LONDON/MOSCOW Rising discontent with the 12-year rule of Russia's Vladimir Putin and the likelihood of more turmoil before presidential elections next March are adding an extra layer of concern for foreign investors.
Unexpected public fury over last weekend's parliamentary election have led to protests, which could gather steam in coming weeks to pose challenges to Putin as he sets his sights on returning to the Kremlin.
Eoghan Flanagan, head of emerging markets equities at fund manager Liontrust in London had already cut exposure to Russia before the election, mainly as part of a euro zone crisis risl reduction.
But he is now concerned about the risk of turmoil like that which toppled long-time Egyptian leader Hosni Mubarak but sent the country's economy into a tailspin and led to massive investment outflows.
The election turmoil has pushed Russian stocks down 8.5 percent this week, with Tuesday seeing a 5 percent selloff.
"Everyone who invests in Russia knows they are investing in a status quo that doesn't have very deep roots in democracy," Flanaghan said, adding the possibility of an Egypt-type scenario in Russia had gone "from zero to 5 percent."
While Putin remains the only viable presidential contender, another fund manager said any interpretation of the latest election as a 'primary' for his Kremlin bid suggests he has a lot of work to do to win the confidence of the Russian people.
"We run a global mandate and it is not appropriate for us to invest in Russia at this stage," he said, asking not to be named. "It is not a destination for new money."
Very few expect next year's election to throw up a Russian Spring, however.
So foreign investors' reaction has been muted so far -- this week $36 million was withdrawn from Russia or 0.07 percent of assets managed by selected funds, data tracker EPFR says.
For now at least, prices for oil, Russia's mainstay, are not seen falling below $100. And Russian stock valuations are extremely attractive, trading at a less than 5 times forward earnings - the lowest among major emerging markets.
But stocks have fallen far more than the 1 percent loss for broader emerging markets over the same period, reflecting the rising political risk. On bond markets, premiums investors demand to hold Russian dollar bonds are up.
"In the current environment all this will be a convenient excuse to reduce exposure to Russia," said Zsolt Papp, who helps run $1.2 billion in emerging debt at Union Bancaire Privee.
"The protests may not affect the fundamental picture but it's not the best thing to happen in an environment where people are nervous and there are fiscal and commodity price concerns."
One fear is the Kremlin will ramp up spending to appease an angry population. Coming on top of this year's big salary and pension rises, that's bad news for the budget and will increase Moscow's vulnerability to any oil price reversal.
Capital flight, Russia's old headache, is seen topping $80 billion this year, well above forecast. Any escalation will hit the rouble's exchange rate versus the dollar, making investments in rouble-denominated securities unattractive.
That fear for the rouble is why UBP is underweight rouble-denominated bonds, Papp says.
STOCKS AT RISK
Ultra-cheap valuations have kept emerging fund managers sweet on Russia for some time now. They have been overweight since mid-2009, Bank of America/Merrill Lynch's monthly surveys show. Last month's poll showed 56 percent overweight Russia.
Those valuations just got cheaper. Moscow tends to trade at a 30 percent discount to emerging peers, due to a heavy commodity weighting and corporate governance concerns. That discount is 50 percent now.
"There has been a big rise in political risk," says Julian Mayo, who runs $3 billion in emerging stocks at Charlemagne Capital. "Russian stocks have never looked cheaper compared with oil prices, not even in 2008 when oil went to $50 a barrel."
Some investors had clearly been apprehensive even before the election -- Mayo noted that Russian stocks have fallen 20 percent this year, bucking the 14 percent oil price rise.
But Russia still has its fans -- Mayo for instance notes high oil prices will keep cash flowing into Moscow's coffers and ultimately into the pockets of civil servants and pensioners. That should drive corporate profits.
And in an increasingly risky world, Russia may not be the worst bet. As long as oil doesn't collapse to $50 a barrel, Russia's government and firms can keep up with debt repayments. And 4.5 percent GDP growth compares favourably not only with the West but also regional peers such as Hungary or Poland.
ING's emerging Europe fund is overweight Russia. "If you sell Russia, what do you buy? Central Europe looks even more vulnerable," fund strategist Maarten-Jan Bakkum said.
But even he has cut Russia to neutral in ING's global EM fund. "You don't really want to be positioned with an overweight ahead of the March elections," he said.
(Reporting by Sujata Rao)