Graham Stack in Moscow -

Despite a sharp fall in returns in 2007 and an outflow of money, the leader of Russia's nascent mutual fund sector Troika Dialog looks well positioned to cash in on a burgeoning business.

Troika Dialog Asset Management is Russia's market leader for mutual funds, managing 22%, or $4.5bn, of the total assets under management in Russia. Considering their pole position, it's fitting that Troika's funds take their names from invincible Russian folk heroes: the "Dobrynia Nikitich" equity fund is Russia's largest mutual fund, and the "Ilya Muromets" bond fund and the "Druzhina" balanced fund are the largest in their categories.

For all their mutual funds, 2007 was a splash of cold water, with Troika's total assets under management falling over the year by RUB4bn (€111m), and returns dropping from 50-90% over the previous two years to 15-20%.

Troika Dialog's portfolio manager Oleg Larichev was named Russia's top portfolio manager by business magazine Kommersant Den'gi in 2006, when Troika funds Dobrynia Nikitich and Druzhina took first and second place in Russia in terms of funds attracted, raising RUB7.96bn and RUB3.6bn respectively. But Larichev, asked if he was disappointed by 2007, shrugs off the drop in performance: "The market was pretty difficult, but we managed to keep our leading positions in the asset management and mutual funds business. The investment outflow was relatively small. The main reason was that the market did poorly in 2007 compared to 2006 and 2005. Returns were far lower. Investors who had been expecting high short-term returns to continue left. But overall we managed to raise a lot of new money and are attracting new customers every day."

"If you look at the RTS index, on a gross fees basis, we beat the market in 2007. RTS index growth for 2007 was 11.5%, and our fund returned 9.2% net fees, close to the market, and 14% gross fees. You could say we saw some consolidation."

The summer's liquidity crisis added to the slowdown, with large outflow of funds concentrated in October. "The global financial turbulence negatively affected investor sentiment, that's for sure," says Larichev. "Investors grew more cautious during the autumn especially. Overall, the Russian investor is becoming more and more informed and dependent on what is happening in global markets. The links are getting tighter between markets."

Troika of old and Troika of new

"Our main fund, Dobrynia Nikitich, invests in Russian stocks, following a long-only strategy, roughly 80% large cap, 20% small cap," explains Larichev. "The strategy is long-term capital appreciation, aiming to maximize returns over longer periods of time, ie. 3-5 years. Ilya Murometz is the oldest fund we manage, and holds long-only Russian fixed-income instruments, 100% bonds, corporate, federal, sub-fed. The third biggest of our mutual funds is Druzhina, which is a balanced fund comprising Russian bonds and equity, with equity comprising 30-70% of the mix, depending on our current view."

As of 2006-2007, Troika also offers a range of sectoral equity funds, catering for more sophisticated investors. The highest returns in 2007 were posted by electricity (32.36%), metals and mining (26.14%), and telecommunications (25.14%).

Not content with this, Troika Dialog Asset Management has shown it can innovate, by launched three pioneering funds that count as Russian firsts in their categories.

Troika's closed-end commercial real estate mutual fund is intended as the Russian equivalent of a US real estate investment trust, or REIT. "What we're doing in this fund is buying commercial real estate and leasing it," says Larichev. "We pay out income once annually, a dividend in an economic, but not legal sense. It has a pretty good return since current rental yields are in double digits due to a lack of commercial real estate in Moscow and in Russia in general, and we believe there is further upside in the price of real estate."

"Our venture fund is also pioneering," enthuses Larichev, "but definitely for more aggressive investors. We invest in start-ups in the technology sector." Troika points out that Russia has the highest scientific research per capita than any country besides the US. Moreover, private investment in technology and innovation benefit from state support.

The Troika life insurance fund is also unparalleled in Russia. "It basically combines exposure to equity market with life insurance," Larichev says. "The idea is that an investor gets a portfolio, but if something happens to him, his heirs inherit his position doubled, so the insurance is a bonus." The rationale is that life insurance is a long product, "and we strongly believe that over the long term the equity market gives the best returns compared to any other instrument."

Chasing the middle-class in 2008

The future growth of investment in mutual funds depends strongly on whether Russia's growing middle class will regard them as natural, profitable and secure investment instruments. "A lot depends on the returns mutual funds provide relative to bank deposits," Larichev argues. "Bank deposits currently give pretty high returns, so we need 15-20% returns to compete. Even last year, we achieved this. The returns should be around 20% to attract the Russian middle class. And bank interest should start to fall soon."

Troika has launched a countrywide educational and advertising campaign, focusing on the big cities, to tell people what mutual funds are and persuade them to invest some of their growing income. However, Troika and other investment banks often hit against a wall of ignorance regarding their operations. The Public Opinion Foundation conducted a survey across 44 Russian regions in March 2007 that found that just 1% of respondents could accurately describe a mutual fund.

For Oleg Larichev, this is both an obstacle to battle against and a reason for optimism. "One astonishing fact is that in China a higher percentage of the population are involved in the stock market than in Russia, although Russian GDP and income per capita is three to five times higher than Chinese. That underlines just what amazing potential for growth exists here," he says.

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