Fools Russia in

Recent events in Russia have put the Eurasian powerhouse in the spotlight after protestors filled the streets in support of political change, but what does it mean for investors?

Yet, there are other challenges facing Russia. It’s not just the internal political issues that Russia needs to be aware of and address. Russian authorities will be keeping one eye on Europe to the West, as it calls for greater political reform.

Herman van Rompuy, president of the European Council, recently highlighted the ties between the European Union and Russia, saying: “We are indeed strategic partners. In many ways we are strongly inter-dependent.

“In a spirit of mutual benefit we can only win by deepening our cooperation even further.”

That inter-dependence and cooperation is highlighted by the level of trade between the European bloc and Russia.

According to the European Union’s statistics office, the trade deficit between Europe and Russia grew from €52 billion (£43 billion) to €74 billion between 2009 and 2010.

During the first nine months of 2011, the trade deficit increased to €67 billion, compared with €52 billion during the same period in 2010, making Russia the European Union’s third biggest trading partner.

If Europe falls into recession, Russia could lose one of its biggest trading partners, and could put further pressure on its economy.

However, the ratings agency Fitch still has confidence in the Rusian economy, having affirmed its BBB rating as recently as September, having highlighted a number of positive indicators. However, it also wrote of the potential impact of commodity price shocks to the oil and commodity-rich country and heightened political risks. (Continues below)

And what of the funds?

There are few funds in the Investment Management Association’s retail universe specialising in Russia. Yet there are a number of notable offerings for retail investors seeking specific exposure to the BRIC country.

There is little doubt that 2011 has been a volatile year for stock markets, but Russia has seemed to have fared worse than other traditional markets.

Over the past month, or rather since the December 4 elections, the MSCI Russia index has contracted by more than 2.4%, while the MSCI World index has grown by 2.8%.

During the past year, the Russian index has shrunk by 19.8%, compared with a 7.5% contraction in the MSCI World index and 6.2% in the FTSE 100 index.

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The funds available include the £883.5m JP Morgan Russian fund and Robin Geffen’s £465.9m Neptune Russia & Greater Russia funds.

As the chart below shows, Russia funds have suffered during 2011. However over the medium term the funds offer a compelling investment argument.

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Some managers seem divided on what the current political situation could mean for the Russian economy and life in the country.

Eoghan Flanagan, head of emerging markets at Liontrust, warned the situation could turn into a similar situation to that seen in Egypt.

In its latest update, the Eastern European Trust, managed by regional investment expert Sam Vecht, also highlighted its concerns over Russia.

“While we are positive on the upside for a number of individual companies and markets, we are concerned about the prospects for Russia, where there is potential for increasing political disruption following the parliamentary elections and in the lead up to March’s presidential election,” the latest investment trust reported. “We are monitoring developments closely and the trust remains underweight Russian equities.”

However, the latest update by the Baring Emerging Europe investment trust says Putin could distance himself from his own party, adding:  “We believe it is a step too far to draw parallels between the protests in Moscow and the developments of the ‘Arab Spring’ however.

“Russia remains, at heart, a conservative country, and United Russia still holds 49% of the popular vote. “

Russian bear or bull?

So what are the prospects? Long-term investors will have plenty to feel pleased about; the Russian economy has performed strongly in recent years.

The GDP figures have shown strong growth since the break-up of the former Soviet Union, albeit with a blip during 2009.

Click for Russian GDP data

Valuations remain at low levels currently and although strong commodity price rises are not expected, they have remained steady.

Fitch has also confirmed that despite heightened levels of capital outflows in the fourth quarter, it was not enough to warrant a change to its BBB rating.

“Many emerging markets have experienced capital outflows in recent months, partly related to heightened global risk aversion emanating from the eurozone sovereign debt crisis,” it explains.

“Nevertheless, historically, capital flight from Russia increases at times of stress. The rise in political risk following this month’s disputed parliamentary elections may well cause capital flight to increase further. Of particular importance will be how Russia’s political and business elite reacts to the popular challenge to Vladimir Putin’s authority. If it fragments – which is not Fitch’s base case – then political risk and capital flight are likely to increase.”