Russia opens arms to private equity

Kirill Dmitriev, CEO of the $10bn Russian Direct Investment Fund, told Private Equity International the fund will be taking on risk alongside GPs, which should give them more confidence in Russia as a secure investment destination.

Russia has a $10 billion bet riding on its private equity market, and it’s looking for international investors to match it.

The country’s private equity industry has never really taken off as investors have remained hesitant to jump into a country historically plagued by corruption and heavy-handed government measures toward the private sector.

However, all that is changing and Russia is ready to partner with offshore private equity firms and sovereign wealth funds to kick-start the economic-engine in the country. The country has set up the Russian Direct Investment Fund using money from governmental reserves to make direct private equity investments primarily in Russian companies.

The fund is mandated to match each of its investments with that of an international co-investor. The fund is fully staffed, and is expected to make its first investment by the end of this year or early 2012.

Skin in the game

In a recent interview with Private Equity International, Kirill Dmitriev said he understands the hesitancy of investors to bet on Russia, but the fund will be taking on risk right alongside investors, which should (and did) give private equity managers confidence that Russia is a more secure investment than in the past.

“People want to seize these opportunities, but they don’t have enough confidence, they don’t have enough reassurance to do the first transaction … we highly increase that probability, that likelihood. We obviously share risks by investing with them,” he said.

Last week, the $10 billion vehicle appointed some of private equity’s biggest names to its international board of advisors, including The Blackstone Group’s Steve Schwarzman, Apollo Global Management’s Leon Black and TPG Capital’s David Bonderman.

“I was talking to one of the leading private equity shops in the world, basically the founder, and he said, ‘Over the last three years we’ve looked at 18 deals in Russia, and really would love to do something but we haven’t done one … and with you it’s much easier because our interests are aligned and there’s a second pair of eyes looking at this,’” Dmitriev said. 

Strong fundamentals

Doubts about Russia are rife among emerging markets investors, some of whom remember the Russian default on its national debt in 1998 that led to shocks in the global markets. At Harvard University’s private equity conference in March, Russia-focused ALPHA Associates managing director Richard Seewal, said that negative perceptions have contributed to institutional investors’ wariness of country.

“I think if you asked your [non-European] friends how many positive stories they read about Central and Eastern Europe and Russia…It would probably come out at zero,” Seewald said. “That trickles down to the institutional investors that we go out to.”

However, the country’s macro fundamentals are strong, as illustrated by elevated GDP growth, a rising middle class and the low national debt load, especially as compared to more developed economies. According to the International Monetary Fund, Russia’s GDP growth is expected to hover around 4 percent annually through 2016.

The government also has made efforts to make the country more business friendly. For example, counter to its reputation as a hostile business climate, Russia’s capital gains tax is structured to encourage investments in what’s classified as “innovative technologies”, a term that includes information technology, services and other sectors. Such investments held for five years are taxed at a capital gains rate of zero, according to Dmitriev.

“At the end of the day, it’s about risk-reward profile, and we think it’s attractive in Russia. At the end of the day, it’s investors who have to make this call,” he said. “There’s no question there are issues to deal with, same as other markets, but there’s no questions in our minds that the returns can be significantly higher as well.”