Russia's stock market has rediscovered political risk and buyers are unlikely to return in force until fraught relations with the West improve and the identity of the next Kremlin leader is known, investors say.

The Russian stock market has lagged every emerging stock market this year except Venezuela. Its estimated 2007 price/earnings ratio of around 10 makes it one of the world's least expensive markets.

Rows over U.S. plans to site a missile defense shield in eastern Europe, Britain's investigation into the murder of former KGB spy Alexander Litvinenko and the future status of Kosovo -- to name just three -- have dented confidence.

That has depressed the MSCI Russia index by 5 percent in the year to date, after a gain of 54 percent in 2006. MSCI's emerging markets index, meanwhile, is up 16 percent.

Leading Moscow investment house Renaissance Capital put on a brave face at its annual investor conference this week, wheeling out former U.S. Secretary of State Colin Powell to tell the audience that the Cold War really is over, despite months of rowing between Russia and the West.

RenCap CEO Stephen Jennings urged investors to ignore what he termed sometimes deafening, often self-serving and usually misleading noise triggered by Russia's resurgence as a major global power and focus instead on the bullish case for Russia.

But with President Vladimir Putin's recent strong speeches against the West ringing in their ears, not all investors were convinced.

President Putin should be careful about what he says, said one western European investment manager, who requested anonymity. When he talks about pointing missiles at us, this has a big effect on sentiment.

The mood is bad, agreed a Swiss-based fund promoter. Most people are waiting until after the elections because they're not sure what will happen.

Putin has given no clues about whom he will endorse as his preferred candidate in presidential elections next March -- something which has made businessmen and investors anxious.

Putin's huge popularity at home, and the Kremlin's influence over the media, mean his preferred candidate is almost certain to win, supposedly ensuring a smooth transition of power.

But investors here remember the last such handover in 1999 when an ailing Boris Yeltsin made way for his own continuity candidate, Putin. A number of leading oligarchs, including YUKOS oil chief Mikhail Khodorkovksy and media magnate Boris Berezovsky, quickly fell from grace under the new regime.

Who will lose out this time around, investors wonder.

TAX TOLL

Politics are not the only problem. A marginal tax rate of over 90 percent on each extra dollar on the price of a barrel of oil is hurting energy stocks, which account for three-fifths of the MSCI Russia index.

Heavyweights Gazprom and LUKOIL, down 7 and 4 percent respectively this year, have acted as a drag.

Investment requirements in the sector are bigger than we have seen in the past, RenCap's oil and gas analyst Adam Landes told a news conference. But the tax system in Russia is not consistent with high investment needs.

John Connor, an American who runs the $120 million Third Millennium Russia fund, has managed to just stay ahead of break even this year by cutting exposure to oil and gas.

We were 50 percent oil and gas last year -- now we are 15 percent oil and gas, Connor told Reuters.

Investors prepared to take on the political risk of buying into Russia are focusing instead on opportunities in the consumer and real estate sectors, taking advantage of soaring disposable incomes in a tight labor market.

Contrarians, of course, see a wider opportunity.

Eric Kraus of the Nikitsky Fund, argues that Russia's recent underperformance is at odds with its excellent economic fundamentals and blames unbalanced, misleading press coverage in much of the Western press for poor sentiment towards Russia.

He points to continued strong economic growth, predicted to hit 7 percent this year, declining inflation, capital inflows and growing profits in the non-oil sector as reasons to buy.

That sentiment is echoed by some of the hedge funds springing up in Russia.

Every time Putin opens his mouth and says he's pointing rockets at Europe, it's a buying opportunity for people like us, one hedge fund manager attending the conference said.

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