Worst Return Turns to Best and Back as Kiev Scuffle Stirs Bonds

  • Ukraine bonds fall in February as economy minister quits
  • Political upheaval has analysts split on outlook for debt

Investing in Ukraine’s bonds isn’t for the faint-hearted.

The eastern European nation’s debt handed investors the worst return in emerging markets in February after Mongolia as political wrangling over reforms needed to keep a $17.5 billion International Monetary Fund bailout afloat and corruption threatened to take down Prime Minister Arseniy Yatsenyuk’s government. In January, they were the second-best performers. As for how they will behave in March and beyond, there’s little consensus.

Volatility since a restructuring last year is prompting divergent bets on Ukrainian bonds, as investors pit the benefits of a relatively light short-term debt load and the highest yield in Europe, against emerging cracks in the coalition that’s seeking to transform the country’s post-Soviet economy. Societe Generale SA, JPMorgan Chase & Co. and Bank of America Corp. recommend keeping an overweight stance on the country’s debt, while Barclays Plc and Raiffeisen Bank International AG are underweight.

"Politics are a mess in Ukraine," said Jetro Siekkinen, a money manager who helps oversee $1.5 billion in emerging-market debt at Aktia Asset Management in Helsinki. "It’s surprising that the slow reform process and corruption have taken this long to get in the spotlight."

Siekkinen said he’s waiting for what he sees as a potential second restructuring before considering investing in the country’s debt.

The yield on Ukraine’s Eurobond due 2019 has risen or fallen at least 10 basis points on 30 of 41 trading days this year, rising as high as 12.15 percent last month and falling to as low as 9.26 percent in January. Thirty-day volatility on the notes rose to 18.4 percent on Monday, the highest since the November restructuring and compared to a reading of as low as 7.02 percent in January.

Those swings left investors with a 4.4 percent loss in February after a 3.4 percent return the previous month, according to data compiled by Bloomberg. The bonds have dropped 6.4 percent since trading started in November, compared with a 1.1 percent gain in the Bloomberg USD Emerging Market Sovereign Bond Index.

The 30-day volatility of Ukraine’s dollar bond due 2019 rose to the highest since a November restructuring

“Ukrainian dollar bonds are more volatile than most," William Jackson, an economist at Capital Economics Ltd. in London said by phone. "When things are going well there are hopes that the country will be able to continue servicing its bonds, but it’s very easy for that to turn around and raise the very real prospect of another debt restructuring.”

The bonds have handed owners a roller-coaster ride since the $15 billion restructuring last year as lawmakers wrangle over steps needed to unlock the next tranche of the IMF bailout. While the government pushed a budget through parliament, Economy Minister Aivaras Abromavicius resigned in February and the prime minister lost his majority in parliament as two parties left the ruling coalition. The upheaval has left investors assessing whether the government will stay beyond September, when lawmakers can call for a no-confidence vote.

Under the restructuring, Ukraine has about $500 million in coupon payments every six months until the first bond matures in 2019, with the first installment due Tuesday.

JPMorgan raised its recommendation to overweight from market weight on Feb. 11, citing “attractive” prices as a result of the recent political turbulence and a “very low” external near-term debt burden.

Bank of America raised the debt to "tactical overweight" the next day, following a shift from underweight to neutral in December, amid what it saw as limited risk of early elections. The same day, Barclays switched to a "small underweight," recommending caution amid "increasingly challenging prospects, especially if government tensions lead to a new round of elections."

"Most investors are in wait-and-see mode," said Fyodor Bagnenko, a managing director for fixed-income trading at Dragon Capital in Kiev. "That reduces market activity and liquidity, and in turn leads to higher volatility."

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