Ben Aris in Moscow -

At a time when most investors are clinging to their cash in anticipation of yet another financial firestorm, Russia's leading private equity firm Baring Vostok Capital Partners just raised $1.15bn for its fifth fund, Baring Vostok Private Equity V LP, and another $350m in a co-investment fund.

Private equity investment into Russia has never been particularly popular, but when Baring Vostok goes cap in hand to the market it has to turn investors away: the fund-raising had a hard cap at $1.5bn, says partner Michael Calvey, and was oversubscribed.

Baring Vostok has never spoken publically about its performance, but Calvey points to its investment in Burren Energy as an example of a "home run" - the fund invested $27m in the company from 1995 to 2000 and made a return of about 15-times when it exited following an IPO on the London Stock Exchange in 2003. "If you are a global investor, China is so big you have to have a strategy for it, but not so for Russia: you don't have to be here," says Calvey. "Our investors don't invest into Russia for pedestrian returns."

Eye for good business

Baring Vostok has a knack for spotting good companies early on and takes anything from a small minority investment through to complete control as part of the process of growing the company to its full potential. For example, it invested $5m in the early days of Yandex - Russia's leading search engine that is now five-times the size of Google in Russia - which was the only capital Yandex ever raised before its eventual IPO in May 2011. That deal valued the company at about $8.0bn, making it one of the largest internet companies in Europe and another "home run" for Baring Vostok.

Still, investing in Russian and other companies in the Commonwealth of Independent States is not easy. Calvey says about one in five investments go badly wrong; even Burren Energy needed several rounds of financing before its business turned around and it became seriously profitable. However, the high risks bring high rewards and another one in five investments turn out significantly better than expected at the time of the initial investment. "We have never lost money on investments in natural resources, but we broke even on some of them. The trick is to have a few home runs as well, like Burren Energy," says Calvey.

The key to operating in a such a volatile environment is to understand the people you are dealing with. Calvey is an American, but he runs the fund together with his co-senior partners, Russian nationals Elena Evashentseva and Alexei Kalinin. "We have 13 partners in our firm and 11 of them are Russian," says Calvey. "They have the same mentality, culture and background as the entrepreneurs we are backing. There is alignment of interests and a common vision for the future, otherwise we won't invest. There is really not much room for passive investors in private companies in Russia.

Russia's private equity business is far too immature to have developed specialist funds and Baring Vostok invests in everything. However, the types of company can be broken down into four main blocks.

The first is software and the internet, which has been a staple of the portfolio. In addition to Yandex, the fund was an early investor into Ozon.ru, Russia's answer to Amazon.com, which has since branched out to become a general retailer. More recently, the fund invested in ivi.ru, Russia's answer to TV streaming site Hulu.com. "ivi.ru streams movies but makes its money from advertising; the pay-per-view model doesn't work in Russia. There are other competitors in this space, but we are betting that it can get to critical mass and become the category leader," says Calvey. "Russia has one of the best computer programming talent pools in the world and we have had lots of success with software companies."

The second block is financial services - one of the best ways to play on the growing middle class and rising income story. Russian bank assets were growing at between 40% and 50% a year before the crisis and are still growing at about 25% post-crisis, but the level of financial service penetration is still very low by European standards. Amongst the fund's investment is the Tinkoff Credit Systems, a credit card specialist and Russia's first purely virtual bank; automotive leasing company Europlan; the express credit outfit Vostochny Express Bank; and Caspian Bank in Kazakhstan. "Russia is still very underpenetrated in terms of financial services - there is still 10-15 years of fast growth ahead in the sector," reckons Calvey.

The third block is businesses that cater directly to the consumer. Here the selection is broad, as nearly every sub-sector is missing services or those that exist have a lot of development work to do. "We have invested into things like medical services, clinics, Borjomi [mineral] water, beer companies. Some of these sectors are by now well developed, but lots of them are still in 'catch-up' mode so their growth rate is stronger than GDP growth overall," says Calvey.

The first three blocks are all connected in some way to the rise in incomes, but the fourth caters to Russia's traditional strength - natural resources. "This is still the richest country in the world for mineral and hydrocarbon deposits. About 90% of the resources are being exploited by the major, state-owned companies, but that still leaves about 10% of the resources that are being developed by small independent players, many of whom don't want to partner with an oligarch or the state," says Calvey.

Baring Vostok has its own team of technical experts and geologists, and focuses on resource companies that have already finished the exploration stage but are looking for capital to go into production. "The risks in these sorts of projects are mainly in the execution, infrastructure and technical issues, but we are willing to take these sorts of risks if we believe in the management team," says Calvey.

Back in favour

The success of Baring Vostok's fund-raising suggests that investors are becoming more interested in Russia again and certainly Calvey says Russian private equity is becoming more competitive. On the one hand, the oligarchs are increasingly investing their billions in new ventures as a way to diversify from the business that made them rich. On the other, the state has poured tens of billions of dollars into things like the Russian Direct Investment Fund, Rusnano and Rostekhnologiia - part of its drive to diversify the economy. A few western funds are also starting to eye the market, according to bne sources.

However, the heady days of excessive gains are probably behind private equity funds in Russia as the country becomes increasingly normal. According to the UN Development Agency, Russia is already a "developed market" in the middle-income bracket, unlike all its BRIC peers. And as the country stabilises the returns will become more normal too, says Calvey. "The big returns we earned between 1999 and 2008 are probably a thing of the past. Over that period, the economy grew nine-fold in size. That will never happen again," says Calvey. "In the next 10 years, Russia will continue to grow much faster than the developed markets, but people need to lower their expectations a bit as Russia is starting to mature."