Russia Junk Selloff No Reason to Buy as Ukraine Flares Up

A selloff in Russian bonds after Standard & Poor’s cut the sovereign to junk by is failing to lure money managers from Aviva Investors to Rogge Global Partners Plc back to the securities because the Ukraine conflict is worsening.

Russia’s 2020 Eurobonds fell this week, taking the increase in yield since S&P put Russia on negative credit review last month to 1.44 percentage points. Even as investors speculated bond prices reflected the S&P rating cut, the outlook was clouded by the European Union’s threat to tighten sanctions on Russia as soon as Thursday after dozens of civilians were killed in renewed violence in eastern Ukraine.

“I would rather keep my powder dry for the time being,” Michael Ganske, who helps oversee $7 billion in emerging-market bonds and currencies at Rogge in London, said. “S&P was priced already, but there is a problem: the eastern Ukraine situation is deteriorating and the West is starting to talk about additional sanctions.”

S&P downgraded Russia’s foreign-currency credit rating on Jan. 26 by one step to BB+, the same level as Bulgaria and Indonesia, and said the outlook for the sovereign remains negative. That might force funds with a mandate to hold investment-grade debt to sell Russian bonds, further hurting Russia’s ability to borrow abroad.

‘Challenged Credit’

Moody’s Investors Service and Fitch Ratings both cut Russia to the lowest investment grade this year. If they take the sovereign to junk it would trigger $4.66 billion of “forced” selling of sovereign foreign-currency bonds and $1.1 billion of domestic notes known as OFZs, JPMorgan analysts led by Anatoliy Shal wrote in a note to clients.

“On average, Russia is still investment grade,” said Lutz Roehmeyer, who oversees $1.1 billion of emerging-market debt at Landesbank Berlin Investment GmbH. “Once Russia loses the BBB-rating from other rating agencies, the selloff will be more severe. So yes, we selectively buy Russian assets but we will buy more when the second and third downgrades come.”

The worst clashes in eastern Ukraine between the rebels and government troops since a September truce and increased the risk of further sanctions make Russia a “challenged credit,” said Aaron Grehan, a London-based fund manager who helps oversee $4.5 billion in emerging-market debt at Aviva Investors.

“We are not required to act on the downgrade but we continue to assess the technical impact it will have on the flow from investors who may be unable to hold high-yield rated assets,” Grehan said. “I do not believe there is imminent risk to a downgrade from the other agencies but the trajectory is no doubt lower.”

Buying Time

Investors following rating decisions risk selling the bonds near the bottom, when they should actually be buying, according to Jan Dehn, the London-based head of research at Ashmore Group which oversees about $70 billion in emerging-market assets.

“I like Russia sovereign debt at these yields,” he said.

Still, there are enough concerns in Russia to put off all but the most brave of investors. The economy may shrink 3.5 percent this year, according to the median estimate of 29 economists surveyed by Bloomberg. Oil, the country’s main export commodity, has plunged 57 percent from a high in June and the ruble has sunk 48 percent against the dollar in the past 12 months, the worst performance among global currencies tracked by Bloomberg. Borrowing costs are the highest in more than a decade.

“We have seen a massive adjustment in Russian exposure over the last several months,” Grehan of Aviva said. “We expected a muted price reaction from the eventual downgrade, so were not assessing it as an opportunity to alter our exposure.”

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