Original Article

Investors Credit Putin As They Pile Up Profits: Hot Stock Market Makes Russian Leader a Hero With Money Managers
By GUY CHAZAN
The Wall Street Journal
January 22, 2007

MOSCOW -- In Western capitals, Vladimir Putin has an image problem. Politicians in the U.S. and Europe routinely accuse him of squelching domestic dissent, strong-arming foreign oil companies and using Russia's vast energy resources to blackmail neighbors.

One constituency, however, has a strikingly different take on the Russian president. To many investors, Mr. Putin is a hero. The reason: the Russian stock market's spectacular rally during his seven years of rule.

When Mr. Putin took office in January 2000, the country's publicly traded stocks were valued at $74 billion. Their value now exceeds $1 trillion. Russia's benchmark RTS index rose 71% in 2006, the fourth year under Mr. Putin that the market has returned more than 50%.

"He's done a helluva of a job," says Mark Mobius, an emerging-market guru and managing director of Templeton Asset Management Ltd. "The country has made tremendous strides in the time we've been there, and you've got to give Putin credit for that."

Many money managers are betting the rally will continue this year -- even with lofty valuations, falling oil prices and rising political uncertainty in the run-up to Russian presidential elections in March 2008, when Mr. Putin is obliged by term limits to stand down.

To be sure, some investors agree with Western criticism of Russia's spotty human-rights record and of Mr. Putin's moves to undermine the independence of Russia's courts and parliament. They concede that in the long run democratic institutions are crucial for healthy market economies. But for the time being, concern about the state of Russian democracy isn't driving share prices.

Events that shape the West's political stance toward Russia, like the unsolved murder in London last November of Alexander Litvinenko -- the former KGB agent who on his deathbed accused Mr. Putin of having him poisoned -- barely register on most investors'radar screens.
The Kremlin has denied any responsibility for Mr. Litvinenko's death and answers broader Western criticism by saying that Russia is pursuing its own path to democracy.

Huge Strides

Many investors argue that critics don't give Mr. Putin enough credit for the huge strides Russia has made under his presidency. Though he has created mammoth state-run national champions that dominate the oil and gas industry, they say there is plenty of competition in other sectors. And in sharp contrast to the spendthrift populism of Venezuela's Hugo Chávez, Mr. Putin has kept tight control of Russia's purse strings, despite the oil boom.

"Two key factors in any emerging market are economic predictability and political stability," says Chris Weafer, chief economist at Alfa Bank in Moscow. "Russia has the first thanks to oil, and the second thanks to Putin."

Oil is the cornerstone of Russia's rebound. The world's second-biggest crude exporter after Saudi Arabia, Russia has reaped huge dividends from the commodity boom over the past five years. The inflow of oil dollars has lifted the value of stocks and real estate here to unprecedented highs.

But bankers and investors say Mr. Putin's contribution has been crucial. He inherited a country that defaulted on its debt in 1998, reducing itself to a pariah in international financial circles, and repaired its tottering public finances. He also bolstered the central government's waning power. "He did a lot of positive things in a very short period of time," says Mr. Mobius, who oversees $32 billion in emerging-market assets, 5% of which is invested in Russia.

Indeed, Russia now boasts the biggest foreign-exchange reserves outside Asia, huge budget surpluses and an $89 billion rainy-day fund created as a hedge against falling oil prices. It has also paid off most of its foreign debt.

Even among investors, however, Mr. Putin has his detractors. Some were outraged by the Kremlin's politically motivated campaign against billionaire Mikhail Khodorkovsky and his company OAO Yukos, the blue-chip oil giant that was Russia's most popular stock among Western investors until the Kremlin partially renationalized it in 2004. Mr. Khodorkovsky ended up in prison on fraud and tax-evasion charges.

Others shrink from his aggressive brand of state capitalism. Many took exception, for example, to the way Royal Dutch Shell PLC was forced to sell control of the huge Sakhalin energy project to the government-run natural-gas monopoly OAO Gazprom last month after Russian regulators suddenly discovered a raft of environmental violations. Shell acknowledged some lapses but said it had been working to fix them.

Western investors also frequently cite widespread corruption and a lack of transparency as major obstacles to doing business in Russia. Last year the country shared 121st place in watchdog group Transparency International's annual corruption perceptions index with Third World countries like Rwanda, Benin and Honduras. Some businessmen complain that corruption has got worse under Mr. Putin.

"In general, Putin's been a good leader, though former Yukos shareholders and current Shell executives may beg to differ," says Samuel Oubadia, co-manager of the ING Russia fund, which has $940 million in assets under management and was up 67.5% last year, the best 2006 return among U.S.-based emerging-market funds.

Though the Yukos case cost investors around $45 billion in lost value, the Kremlin followed up with investor-friendly moves that did much to restore market confidence: the removal of restrictions on foreign ownership of shares in Gazprom, and the sale of stock in the state oil company OAO Rosneft last summer.

As a result, the RTS has delivered a 250% return since its lows at the depths of the Yukos crisis in July 2004. Shares in Gazprom have nearly quadrupled over the same period: It is now one of the world's largest companies, with a market capitalization of $239 billion, and is showing up in portfolios all over the world. Fidelity Investments is a big shareholder and U.S. mutual-fund manager T. Rowe Price Group Inc. says Gazprom is among the top 10 holdings of two of its retail emerging markets funds.

Meanwhile, Western corporate giants, such as General Motors Corp., Citigroup Inc. and Toyota Motor Corp., unfazed by the Kremlin's heavy-handed treatment of companies like Shell, have poured into the country to get a piece of Russia's consumer boom. Foreign direct investment, though still low in proportion to the size of the country's economy, doubled last year to $30 billion. Major U.S. investment banks like Goldman Sachs Group Inc. and Morgan Stanley have ramped up their Moscow operations, drawn there by the emergence of strong, cash-rich Russian companies looking to list overseas and buy assets abroad.

Against that backdrop, the market is ready to indulge Mr. Putin. When Bill Browder, one of Russia's biggest foreign investors and once a staunch defender of the Kremlin's policies, was refused entry into the country in November 2005 as a "threat to national security," the initial reaction was disquiet: Over the ensuing months, investors pulled hundreds of millions of dollars out of his fund, Hermitage Capital Management. But the outflows stopped last summer, and Mr. Browder's fund, which has $3.4 billion in assets under management, was up 39% last year.

Mr. Browder says he is still "selectively bullish" about Russia, though he is less likely these days to give Mr. Putin all the credit for the country's turnaround. "My logic is that it's a liquidity-driven market, and the forces driving liquidity are still there," says Mr. Browder.

Highly Vulnerable

Skeptics warn that with a stock market dominated by natural-resource companies, Russia remains highly vulnerable to swings in commodity prices. So far this year, a fall in the price of crude has helped push the RTS down 5.7%

"If we get oil prices in the region of $45 per barrel this year, I wouldn't be surprised to see the market trading at around 1200," or roughly a third from its record end-of-2006 close, says John-Paul Smith, global strategist at Pictet Asset Management, which has around $11 billion invested in emerging markets assets.

Part of the problem is that Mr. Putin has made little headway diversifying Russia's economy and lessening its dependence on energy exports. "In the past, investors were able to give Russia the benefit of the doubt because its assets were so cheap," says Mr. Weafer, the Alfa Bank economist. "Now they need to know where the long-term growth is going to come from."

Politics is another potential danger. Though there is little doubt that Mr. Putin's preferred candidate -- he hasn't said who that is -- will win the 2008 elections, uncertainty about the succession could still spook the market, some analysts warn.

But betting against Mr. Putin has been a losing proposition for investors in the past. "I've said at the start of every year there's no way we can get more than 30% out of Russia," says Alexander Schwarzkopf of Altima Partners, which has $2.5 billion in assets under management, a quarter of it in Russia. "Everytime I'm proved wrong."