Introduction of ETFs to Russia boosts market liquidity

Recent changes to Russian legislation that allow the formation of exchange-traded funds in Russia are set to boost capital inflows and liquidity in local securities, analysts predict.

Until this summer, all mutual funds in Russia were either open-, closed-ended or blended investment vehicles. A law passed in July introduced the concept of ETFs to the local market, and outlined the rules and principles of trading such products.

The amendments to the law came into effect at the start of September, so the market has not yet had enough time to respond to the changes. It remains to be seen what exact form these new vehicles will take, but local analysts expect the development to give a boost to the local market.

Daily liquidity

Russia’s market participants have been concerned for some time that the local market has lacked liquid investment options. Simon Fentham-Fletcher (pictured), Renaissance Asset Managers’ portfolio manager and chief of staff in Moscow, says daily liquidity is a key concern for Russian investors, who were severely burned by the 2008 crisis. ETF products offer this liquidity, which leads market practitioners to conclude local product providers will not make clients wait long for the first fund launches.

One of the advantages of ETFs is they are easier to invest in for retail clients than mutual funds. Since the global financial crisis, Russia’s mutual funds have had a bad run. Total mutual fund assets fell in 2008 and have not recovered. Funds have been faced with hard competition from bank deposits: a much less volatile investment option, which currently offers annual rates at 10% or more. In addition, ETFs do not incur management fees.

Lawyers from global firm Dechert also point to increased transparency and investor protection as advantages of ETFs over mutual funds. In a market as volatile as Russia, these advantages can give allocators the much needed peace of mind. “Russian retail investors often don’t understand how a mutual fund works. In an ETF, they can easily track the fund holdings and portfolio structure,” one local market player says.

Apart from this, ETFs allow investors to move in and out of asset classes quickly in response to market conditions. Mutual funds, on the other hand, are less flexible, since they lock an investor into an agreement with the fund provider.

But ETF providers will be able to target a much wider audience than just local investors. According to the new legislation, Russian ETFs can be traded on foreign stock exchanges, subject to the local rules of each exchange. Thus, the new product will give foreign allocators better access to the local market.

SPDR ETFs, the ETF platform of State Street Global Advisors, says ETFs are not only popular with retail investors, but are increasingly being used by institutions, too.

They use the investment vehicle to gain flexibility within the positions they hold, because the transparency offered by ETFs allows them to make quick moves within their allocations.

Dechert lawyers think it remains to be seen how popular ETFs will become with investors, particularly those based outside Russia. They point to existing Russia-focused ETF products available on the market, with which the new launches will have to compete.

The list includes Market Vectors Russia ETF, SPDR S&P Russia and iShares MSCI Capped Index Fund. All three have shown comparable performance figures year to date, rising by about 8%-9%.

Foreign interest

Russian ETF providers will have global competition to face, if they are to attract interest from foreign allocators, especially since it takes time to build a brand name investors can trust. They do, however, have the advantage of operating on the local market, which makes it easier and quicker to trade stocks.

This year’s fund flow data suggests there is foreign investor appetite for Russian ETFs. According to fund flow data from Russia’s Troika Dialog, most of the inflows into Russian retail funds over the past few months have been coming through these types of investment vehicles. Much of this has come from retail investors.

If the trend continues, the ETF market in Russia may prosper and attract the much needed foreign capital into the local market, giving it the liquidity boost it needs.


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