Tim Gosling in Moscow -

Unsurprisingly, investor's options for getting exposure to the Russian defence industry are limited, with the very few targets extremely illiquid. However, this should improve over the next couple of years as the final pieces of the integration puzzle are put in place and the new state corporations clean up their act ahead of planned IPOs.

With the sector populated since the collapse of the Soviet Union by numerous small companies bedevilled by replication in production lines and in a terrible state, the government has been in the midst of consolidating the majority of Russian defence companies into four large corporations since 2006. Therefore, although the likes of aeroplane designer Irkut or Kazan Helicopter Plant can still be found listed on the RTS and Micex stock exchanges, without any information on likely buyouts or swap ratios the shares are essentially redundant.

Of the new corporations, one is up and running and listed: United Aircraft Corporation (UAC), which integrates a large number of Russian companies building both military and civilian planes, as well as aircraft parts. According to its website, it has a free-float of 10.96%, but is still waiting for inclusion in the RTS indices, despite listing in the fourth quarter of 2009, according to Marina Alekheenkova of Renaissance Capital. Of the others, Russian Helicopters holding is the longest established, but yet to release any shares. Likewise United Shipbuilding Corporation (USC), which then-president Vladimir Putin ordered put together in March 2007. Later that same year, he demanded the country's jet engine designers and builders be consolidated into United Engine Corporation (UEC).

Buyer beware

Investors tread extremely carefully in the sector, if at all. The over-riding issue is liquidity. It's no surprise that UAC is not yet involved in the RTS Industrial Index, given a total trade turnover amounting to no more than $2m since the stock was listed in November 2009.

As if the ongoing, politically driven amalgamation of assets in these companies weren't enough to limit investor interest, the political sensitivity of the sector means that transparency is poor even by Russian standards. Put together, these factors will instil nightmares for most investors over corporate governance and minority rights.

That said, Alekheenkova says that transparency has been steadily improving over the last few years, with companies making more numbers available and management coming out of the woodwork to appear at conferences and meet with investors. "They'll have to improve a lot further as they head towards planned IPOs in 2011-13," she points out.

Of those few companies managing to survive outside the new state holdings for now - the likes of Arzamas Instruments - while they're reasonably healthy and stand to benefit from increased federal spending on the military, their size works against them. As Alekheenkova points out, "they may have a free-float of 20% or so, but many of them are only $100m companies, and investors can't build a viable position."