Ben Aris in Moscow -

Frustrated by the slow growth of the mutual fund business at home, Russian asset managers are launching a string of new EU-compliant mutual funds that can be sold to retail investors around world who want a piece of the emerging market story.

The launch of the new funds are a result of the push-me-pull-you forces at play in the international equity markets at the moment. Developed world stock market lost about 20% of their value in the last decade, according to Morning Star, a fund ratings agency, and they are likely to lose more in the coming decade. On the other side of the jump, emerging markets made triple-digit returns over the same period - and the Russia stock market was the best performing major market in the world, up over 740% - and will quadruple in size over the next two decades, according to a recent report by Goldman Sachs. Emerging markets are hot, but until now they have been predominantly the preserve of institutional investors. That is about to change.

"One of the things that we have learned from the crisis is diversification is good, especially geographic diversification of investors," says Anton Rakhmanov, head of Troika Dialog's asset management division, which is in the process of launching several new funds that will be available to small investors in the West.

To target these retail investors, Russian funds have been busily applying for UCITS (Undertakings for Collective Investment in Transferable Securities) status. This is a classification established in 1985 by the EU and offers investors an extremely high degree of investor protection, making them especially suitable for small investors and can be sold through high street banks, insurance companies and the network of independent financial advisors from London to Madrid.

The Stockholm-based East Capital is the granddaddy of emerging Europe's UCITS retail funds. The company set up its flagship Russian fund in the spring of 1998 and today has about half a million investors with a total of €4.6bn under management. As little as €20 will buy a piece of the action and the fund is sold in 14 countries: seven out of 10 investors into East Capital's funds are retail investors. "It is clear that the appetite for emerging Europe is back, as inflows have been picking up," says Karine Hirn, one of the co-founders of East Capital. "Having an exposure to emerging markets used to be only reserved to a few with higher risk appetite, but it is becoming a must now in most investors' portfolios because of the somewhat uncertain and gloomy future of Western capital markets and economies."

Now the big boys are moving in. The latest entry to the game is Renaissance Asset Managers (RAM), which launched a family of funds in October that cover emerging Europe and Africa. RAM is part of the Renaissance Group that includes investment bank Renaissance Capital and was set up by veteran Russian banker Steven Jennings. Amongst its funds are two emerging Europe funds that invest into Russia and its neighbours, as well as a bank fund and an infrastructure fund, with a Russian debt fund in the works. All RAM's funds have the UCITS stamp of approval and the company is in the process of getting "passports" for each of the individual countries in Western Europe. (After a fund meets the EU's UCITS criteria, the asset manager still needs to apply to regulators in each country where it wants to offer the fund.) Most of the funds will go on sale to retail investors in the New Year, although they are already available to institutional investors. "The emerging markets - and especially Eastern Europe and Africa - are coming of age and we are the start of next super cycle," says Plamen Monovski, chief investment officer of RAM. "The markets are volatile, but even in the worst non-crisis year, the worst performance was a gain of 20%. And there were only two crises in the last 13 years."

Mutual fund pioneer Troika Dialog, which launched its first fund in 1997, has a slightly different perspective. Rather than go after the relatively wealthy small western investors, Rakhmanov wants to expand his firm's offerings to enable existing Russian investors the ability to diversify into other emerging markets and so are offering international funds that invest into the Bric story among others. The move was made possible only three months ago when the rules on Russian mutual funds (known as PIFs in Russian) were changed to allow then to take on exposure to foreign securities. Rakhmanov expects to get UCITS certification for his funds by the end of the year.

Pension pains

Diversifying the investor base makes good sense, but to a large extent Troika has been forced to broaden its base because of the glacial pace of reforms to Russia's pension system.

Russian funds currently have a total of about $5bn under management (much of it with Troika) against a total market capitalisation of Russia's stock market on the order of $1.5 trillion. "The asset management business remains very young in Russia," says Rakhmanov. "The total assets under management are equivalent to about 2% of GDP, compared to somewhere like Poland where mutual funds are equivalent to 20% of GDP and even more in the West. Russia is still making baby steps towards reform."

Poland is already at the endpoint of where the reforms should lead. A third of the money invested on the Polish exchange comes from foreign investors, a third is from local institutional investors and funds, and the last third is from individual investors. It is this diversity of investors, all with different time horizons, that give some stability to the Polish market and make it such a useful source of capital for local firms. In Russia, everyone in the stock market is a speculator - that is why the market is so volatile.

Rakhmanov places the blame for the slow progress at the feet of the government. Much hoopla has surrounded the Kremlin's efforts to turn Moscow into an International Financial Centre (IFC), but managers like Rakhmanov complain it is all top down and so far there has been no attention paid to reforming Russia's pension system, which is a key ingredient to the success of the plan.

The first attempt to reform the pension system in the last 1990s was fluffed. New pension funds were introduced and part of the money that workers pay as state pension contributions was made "investable." However, as oligarchs simply bought off their factory foremen to get their workers to invest into their banks' schemes, the entire reform effort was wasted and almost none of the investable money ended up in private funds. The result is there is no investment culture and ordinary Russians have no experience of investing, so most just don't bother. The IFC project will never get off the ground until the average Russian becomes an active participant in the domestic capital markets. "Reform needs to go in two directions - pension and mutual funds," says Rakhmanov. "We need local investors for the long term, which will reduce the volatility. The markets least affected [by crises] are those with the most domestic investors."