreign borrowing Capital outflow
Source: Central Bank, Troika estimates
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DECEMBER 2010 SOURCES OF CAPITAL IN RUSSIA – SHOW ME THE MONEY
26 TROIKA DIALOG
Analyst certification
The following analyst(s) hereby certify that the views expressed in this research report accurately
reflect such research analyst's personal views about the subject securities and issuers and that no
part of his or her compensation was, is, or will be directly or indirectly related to the specific
recommendations or views contained in the research report: Andrey Kuznetsov, Kingsmill Bond.
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Senior Management
Chairman of Board of Directors and CEO,
Troika Dialog Ruben Vardanian
Chief Business Officer Jacques Der Megreditchian
Head of Global Markets Peter Ghavami
Chief Economist,
Managing Director Evgeny Gavrilenkov
Research Department +7 (495) 258 0511
Head of Research Paolo Zaniboni +7 (495) 787 2381
Strategy
Chief Strategist Kingsmill Bond, CFA +44 (207) 583 3257
Strategist Andrey Kuznetsov +7 (495) 933 9844
Oil and Gas
Senior Analyst Oleg Maximov +7 (495) 933 9830
Analyst Valery Nesterov +7 (495) 933 9832
Analyst Alex Fak +7 (495) 933 9829
Utilities
Senior Analyst Alexander Kotikov +7 (495) 933 9841
Analyst Igor Vasilyev +7 (495) 933 9842
Assistant Analyst Andrey Trufanov +7 (495) 258 0511
Telecoms, Media and IT
Senior Analyst Evgeny Golossnoy +7 (495) 933 9834
Analyst Anna Lepetukhina +7 (495) 933 9835
Metals and Mining
Senior Analyst Sergey Donskoy, CFA +7 (495) 933 9840
Senior Analyst Mikhail Stiskin +7 (495) 933 9839
Analyst Irina Lapshina +7 (495) 933 9852
Assistant Analyst Stanislav Ermakov +7 (495) 258 0511
Manufacturing
Analyst Mikhail Ganelin +7 (495) 933 9851
Assistant Analyst Ivan Belyaev +7 (495) 258 0511
Financials
Senior Analyst Andrew Keeley +7 (495) 933 9845
Analyst Olga Veselova +7 (495) 933 9846
Consumer
Analyst Mikhail Krasnoperov +7 (495) 933 9838
Assistant Analyst Artur Galimov +7 (495) 258 0511
Real Estate
Analyst Igor Vasilyev +7 (495) 933 9842
Chemicals
Senior Analyst Mikhail Stiskin +7 (495) 933 9839
Analyst Irina Lapshina +7 (495) 933 9852
Transport
Analyst Kirill Kazanli, CFA, CPA +7 (495) 933 9853
Small and Mid Cap Analyst Mikhail Ganelin +7 (495) 933 9851
Assistant Analyst Ivan Belyaev +7 (495) 258 0511
Market Analysis
Analyst Nadezhda Kireeva +7 (495) 933 9855
Economy
Senior Economist Anton Stroutchenevski +7 (495) 933 9843
Fixed Income
Head of FI Research Alexander Kudrin +7 (495) 933 9847
Senior Analyst Alexey Bulgakov +7 (495) 933 9866
Analyst Ekaterina Sidorova +7 (495) 933 9849
Analyst Stanislav Ponomarenko +7 (495) 933 9857Assistant Analyst Boris Krasnenkov +7 (495) 258 0511
Ukraine
Strategist Roman Zakharov +38 (044) 207 3780
Economist Iryna Piontkivska
Senior Analyst Yevhen Hrebeniuk
Senior Analyst Ivan Kharchuk
Analyst Alexander Tsependa
Analyst Maria Repko
Kazakhstan
Analyst Zaurbek Zhunisov
Analyst Ainur Medeubayeva
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