There’s Value in Russia’s Future

Saturday, February 11th, 2012

There’s Value in Russia’s Future

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

As Americans ponder the merits of Obama vs. Gingrich, Paul, Romney or Santorum, Russia will be electing its own president on March 4.

Perhaps we should say “re-electing” since it’s almost certain former president and current prime minster Vladimir Putin will be elected. While protests and vocal opposition likely won’t prevent Putin’s presidential return, they have forced some interesting changes to the political climate and we’ve observed some positive changes in Russia’s investment landscape.

The story begins last December when Putin’s political party, United Russia, performed poorly in Russia’s parliamentary elections. According to official election results, United Russia retained only 238 seats (down from 315 seats) in the 450-member State Duma, the lower house of the Federal Assembly of Russia.

While these results struck a blow to United Russia’s parliamentary power, it was an uppercut to democracy in Russia as suspicions of fraud emerged following exit polls that predicted an even wider defeat. Another one-two punch combination for Russian democracy came when Putin said he had planned all along to swap seats with President Dmitry Medvedev in 2012.

This did not sit well with many young Russians who were raised with the hope of a democratic Russia, compelling them to take to the streets to voice their opposition.

In an effort to gain popularity among these protesters, Putin announced that he would introduce a one-time tax on oligarch companies that acquired state assets during the privatization of Russia in the 1990s following the fall of the Soviet Union. Privatization helped Russia shift toward a market economy, but it is widely believed that only a few well-connected people (business oligarchs) benefited and caused the wealth gap to increase substantially.

“An overwhelming majority of Russians think—with some justification—that the ‘loans for shares’ assets were sold at substantially below their market value … In other words there is unlikely to be much domestic opposition to this proposal,” says Morgan Stanley.

Putin’s one-time windfall tax appears to be based on the U.K. approach, says Morgan Stanley. In 1997, the U.K. imposed a one-time payment on the owners of assets acquired during privatizations in the 1980s. The tax was 23 percent of the difference between the purchase price and the average net profit during the first four years following privatization, multiplied by the factor of 9.3. This resulted in an extra $8 billion for the British crown, according to Morgan Stanley.

The tax is a political risk in Russia, especially for the oligarch-owned businesses. However, our team has always preferred self-made businesses as the owners generally have their own skin in the game.

To understand the complex political situation in Russia, it helps to hear many sides of a story, so last week we sent Tim Steinle, co-portfolio manager of the Eastern European Fund (EUROX), to Moscow in advance of the historic presidential election. While in Russia, Tim had the opportunity to hear Alexey Navalny, a leader of Russia’s opposition movement, give his side of the story.

Navalny coined the name “the party of crooks and thieves” that became popular for United Russia. According to a profile by The New Yorker, when United Russia threatened to file a suit against Navalny for slander, he posted a poll on his blog asking readers whether they thought United Russia was a party of crooks and thieves—Ninety-six percent of his readers agreed with him.

Trained as a lawyer, Navalny has positioned himself as a defender of minority shareholder rights against state-owned companies. He alleges a theft of $4 billion from pipeline operator Transneft that the government refuses to prosecute. In addition, Navalny points out that few management boards have independent directors, and even though by law just 2 percent of shareholder votes are sufficient to nominate a director, all nominations are done by the state. Even relatively investor friendly Sberbank has only one independent director out of 17.

Tim says there is a yearning for positive change among the reform-minded intelligentsia, the name given to Russia’s intelligent social class. The intelligentsia also pushes for a fair playing field and registration for political parties and a free media.

Navalny compares gains by communists and socialists in the recent election to political dynamics in Eastern Europe in the 1990s, when the pendulum swung to liberals and back. In his view, this is a healthy development, as the economic platform of Communist and Just Russia parties are not that different from United Russia.

Navalny wages a battle of a thousand cuts to increase the stress on the regime he says is “on manual control.” Historically speaking, reformers such as Kruschev, Gorbachev, Yeltsin, and Putin came from within the system. Navalny is clearly on the outside looking in.

Tim also sat in on a discussion with former finance minister Alexei Kudrin, who served as Russia’s minister of finance from 2000 until September 2011. He was the longest-serving finance minister in post-Soviet Russia, credited with prudent fiscal management and a champion of the free market. He helped Russia weather the global financial crisis in 2008 by creating finance reserves which held a portion of the revenue from oil exports in a stabilization fund despite strong opposition from others who wanted to spend the money. Those savings were crucial to Russia’s economy when the crisis hit and oil prices dropped.

Over the past 10 years, Russia’s GDP grew at a robust pace of 7 percent annually and Russian companies greatly benefited from profits reinvested in their businesses. Russia’s growth story now turns to value as Kudrin expects Russia to grow at a much slower pace, averaging around 4 percent.

We have seen this transformation in some Russian companies lately. Domestically, we have looked for growing, profitable and well-run companies that demonstrate significant growth in three key areas: revenue, earnings and return on equity.

Russian companies have not usually met the criteria, but when we run this screen today, we see that many large-cap businesses are showing significant revenue growth, earnings per share growth and return on investment. Additionally, many of these companies can be purchased at the lowest valuations they have been at in three years. Whereas the price-to-earnings ratio for the Russian MICEX Index has averaged near 10 times since 2003, the current ratio of 5 times.

Increasingly, Russian companies have begun paying dividends too, with some companies paying as much as a 10 percent annual dividend. As interest rates around the world will remain low or even negative for years to come, dividends offer investors the opportunity to earn income with the potential of appreciation.

Although political risks remain, we believe the country continues to be a hotbed of opportunity for emerging market investors. For the Eastern European Fund (EUROX), we’ll continue to seek self-made businesses that pay dividends. These companies generally are run by owners who have invested their own capital and have a track record of growth.

Tags: Chief Investment Officer, Democracy In Russia, Democratic Russia, Dmitry Medvedev, Fall Of The Soviet Union, Frank Holmes, Interesting Changes, Investment Landscape, Official Election Results, Parliamentary Power, Paul Romney, Political Climate, Prime Minster, Punch Combination, Russian Democracy, State Assets, U S Global Investors, Vladimir Putin, Vocal Opposition, Wealth Gap
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A Top Priority for NDP Opposition?

Thursday, May 12th, 2011

A Top Priority for NDP Opposition?

by Leo Kolivakis, Pension Pulse

Jeff Lee of the Vancouver Sun reports, Layton singles out pension reform in Vancouver:

NDP leader Jack Layton signalled Wednesday that pension reform will be his party’s main thrust as the official Opposition, saying Prime Minster Stephen Harper is “practically alone in ignoring the looming retirement security crisis.”In his first major speech since winning 103 seats in the May 2 federal election, Layton told delegates at the Canadian Labour Congress in Vancouver that “yes, Stephen Harper won a majority, but he is facing the largest, most united official Opposition in 31 years.”

It is a reference to the 1980 election in which Pierre Elliott Trudeau returned to power with a majority, reducing Joe Clark’s Conservatives to 103 seats.

Layton said the NDP will use their strength in Parliament to pressure the Harper government to improve retirement security for Canadians, many of whom he said had seen their savings wiped out in the recession.

Layton’s speech to the entirely friendly CLC convention came after an election that propelled his party to official Opposition status and gave the Conservatives a solid majority with 166 seats. The Liberals were reduced to just 34, and the Green party won one. The NDP’s rise included 59 seats in Quebec, where the once-dominant Bloc Quebecois was reduced to a rump party of four seats.

In a scrum with reporters later, Layton also weighed in on B.C.’s HST referendum, saying he doesn’t think taxpayers should have to repay the $1.6 billion Ottawa gave to Victoria if the tax is voted down this summer.

He said it would be too late to collect back Ottawa’s prepayment.

“It is not the fault of the people of British Columbia that this policy was brought in. It is Stephen Harper’s fault and Gordon Campbell’s fault. That money has already gone into education and health care.”

And he said the Harper government needs to go after “the collusion” that may exist between gas companies in light of the recent spike in prices at gas pumps.

“We believe Ottawa should play a role here, and that we need to get really tough with our anti-competition bureau should go after the collusion that may or may not be taking place. It is tough to prove it with these companies, of course, but you need to have real teeth there,” he said.

But it was on the issue of pension reform and retirement security that Layton spent most of his time. He said provincial governments have already recognized the “brewing storm” and are wanting to strengthen the Canada Pension Plan and the Quebec Pension Plan.

“So far, Stephen Harper has not been a willing partner,” he told convention delegates.

In his scrum, Layton said Harper ignores Canadians’ concern over retirement security at his peril. One only has to look at Quebec, where the NDP won so many of its seats. Quebecers are deeply worried about the Quebec Pension Plan, he said.

“[Harper's] complete absence of real commitment to deal with the retirement security crisis that so many seniors or near seniors are facing is one of those issues we’re going to push very hard,” he said.

“We’re suggesting the whole question of pension reform and strengthening peoples’ retirement security could be one of those areas where he can demonstrate he’s actually been listening to Canadians.”

The Conservatives have instead opted for a private pension scheme and have put improvements to the Canada Pension Plan on a slow track.

Layton brushed aside questions that continue to dog Ruth Ellen Brosseau, the young Quebec MP who was elected without ever having visited her riding of Berthier-Maskinonge and instead went on a vacation to Las Vegas. He said Brosseau was in her riding Wednesday. He refused to say whether the party would insist all future MPs first visit their ridings before seeking election, calling the question hypothetical.

But he said he found it contradictory that people complain when young people don’t vote or get engaged in politics, and then complain again when they do and end up getting elected.

“Now that they got out to vote and some of them ran for election and some of them won, now we’re saying that’s not right that these young people got elected as members of Parliament,” he said. “To me that is ridiculous and most young people and others are seeing really how silly that is.”

Someone told me I should have ran for the NDP. I’d be collecting a $158,000 a year paycheck as an MP and if I won a second term, I’d be collecting a nice gold plated pension (managed by my former employer, PSP Investments).

The problem is that I am fiercely independent and have have little patience for political posturing. The last time I testified at Parliament Hill, I left MPs from all parties with their mouths open (you should have seen the looks on their faces — priceless!!). Can you imagine if I was in Ottawa now as an MP debating pensions? I’d make a lot of powerful senior pension fund managers in Canada very nervous.

I’d probably start by exposing the risks public pension plans are taking, carefully examining leverage and other risks across all investment portfolios. I’d demand a hell of a lot more transparency, including detailed discussion on benchmarks and board minutes. I’d then ask those polite folks at the Treasury Board to dust off that 100 plus page report on the governance of the Public service pension plan I prepared for them back in 2007 that was suppose to be followed up by the Auditor General of Canada (not surprisingly, they buried it as it scared them to death, and to my knowledge, none of my recommendations were ever implemented or followed up on by the Auditor General of Canada). I’d educate MPs on the good, bad and ugly of pension fund governance in Canada and what needs to be done to bolster our public pension system.

Having said this, I’ll tell you one thing, while our public pensions aren’t perfect, they’re infinitely better than the private sector defined-contribution (DC) plans that banks and insurance companies are peddling. In my open letter to Prime Minister Harper, I praised the Conservatives for introducing tax-free savings accounts (TFSAs), but I also stated that we need to reform our pension system and that the Liberal and NDP platforms on pensions are way ahead of what the Conservatives are proposing because they’re not pandering to banks, insurance and mutual fund companies.

I’m not against the private sector, and do see a role for them managing money, but in my ideal world, corporations would shift over their pensions (DB and DC) to new government sponsored Crown corporations which would invest in both public and private markets around the world. These new entities would follow the best pension fund governance standards from across the world and they would be capped at a certain size so we’d avoid having a behemoth fund like Japan’s giant GPIF (at one point, economies of scale work against you).

But how can we afford public defined-benefit plans for everyone? Private sector interest groups like the Canadian Federation of Independent Business are calling for the end of unions and attacking the proposal to expand the CPP. Unfortunately, the current CFIB president, Catherine Swift, is absolutely clueless on pension matters.

When I was working at the Business Development Bank of Canada (BDC), I urged senior managers there to look at pensions and come up with a cost-effective way of pooling resources from Canadian small businesses. The money can be managed by the Canada Pension Plan Investment Board (CPPIB) or one of the new entities I discussed above. Small businesses want access to a safe retirement, much like the ones MPs and civil servants have, but they’re scared off by a bunch of fear mongering nonsense that Ms. Swift and others are peddling when they state we can’t afford it (I think we can’t afford not to reform our pension system).

Speaking of rubbish, Jonathan Chevreau of the right-wing National Post wrote another terrible article attacking the NDP proposal. This is the same guy who attacked “Big CPP” and showed me he too is clueless of the benefits of public defined-benefit plans. It doesn’t matter whether you’re on the right or left end of the political spectrum, facts are facts. And the fact is that large Canadian public defined-benefit plans have outperformed private sector defined-contribution plans over the long-term and will continue to outperform them for the simple reason that they’re cheaper and can invest in the best managers around the world in both public and private markets.

At the end of the day, all Canadians should enjoy the same retirement security that MPs and the federal civil service are entitled to. We have enough smart actuaries and investment professionals to figure out the cost and management of such a proposal but it’s high time we stop peddling nonsense and actually do something to bolster our pension system. And let’s start by building on what already works well, our large public pension plans which are among the best in the world. If we do this right, we will become global leaders in pension reform. If we do nothing, we’ll ensure more pension poverty down the road.

Tags: Bloc Quebecois, Canadian, Canadian Labour Congress, Canadian Market, Clc Convention, Collusion, Federal Election, Gold, Gordon Campbell, Joe Clark, Leader Jack Layton, Ndp Leader, Official Opposition, Pension Reform, Pierre Elliott Trudeau, Prime Minster, Retirement Security, Scrum, Security Crisis, Stephen Harper, Sun Reports, Top Priority, Vancouver Sun
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