Thoughts on Capital Allocation and What I Want To Do in Russia.

“Economic growth should be a national idea, and it should be generated not by the extraction of mineral resources but by the development of innovative industries,”

Vladimir Putin -22 May 2005

"...over the next few years the country's economy will not be able to ride the oil engine anymore. So the issue of new, innovative sources for [economic] development becomes crucial for reaching the social targets set and ensuring a decent position for Russia in the world."

German Gref, Minister of Economy - 16 June 2005

I've been thinking about the Russian economy quite a bit during the research phase of what I want to do for the professional assignment part of this fellowship. Oil is currently getting all the attention, and the country's prosperity is certainly largely a function of >$50 a barrel crude. Russia’s giant oil companies already command hefty market capitalizations. Indeed, the largest components of the RTS exchange already have demonstrated access to global capital. Adding to that market cap is helpful to a degree, but the benefits to the companies and the general economy are at best an indirect function of the secondary marketplace.

The real engine of sustainable economic growth has to be developed outside of commodity markets. I believe that Messrs. Putin and Gref are looking into the future and getting nervous. Broad-based prosperity can only continue long-term if other industries are born. Russia should be using the oil windfall as capital for development of emerging industries. If Russia were a company, we'd say it should milk its cash cow and redeploy the capital into new ventures.

Certainly, Russia is making some of the right moves. It's using oil profits to pay down its debt and to boost foreign currency reserves. But the government needs to follow up on Putin's and Gref's comments by creating a more hospitable environment for small and medium (non-oil) businesses.

I'm fascinated by this turning point in the development of the Russian economy, and I would really like to get a much closer look. So, private equity, venture capital, and the IPO functions of investment banking are the main areas for me to explore as a professional assignment. All these capital allocation functions are vital ways that small and mid-sized businesses get funded in a critical period of their growth cycle. Jobs get created, social welfare increases, economic and legal frameworks are born, people gain experience in professional workplaces and eventually start their own businesses, and the national economy is founded on more solid bedrock of many stakeholders creating their own futures. In short, it may be the birth of a virtuous circle.

Of course, a statement as simple as that is obviously complicated in a place like Russia. Only days before my first conversation on professional assignment interests, The Carlyle Group abandoned its efforts to raise $400 million for a Russia-dedicated fund. They even went so far as to pull the plug on the Moscow office. Now, Carlyle is a successful private equity firm - but their real core competency is as a fundraiser. They've been able to tap nearly bottomless pools of capital for funds all over the world. And a relatively modest $400 million fund for Russia completely stymied them. Hmm.

That would seem to have put the kibosh on the Private Equity idea, but several other pieces in the news point to a slightly rosier picture. In February, Barings Vostok raised a $400 million fund. Alfa Capital announced its participation in a $180 million fund as of April. And last but not least, Delta Private Equity Partners raised a $120 million fund the same week Carlyle called it quits. Perhaps there's hope after all.