Oxford SWF Project

Ashby Monk

Russia is a hard place for foreign investors to operate. Russian President Dmitry Medvedev recently summed up the situation succinctly:

“I have already given my opinion on the investment climate in this country — it is very bad … Corruption remains a factor.”

Indeed. According to PWC’s 2010 ‘Doing Business and Investing in the Russian Federation’,

“…the operating environment remains hazardous on a number of fronts, with many foreign investors scared off by poor legal safeguards.”

So what to do? How can foreign investors be convinced to come back? Seriously, put yourself in Medvedev’s place. How would you go about convincing foreign investors to come back to Russia and make private equity investments?

Interestingly, Medvedev has some new and innovative answers to that question. And the cornerstone of his ‘investment attraction policy’ is a new government investment vehicle that will allow private equity funds to partner with the government in Russian investments. The new fund will be called the Russian Direct-Investment Fund, and the Kremlin hopes it will attract upwards of $90 billion in foreign investment over the next five years.

I’m sure some of you responded to the question above (how to attract foreign investors) by shrinking the imprint of Russia’s government on the Russian economy, and/or by limiting the influence of the government. But Medvedev’s plan to create a new government-backed investment vehicle (i.e., temporarily increasing the scope of the government’s involvement in the private sector) is actually pretty smart, as it will ultimately align the interests of the public and private sectors and provide confidence to the private co-investors that corruption or government interference won’t get in the way of returns. According to Vladimir Dmitriev, who is head of the state bank tasked with setting up the new investment vehicle,

“Investors are simply scared…Investors are ready to come only on [the] condition the government shares the risks with them.”

Put simply, the impetus for the new sovereign fund is to assuage the fears of foreign investors by creating a government-backed vehicle that they can participate in. The subtle sales pitch in this is to say that the individuals who might otherwise engage in corrupt practices with private investors wouldn’t dare mess around with the Kremlin. Creative.

Now, as you know, Russia already has two other sovereign funds: the Reserve Fund and the National Welfare Fund (which are both descendents of the Stabilization Fund, which was split up in 2008). But RDIF will operate quite differently:

“Unlike a traditional sovereign-wealth fund, which usually invests outside its home country, the new fund will put its capital into projects inside Russia. Foreign partners—big international private-equity and sovereign-wealth funds—will be offered the chance to take stakes alongside it, but won’t hold shares in the fund itself… The fund will take stakes of 15% to 25% in each project, spending between $50 million and $500 million…The bulk of the investment in the projects—including controlling stakes—will come from the foreign partners. Typical for private equity, the fund and its partners will hold stakes for five to seven years, exiting through public offerings or other sales… Returns of about 20% are expected over a five- to seven-year investment plan…The fund’s management will be independent, made up of professionals from the industry to allay any fears of political influence or conflicts of interest.”

What’s more, Medvedev only views Russia’s participation in the fund’s investments as temporary:

“The state must not take part in the management of such a fund and must necessarily guarantee withdrawal from the company’s capital in about seven or eight years…The fund will be managed by a team of investment market professionals.”

So the fund is really just a private investment catalyst rather than a long-term investment vehicle for the sovereign’s wealth. Again, that’s quite creative.

Still, it will be very interesting to see how foreign investors react. To date, some funds have already expressed interest, including sovereign funds from China and Abu Dhabi. And it’s not hard to see why: If I were looking for a partner for private equity investments in Russia, the Kremlin would be top of my list.