The Russian stock market is relatively young, but an increasing number of its tools are attracting local investors. One of them is unit investment funds (UIFs).
The securities market emerged in Russia when the country began its transition to a market economy, but the financial system was very weak at the time and contained numerous risks. The population's lack of confidence in the system, mainly due to financial crises in the 1990s, and lack of spare money stalled its development for a long time.
As the economy stabilized and financial markets developed, the stock market began growing as well. An increasing number of Russians are now gaining modern financial experience. Economic growth leads to more spare cash in the hands of the population. Traditionally, Russians have saved money in foreign currency, but recent fluctuations in the exchange rate of the U.S. dollar and the euro have made this way of saving less profitable. The interest rates offered for bank deposits, at best, keep pace with inflation. This has made people look for new ways to invest their savings.
Today those with free cash are increasingly turning to collective investment, with UIFs believed to be the most accessible to ordinary people. These UIFs accumulate money from many investors and invest them in stocks and bonds issued by Russian companies. Russia, at present, has 600 such funds, with an average capital of 634 million rubles ($23.5 million) as of October 31, 2006, according to the Federal Financial Markets Service. This market is not big yet, but the pace of its growth is worth noticing. The total value of UIFs' assets soared by 57.5 percent from January to October 2006, to 365.8 billion rubles ($13.5 billion).
UIFs' profitability is significantly higher than that of the banking sector: It surged by 85 percent to 90 percent in some funds last year. The variety of funds is also increasing: Apart from those specializing only in stocks and bonds, there are now mortgage, index and industry funds.
UIFs are now also beginning to invest in retail, telecom and other second- and third-tier stocks instead of only commodities. They could also provide an incentive for developing investment projects in manufacturing sectors.
Today 1.5 million Russians invest in UIFs, according to the Federal Financial Markets Service. This is about 1 percent of the country's population. Individual clients are mainly young people with a higher education and a certain amount of savings. When promoting their products, management companies usually target people age 25 to 45. People who are younger do not have money, they say, and those who are older do not trust new tools and are impossible to persuade. At the same time, UIFs are becoming more accessible. Just a few years ago you could not invest in a fund with less than $1,000. Now, however, there are numerous funds in which the minimum unit costs $100 to $300. People are also becoming wealthier, and management companies are spreading to the regions more aggressively.
The current tendency is for Russian UIFs to expand. In early November, the Financial Markets Service more than tripled the lower limit of a fund's assets: to 10 million rubles for an open UIF, 15 million rubles for an interval UIF and 25 million rubles for a closed UIF. It argued that small funds had difficulty diversifying and managing their assets. However, UIFs actually in operation had long ago surpassed these figures anyway.
The main problem with collective investment in Russia is that UIFs do not guarantee their investors anything, and the latter assume all the risks. The banking system has deposit insurance, but other financial companies do not have any compensation mechanisms for their clients. This is another obstacle for Russian people who are used to having certain guarantees on their investments.
The Russian financial authorities understand this, and included the idea of introducing compensation mechanisms for UIF investors in the Strategy for Financial Markets Development Until 2008. Special funds will be set up to reimburse investors if a management company fails to honor its commitments—for example, if its license is revoked. A corresponding bill will be submitted to the government in the first quarter of 2007.
These measures could really help to spur the development of the collective investment market: certain guarantees will bring in new groups of people. A similar thing happened in the banking sector, where the introduction of the deposit insurance system boosted people's confidence.
At the same time, it's unclear where the money for compensation funds will come from. The Federal Financial Markets Service believes they should be financed by companies involved in the field, with minimal involvement of the federal budget. But the main question is whether this means that additional costs will be shifted to the investor. Moreover, such mechanisms do not offer reimbursement for losses caused by a decline in the market, against which there is no protection.
Overall, the Russian UIF market has a fairly good outlook, and most analysts forecast that it will grow over the next few years. UIFs are unlikely to become an alternative to bank deposits any time soon, but people's interest in these funds will most probably grow as the prosperity and "financial literacy" of Russians improves. This is all the more important because this function of the financial system—re-channeling people's savings into investment—is a crucial factor in the country's economic development.
By Nina Kulikova