The U.S. may have won the Cold War, but Russia is cashing in on the peace dividend.

In the past five years, the Russian stock market's benchmark indices have posted some staggering gains; the Russian Trading System Index has jumped more than 60% per year in dollar terms and the Moscow Times Index has increased at an 80% rate, while the

S&P 500

shed 2.19% during that time. (See chart.)

Not a bad five-year plan for a nation whose modern capitalist roots only go back to the dissolution of the Soviet Union in 1991, and whose currency devaluation caused a global financial crisis in the summer of 1998.

A number of Russia-based mutual funds have raced upwards along with the market's benchmark indices. The

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ING Russia fund, for example, has a total return of 47.69% a year for the last five years, making it the best-performing equity fund out of Morningstar's entire research universe. Sitting two places behind it in third place is the

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Third Millennium Russia fund with a five-year return of 33.18%.

But as far as Russia's equity markets have progressed in just a few years, some fund managers believe that the Russian revolution in stocks is far from over. At least not if President Vladimir Putin keeps pushing through his structural reforms and oil prices remain high.

The Russian Republican

Not only has the former communist country shown the U.S. that it has learned a thing or two about capitalism since President Ronald Reagan's defense buildup broke the bank of the evil empire, but Russia's second freely elected president seems to have taken a page from the Republican playbook when it comes to lowering taxes and calling for a smaller government.

Since his election in 2000, President Vladimir Putin has successfully lowered personal taxes as well as simplified the tax code. As a result, Russian tax revenues have increased substantially. And after his landslide re-election in March, Putin cut the number of ministries from 30 to 15 in an attempt to rein in the long entrenched Russian bureaucracy.

Michiel Bootsma, portfolio manager at the ING Russia fund, says Putin's most significant economic reform was in restoring the government's power over the oil barons and other corporate oligarchs who were dominating local and national politics.

"As opposed to former President Boris Yeltsin, who sided with Russia's oil oligarchs, Putin told the oligarchies to stay out of politics," says Bootsma. "Some oligarchs were exiled or jailed -- and the rest got the message."

One oligarch who failed to heed Putin's warnings was Russian oil giant

Yukos Oil's

majority shareholder -- and Russia's richest man -- Mikhail Khodorkovsky, who was jailed after he refused to stop supporting the formation of liberal parties opposed to Putin's majority. Khodorkovsky's imprisonment was decried by many members of the international community as a return to Russia's totalitarian past, and also spooked analysts.

Bootsma says that corporate governance has improved since Putin confronted the oligarchs. They even learned the valuable lesson -- forgotten by a number of American CEOs in the late 1990s -- that if you take care of the minority shareholder, you can actually do better than just stealing money from the company by yourself.

Despite Putin's successes, analysts say the country is still closer to the beginning than the end of the reform process, which poses one of the biggest risks to Russian markets going forward.

John Connor, portfolio manager for the Third Millennium Russia fund, says the bureaucracy is still immense and the banking system is very weak (he calls Russia a "second-world country"), but increased economic reform will create additional market opportunities down the road.

"Putin reorganized the telecom industry and now telecom is more important to our portfolio than oil," says Connor, whose fund's largest holding, at 8% of assets, is Russian wireless provider

Vimpel Communications

(VIP)

. "And the utility and banking industries are next," added Connor.

Connor owns Vimpel Communications as an American Depositary Receipt, one of only five Russian companies trading as ADRs on the

New York Stock Exchange

, which makes investing in Russia through a mutual or closed-end fund almost unavoidable.

It's All About the Oil

Telecom, banking, utilities and other sector opportunities may soon follow, but for the time being, investors interested in Russian funds should realize that there's no escaping the influence of oil.

Morningstar analyst Gregg Wolper points out that the ING Russia fund has a potentially dangerous 30% concentration in two oil stocks -- Yukos Oil and

Lukoil Oil

. "Should commodity prices tumble," says Wolper, "there would be no place to hide."

Fund managers seem to be less fearful about the effects of a decline in oil prices, as long as they don't crash. "We recognize that the price of oil is important," says Julian Mayo, investment adviser to

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U.S. Global Investors Eastern Europe fund, "but Russian growth should continue to be strong unless oil prices collapse to half their current levels."

So far oil prices have not buckled and the oil companies continue to be profitable. Third Millennium's Conner says Russian oil companies continue to be attractive investments because they trade at low-single-digit P/E's compared to western companies trading at twice those multiples. Furthermore, they have huge reserves and pay dividends.

Diversifying out of oil stocks is also not a walk in Gorky Park for fund managers. Even after all the strides made by Russian companies, there are still very few blue-chip stocks available from which to choose. Bootsma estimates that there are only 10 to 12 blue-chip liquid Russian names to choose from, a far cry from the many alternatives in the S&P 500.

"We have a bias towards the liquid names," says Julian Mayo. "Below this, liquidity is a problem that needs to be analyzed very carefully."

The lack of choice is certainly not stopping Russian fund managers from charging higher-than-average management fees. The ING Russia fund and the Third Millenium Russia fund carry fees of 2.09% and 2.75%, respectively, higher than the 1.85% Morningstar average for international stock funds.

Until that liquidity problem is solved, the main liquid influencing Russian stocks will continue to be oil.