Russia reforms fail to win over investors For the past four years, the Kremlin has been pouring time and money into turning Moscow into an international financial centre and, in principle, ticking all the right boxes. It has merged Moscow's two exchanges, created a central securities depositary, reduced settlement time for trades and is in the process of selling off stakes in state companies, including Sberbank, as part of a sweeping privatisation programme. Yet for global equity investors, the reforms do not appear to have clicked. Russian stocks are among the cheapest in the world, a strange distinction given the country's political and economic stability, low debt and growing middle class. The Russian Micex index has drastically underperformed the MSCI Emerging Markets gauge in recent years. It has dropped a further 3.2 per cent this year, while the broader index is roughly flat. The index now trades at a forward-looking price-to-earnings ratio of just 5.5 times, a low figure even for Russia, and beaten by markets such as Pakistan and Greece. In fact, Russia has consistently underperformed other emerging markets since the global financial crisis and most investors chalk up the discount to an exaggerated perception of Russian risk. "The Russian worries are overstated," says Sam Vecht, head of BlackRock's emerging markets specialist equities team. It's everyone's favourite place to be negative about. Yet the market is also reeling from a string of disappointing news, developments that would have been easy to brush off on their own but which collectively have dampened sentiment. In April, ministers began sounding alarm bells about a Russian economic slowdown, after the country reported close to flat growth for the month of February. While the economy expanded by a healthy 3.4 per cent in 2012, Russia's economy ministry now expects the country to grow at just 2.4 per cent this year, down from an earlier forecast of 3.6 per cent. The news of the slowdown came shortly after the bailout of Cyprus, a huge hit for Russia given the large number of Russian companies, state groups included, that have operations there. Investors have also taken issue with corporate governance issues at state companies, particularly in the energy sector. Following its March acquisition of TNK-BP, state-owned Rosneft is now the world's largest publicly traded oil producer by output. Yet while the deal was meant to herald a new era of corporate governance for Russian state groups - John Mack, ex-Morgan Stanley chairman, and Igor Sechin, steely Rosneft chairman, are now regularly trotted out in front of investors - shareholders have balked at the treatment of TNK-BP minorities. The Russian corporate sector is still dominated by resource companies with a lot of state involvement. Gazprom doesn't care about me, or about shareholder returns in general. It cares about the Russian government and its policies Matthew Vaight, M&G Investments Mr Sechin has refused to buy out the minorities who were left holding 5 per cent of Rosneft stock following the deal, saying it was shareholders" fault they had decided to remain in TNK-BP. While last month he finally indicated that Rosneft was willing to negotiate with the minorities, he insisted that the state group would play hardball, noting that Rosneft was "not a charity fund." Investors note parallels between the situation at Rosneft and that of Gazprom, which recently disappointed investors on dividends. It cares about the Russian government and its policies," says Matthew Vaight, an emerging market equity fund manager at M&G Investments. South Africa and Mexico are the best performing markets over the past decade and it's no coincidence that they have the least amount of state-controlled companies. Another energy group, Surgutneftegas, number-three oil producer, reported annual results by International Financial Reporting Standards for the first time in 11 years on April 30, but neglected to inform investors about what had happened to $15bn worth of treasury shares that were no longer on the books. "Investors are disappointed with the slowing economic growth, the inconsistent execution, or lack thereof of important economic reforms, especially on behalf of most of the state-owned companies," says Vladimir Savov, an equities strategist at Otkritie Capital in Moscow. Over the past two weeks, Russian equities have enjoyed a slight rebound, with the Micex index rising 7 per cent since April 22. And in the end there are some investors who think that even with the corporate governance concerns, the current Russian discount is too big to miss. We like Russia and think it's the cheapest way to buy into the oil and gas story. It's cheap in both relative and absolute terms," says Philip Poole, global head of strategy at HSBC Asset Management. The Russian issues are well known and that continues to dampen interest. But if you think the world economy is on the mend, then it is a cheap way to gain exposure to a cyclical market.