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Greylock Buys Ukraine Debt as Hedge Funds Trade Conflict

Photographer: Andrey Rudakov/Bloomberg

Russian President Vladimir Putin. Close

Russian President Vladimir Putin.

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Photographer: Andrey Rudakov/Bloomberg

Russian President Vladimir Putin.

As Russian president Vladimir Putin ratchets up tensions with the U.S. and its allies over the annexation of the Crimean peninsula, the geopolitical turmoil is prompting hedge funds to trade around the conflict.

Carlyle Group LP’s Emerging Sovereign Group LLC, Greylock Capital Management LLC, LNG Capital LLP and GoldenTree Asset Management LP are unearthing opportunities from currency trades, Ukrainian sovereign and corporate debt to Russian bond investments. The crisis that started in November with a violent rebellion sparked by pro-European Ukrainians seeking a decisive break from the nation’s Soviet past, has split the country and provoked the tensest standoff between Russia and the U.S. since the Cold War.

The markets in Russia and Ukraine are deeper than other countries where there’s been political tension and “also extraordinarily cheap,” said Peter Rup, chief investment officer at New York-based Artemis Wealth Advisors LLC, which oversees $800 million and invests in hedge funds.

Ukraine has $44.5 billion of government bonds, with the dollar-denominated securities yielding more than 11 percent, according to data compiled by Bloomberg and JPMorgan Chase & Co. Russia has about $148 billion of government bonds and its companies have $136 billion of dollar-denominated debt. In Syria, which has been in civil war for four years with more than 130,000 people killed, there’s no investment from a capital markets perspective, said Rup.

Close Attention

Andrey Popel, is paying particularly close attention to the conflict in Ukraine.

The 29-year old director at New York-based Greylock helped the hedge-fund firm invest in the sovereign debt of the country last year and is now backing company debt from his homeland. He also has family in eastern Ukraine, from where he emigrated to the U.S. 15 years ago.

“Ukraine has the unique opportunity to get rid of kleptocracy and cronyism and emerge as one of the least corrupt, pro-human rights, pro-business, pro-West countries in Eastern Europe,” Popel said in a telephone interview. “Unfortunately the Crimean situation diverts attention from this cleansing process and makes it a lot more difficult.”

Greylock, which manages $850 million and invests globally, started buying Ukrainian sovereign debt late last year, said Popel, who joined in 2008 after working at Bear Stearns Cos. as an analyst and focuses on Central, Eastern and peripheral European debt.

Yields Climbed

Yields had climbed after now-ousted President Viktor Yanukovych refused to sign the European Union Association Agreement, a treaty between the EU and a non-EU member that creates a framework for co-operation on political, economic, trade or human rights reform. Instead it struck an accord with Russia.

In December, the bonds jumped in value after a $15 billion pledge by Russia averted the risk of default, prompting Greylock to sell, Popel said. The firm then bought again in February as tensions mounted and bond prices slumped.

Greylock has since cut its Ukraine sovereign holdings to 2 percent from 5 percent as yields have dropped, according to Chief Executive Officer Hans Humes. Greylock has shifted into bonds of Ukrainian companies, such as closely-held Metinvest BV, the country’s largest steelmaker, whose yields are in the double digits.

Local Contacts

“Some of the corporates have a strong financial profile,” Popel said, adding it helps for him to talk with local businesses, which Greylock aims to do for any country where it has investments. “The yield on the securities justifies the risk-return. From a purely financial standpoint, the only set of risks we’re seeing is some of the debts can be rescheduled potentially, but even with that the debt burden is manageable.”

So far, the investments have worked. Greylock Global Opportunity Fund rose 4.7 percent last month and 1.2 percent this year, according to a performance update obtained by Bloomberg News. The fund returned 5.1 percent in 2013.

For Emerging Sovereign Group, the $5 billion hedge-fund firm majority-owned by Carlyle Group, Ukraine has been the biggest contributor to 2014 gains for its Credit Macro Event Strategy. The fund gained 1.7 percent this year through Feb. 14 after rising 12 percent last year, according to a Feb. 20 report obtained by Bloomberg News.

Most Vulnerable

The “most vulnerable” emerging-market credits under stress include the Ukrainian currency versus the U.S. dollar, the firm said in the report. The hryvnia fell more than 20 percent against the U.S dollar this year through March 21, the worst performer among all currencies tracked by Bloomberg. ESG said it increased its emerging-markets risk in part by adding to positions in Ukraine.

Randall Whitestone, a spokesman for Carlyle, declined to comment on the report.

LNG Capital, a London-based credit hedge fund that focuses on western Europe, is just getting into trades based on the geopolitical tension. The firm last week started buying one-year Ukrainian sovereign debt and betting against the five-year maturity, said Chief Investment Officer Louis Gargour.

“We want to be short five years because we think there could be more noise and significant events,” Gargour said in a telephone interview. “We don’t want to just be short in case the situation ameliorates.”

Crimea Annexation

Ukraine will probably obtain International Monetary Fund aid even as the Crimean dispute continues, given the strength of support from Europe and the U.S. and the determination of the administration to implement an economic overhaul, Vadim Khramov, a London-based analyst at Bank of America Corp., said by phone on March 17.

Russia last week completed its annexation of Crimea as the European Union signed the accord with Ukraine and expanded sanctions. President Barack Obama implemented sanctions on a wider swath of Russian officials and the world’s leading industrial powers said they won’t attend a planned Group of Eight summit hosted by Putin.

U.S. and European officials said sanctions are already biting. Russia’s Micex stock index has declined 12 percent this year, worse than the 4.6 percent drop in the MSCI Emerging Markets Index.

With Russia’s long-term intentions for Ukraine mostly unknown, LNG plans to stay on the sidelines in terms of Russia-focused investments.

“The effect of the sanctions on Russia will be limited,” Gargour said. “There may be further encroachment on Ukraine sovereignty. It’s better to play Ukraine directly.”

LNG Wagers

LNG last week ended a bet against Russia’s five-year sovereign debt that had been used to offset wagers on corporate bonds of multinational companies that depend on Russian manufacturing, sales or exports, which the firm invests in, he said. The wager against Russian sovereign bonds contributed to a 1 percent year-to-date gain for the firm’s Europa Credit Fund fund after the strategy climbed 16 percent last year.

Other firms are looking more directly to Russia. Steven Tananbaum, chief investment officer of $18 billion New York-based investment firm GoldenTree, said Russian gas monopoly OAO Gazprom (OGZD) presents an opportunity amid turmoil. Russia will do “its best” to honor the debt of the Moscow-based company, Tananbaum said last week at the Absolute Return Symposium in New York. He also said Russia’s sovereign debt is at an “interesting level,” being 50 to 100 basis points cheaper than fair value models suggest.

For Greylock, yields on Russian corporate debt haven’t yet reached levels that justify the risk.

“It’s very tempting in a way, but given the long-term outlook, we expect further economic slowdown that would put more pressure on bond prices,” said Popel. “We’re looking at Russian assets, but we haven’t seen capitulation.”

To contact the reporter on this story: Kelly Bit in New York at kbit@bloomberg.net

To contact the editors responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net Pierre Paulden

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