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Foreign Funds Take New Look at Russia

With a rebounding economy, resurgent commodity prices and a strengthening currency, Russia is beginning to cast itself in a more favorable light to foreign funds, which rapidly decreased their Russia exposure with the onset of the global financial crisis.

A total of $411 million flowed into Russian funds over the week ending March 11, the highest level since October, far outstripping investment flows into Russia's BRIC peers, according to fund tracker EPFR Global. Brazil attracted only $47 million, India $67 million and China $83 million.

"Investors are warming to the Russia story rather than to any particular market themes … especially with the price of oil now hugging the $80 per barrel level and with ruble appreciation also expected to continue," Chris Weafer, chief strategist at UralSib, said in a note Friday.

"Most of that new Russia money was invested into ETFs and index tracker funds rather than to actively managed funds," he said.

About $191 million, nearly half the total investment into Russian funds, flowed into exchange-traded funds tracking Russian indexes, EPFR said. ETFs are rapidly growing in popularity for foreign investors who want to increase their exposure to emerging markets equities.

Getting in on the increasing flows of cash onto Russia-focused funds, State Street Global Advisors unveiled last week their new Russia-focused, SPDR S&P Russia ETF, which aims to compete with Market Vectors Russia ETF, currently the only other U.S.-traded ETF tracking Russian stocks. The fund will attempt to track the performance of the S&P BMI Russia Capped Index, which focuses on firms domiciled in Russia with a market capitalization of $100 million or more.

"The driving force behind the development of this new emerging market SPDR ETF was increasing investor demand for more precise exposure to the BRIC countries," Anthony Rochte, senior managing director at State Street Global Advisors, said in a statement.

The renewed interest has pushed Russia from underweight to overweight in terms of fund investment compared with its BRIC peers, Brazil, India and China.

Total Russia holdings as a percentage of the average emerging markets fund was 7.66 percent at the end of January, slightly above Russia's weighting in the MSCI emerging markets index, Weafer said. That's up from its nadir in January 2009, when the country was heavily underweight, averaging about 5.16 percent.

And foreign investors' eyes are being increasingly drawn from companies operating in the commodities and oil and gas industries toward the retail and banking sectors. Compared with the MSCI emerging markets index, industry giants Gazprom, LUKoil and Norilsk are all underrepresented in the average portfolio, while Sberbank, VTB and VimpelCom are all overrepresented.

The bump in investment flows helped domestic bourses snap a week of treading water to finish the week solidly in positive territory. The MICEX Index gained 1.4 percent on Friday to finish up 0.1 percent for the week, while the RTS Index rose 2 percent, up 1.8 percent on the week.

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