Here's the paradox of the Russian capital markets. On the one hand, the markets appear to be booming. The economy is forecast by the International Monetary Fund to grow by 4.8% this year, the RTS Index of 50 Russian stocks was up 15% by April, although it has fallen back slightly since, and Russian exchange-traded funds have attracted around 50% of all emerging market inflows so far this year.

Yet, on the other hand, Russian initial public offerings are struggling. Five Russian IPOs have been pulled this year while many of those that have managed to come to market have done so at the bottom of their price range, and traded lower still in the secondary market. Only two Russian listings this year, by state-owned bank VTB Group and internet search engine Yandex, are trading above their listing prices.

So do foreign portfolio investors like Russia or don't they? The popularity of Russian ETFs this year doesn't necessarily indicate that investors favor Russia as an investment destination in itself. The increase in ETF flows are more likely to be correlated to the rise in the price of oil. "Investors have been using Russian ETFs as a proxy on rising oil prices, whether to get exposure or as a hedge," says Chris Weafer, chief strategist at Uralsib, a Russian brokerage. Riccardo Orcel, head of Central and Eastern Europe, the Middle East and Africa investment banking at Bank of America Merrill Lynch, believes Russia's economy will continue to be supported by high oil prices and is optimistic for the future. "Prospects for the country are very positive considering several headwinds faced by other countries and regions in the world," he says.

Debt Over Equity

ETFs offer foreign investors an easy way to get exposure to the rising Russian stock market, without having to make the effort to understand a Russian company's accounts or the complex political environment in which it must operate.

IPOs, meanwhile, have underperformed historically. "Russian IPOs do not have a stellar reputation," says Andrew Cornthwaite, deputy chief executive of Renaissance Capital, a leading Russian investment bank. "The average view in London and New York is that Russian companies look to take every possible cent off the table. A lot of the deals over the last year have struggled in the secondary market."

Emerging market debt investors, by contrast, are more comfortable with Russian exposure, because the sovereign and corporates who come to the bond markets typically have robust balance sheets. "Pricing for Russian bonds is back to where it was before the crisis," says Jonathan Brown, head of European bond syndicate at Barclays Capital.

The problem for Moscow investment bankers is that debt issuance levels are falling, because Russian natural resources firms are cash-rich, and there are not many foreign mergers and acquisitions happening. Prime minister Vladimir Putin recently declared that foreign direct investment should rise to $60 billion to $70 billion "in the foreseeable future", from its low level of $13.8 billion in 2010.

But foreign investment is the one thing in Russia that Mr. Putin cannot order. There are always a handful of big deals each year, but a more serious flow of foreign direct investment into Russia would depend on genuine improvements in the country's investment climate.

Wall Street Journal