The RDIF and proof of concept

The Russian Direct Investment Fund, the new $10 billion state-backed vehicle designed to promote foreign direct investment into Russia by acting as a co-investor on big deals, has wasted no time in making its mark: it only officially came into being in January, but it has already closed two deals, with another one imminent, as well as sealing a ground-breaking $4 billion tie-up with China’s sovereign wealth fund. Not a bad few months’ work…

Its first two deals were both interesting in their own way. First up, it chipped in $200 million to support the $1 billion merger between Micex and RTS, Russia’s two biggest stock exchanges, co-investing alongside the European Bank for Reconstruction and Development. Speaking to Private Equity International on the sidelines of the Milken Institute Global Conference in Los Angeles, CEO Kirill Dmitriev insisted that RDIF’s primary focus will be on making a great return (and it has a good chance of doing so, since the exchange sector in Russia has plenty of room for improvement). However, there’s clearly another carrot: by boosting Moscow’s public markets infrastructure, the deal also opens out a potential future exit route for future Russian investments. 

The deal also highlights another of RDIF’s key selling points: the advantage of heavyweight state backing. Russia’s President-elect Vladimir Putin has been a very vocal supporter of the RDIF – and according to Dmitriev, is now doing his bit to help by changing the rules to make it easier for companies to list in Russia. When you have support like that in your corner, it makes life a lot easier. (Indeed, RDIF sees so much potential here that it’s thinking about launching a special vehicle to invest in pre-IPO companies).

Its second deal saw it join forces with an investor group that also includes Russian firm Xenon Capital, Middle East-based AGC Equity Partners and Macquarie Renaissance to buy a 26.43 percent stake in power generator Enel OGK-5. Together, the firms are putting in $625 million, with the RDIF contributing £137.5 million of that. So a very different set of co-investors, and a very different sector – but again, a substantial amount of foreign capital attracted into Russia.

For its third deal, the story is likely to be different again: according to various press reports, it will invest $200 million alongside UK-based Apax Partners in a healthcare deal for Russia’s biggest private clinic chain. Dmitriev refused to comment on this deal. But if it happens, it would represent a further development: the RDIF would not only be attracting fresh capital (this would be Apax’s first deal in Russia) but also sector experience.

But perhaps the most intriguing development has been this new investment venture with China, which will see the two state-owned funds (RDIF and China’s CIC) raise a $4 billion vehicle ($1 billion of their own money, plus a further $2 billion from other investors) to invest in deals with a specific Russia/ China angle. 

According to Dmitriev, this was to some extent an opportunistic move: RDIF started talking to the Chinese and became very excited about the potential opportunity. Currently trade between the two countries is about $80 billion – but China has suggested the total could eventually be ten times that. And since any deals these funds do will effectively be rubber-stamped by both governments, investors will feel that they have a high chance of success, to say the least.

The China fund will have a broadly similar mandate to the main vehicle, aiming for a balanced investment approach across sectors and aiming to generate consistent returns around the 20 percent mark. However, in this case the RDIF won’t be required to act purely as a co-investor on deals – so it will be able to move much more quickly and decisively once it spots a deal. Dmitriev says the RDIF is unlikely to replicate this model elsewhere – but he believes it’s worth it for China. “It’s a recognition that right now, this is a totally open space with tremendous opportunity, where we want to commit extra resources.”

Interestingly, although the two state-backed funds are putting up an equal amount of money, they will not own an equal share in the management company: the RDIF will hold 60 percent to CIC’s 40 percent, largely because the operation will be run out of Moscow and staffed mainly with RDIF appointments.

Another big PR win for the RDIF has been its International Advisory Board, which contains some of the biggest names in private equity (Schwarzman, Bonderman, Halusa et al). This group has already been over for tea and biscuits with Putin in January of this year, and apparently they’ll be back again in June – at the President’s insistence. The Blackstone Group – from whom RDIF has recruited some senior staff – has been particularly helpful in helping the incipient organisation (which is now 60 people strong, including 25 investment professionals) design its processes and practices, Dmitriev said.

For foreign GPs, it’s easy to see the attraction of the RDIF: a well-run local team can act as their eyes and ears on the ground, sourcing deals and doing local diligence. What’s more, given its high-profile backing from the Kremlin, potential co-investors know that the chances of its deals falling through because of a procedural hitch or government opposition are virtually non-existent. 

Dmitriev is keen to stress that he’s trying to build a strong professional team, with the highest standards of governance and best practice. But above all, he wants to be seen as a group that is focused on – and delivers – great returns. Apparently when the advisory board met Putin in January, some expressed concerns that the fund would be used for political purposes, i.e. to boost particular sectors or geographies. But the soon-to-be-President-again was very insistent that the RDIF’s mandate was solely return-driven – because that’s the best way of attracting more direct investment into Russia. “It’s not about promoting this industry or this sector; it’s about making good returns, and people seeing we are focused on that.”

Of course, however compelling this story may seem on paper, it won’t be an easy sell. Investors have had their fingers burned in Russia before, and concerns about transparency, governance and the rule of law remain widespread. Dmitriev freely admits it will take time to address the “major perception gap” that still exists: “We’re changing perceptions, but no matter what we do, it won’t happen overnight.”

So what’s the answer? Getting the message out about how Russia has changed is important, he says (hence his trip to Milken). But perhaps more important will be the proof of concept – delivering market-beating returns for its co-investors. Let’s hope the RDIF can manage that in the next few years.