From South Africa to Turkey, bond markets profit from Russian losses

LONDON - Reuters

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Emerging market investors are dumping once-hot roublebonds due to the threat of tougher sanctions hanging over Russia, shifting funds to the likes of Turkey, South Africa and Hungary, which only recently had been unpopular.

Seemingly conciliatory comments from President Vladimir Putin on the Ukraine crisis have soothed markets this week. But fears remain that the West - which has so far targeted only a small number of Russian individuals and firms - will impose harsher sanctions, including on the financial sector.

“The fear of sanctions is as bad as sanctions themselves. The fear is: what could you do with Russian assets if sanctions get ratcheted up?” said Kieran Curtis, a portfolio manager at Standard Life Investments, who has gone overweight Turkish local bonds at the expense of Russia.

Russian government bonds, one of the top emerging market trades of 2012 and 2013, are feeling the heat far more than equities, which have been out of favour for a long time.

Foreign funds held 22 percent of the locally-issued debt at the beginning of March, sharply down from a peak of over 28 percent hit in mid-2013 after Moscow eased investors’ access to domestic bond markets.

This share almost certainly fell further in April due to the hardening East-West standoff, with the United States and European Union imposing sanctions after Russia annexed Crimea from Ukraine in March.
Curtis has cut his rouble government bond holdings to below their 10 percent weight in the most widely-used domestic debt index, JPMorgan’s GBI-EM, while the reverse is true for Turkey.

He is not alone. Quarterly data from Boston-based EPFR Global shows that debt funds it tracks had an average 9 percent allocation to Russia by the end of March, down from 10 percent three months earlier and 11 percent last October.

That indicates funds have taken an underweight position relative to Russia’s share in the GBI-EM.
Overall Russian exposures fell to a new record underweight in April, according to JPMorgan’s monthly client survey which also showed rouble exposure in April at the lowest since 2009.

Sanctions or not, Russia is the GBI-EM’s worst performer this year, having lost 11 percent in dollar terms while the index gained 3.5 percent. Much of that is down to the rouble which has fallen 6 percent this year against the dollar.

All this has spurred a hunt for alternatives, not all of which have been popular with foreign investors of late. “It’s a bit of a struggle and you probably have to get comfortable with something you may not have liked before,” Curtis said.

Money leaving Russia is also heading to other members of the “Fragile Five,” countries which have been out of favour because of their high reliance on foreign capital for economic growth.

Most of the five - Turkey, Brazil, Indonesia, South Africa and India - have taken steps to rein in their balance of payments deficits since last year.

“The lucky thing from an investor perspective is that the Fragile Five have shown big improvements and that’s made people feel comfortable opening positions in those countries with the money they may have invested in Russia,” Curtis said.

Bond auctions across these countries have attracted robust demand in recent weeks whereas Russia has cancelled 10 of the 16 scheduled debt sales since the start of this year.