Schroders Buys Russia, Brazil Debt as Emerging-Market Run Fades

  • Local drivers put countries on different track, Barrineau says
  • Rally in broader market evaporates on Fed rate outlook

As the growing prospects for higher U.S. interest rates make investors increasingly anxious about investing in emerging-market debt, Schroders money manager Jim Barrineau sees two countries standing out from the pack: Russia and Brazil.

Country-specific issues have those assets “following their own trajectory” while most peers hit a bump as speculation that the Federal Reserve is moving closer to increasing U.S. borrowing costs saps demand, Barrineau said by phone. His Emerging Markets Multi-Sector Bond Fund has beaten 90 percent of its peers this year. He turned overweight on Russia and Brazil’s local-currency sovereign debt a month ago and said he has been buying “aggressively” in recent weeks.

There’s a “window of opportunity” for Brazil to revive its slumping economy as a temporary government took over after President Dilma Rousseff was suspended amid allegations that she doctored fiscal accounts. In Russia, a rebound in oil, the country’s biggest export, is boosting demand for the local-currency debt amid optimism the central bank will resume a rate-cutting cycle, Barrineau said.

“The fundamentals in both countries are improving, if not improving dramatically,” Barrineau said by phone from New York last week. “We’re cautious on the rest of the asset class, but if you have significant exposure to the countries with improving fundamentals -- this year especially -- you’re likely to do much better.”

Market Standouts

Brazilian and Russian local-currency bonds have rallied this year, handing investors returns of 29 and 16 percent, respectively, according to JPMorgan Chase & Co. indexes. That compares with a 7.4 percent average in emerging markets. Brazilian assets have gained on hopes that a new government will step in to revive growth. In Russia, the rebound in oil prices boosted the growth prospects for the world’s biggest energy exporter.

Some investors are still avoiding these markets, saying the investment risk doesn’t justify the returns. Brazil is beset by its longest recession in more than a century amid a widening corruption probe that has prevented Congress from approving measures to revive growth. Russia is mired in its second year of economic contraction as oil selling for half its five-year average price exacerbates the impact of sanctions linked to the Ukraine conflict. 

Choppy Trading

Historical 60-day volatility in Brazil’s 10-year local-currency notes is at about 25 percent, the highest this year. The ruble’s three-month implied volatility, a measure of exchange-rate swings used to price options, is the highest in emerging markets after Argentina’s peso and South Africa’s rand, suggesting investors anticipate wide price swings will persist.

“The risks in both Russia and Brazil are very high,” Paul Christopher, head of international strategy at Wells Fargo Investment Institute, said in interview. “It will take a lot of time to revive the economy in Brazil. In Russia there is a need to shift the economy from its dependence on oil.”

Local-currency bonds in developing nations have fallen 5.7 percent this month, reducing this year’s gain to 7.4 percent, and concern that investors will pull more money out deepened last week when minutes from the Fed’s April meeting showed that most policy makers said an interest-rate increase would be appropriate next month if the economy continued to improve. As of the close of trading Monday, Fed funds futures traders saw a 32 percent chance of a rate increase in June and 63 percent by September, according to data compiled by Bloomberg. That compares with comparable readings of 4 percent and 37 percent at the beginning of last week.

“We are at historically attractive levels for emerging markets,” Barrineau said. “But the market may have gotten a little bit ahead of itself and is rethinking the Fed stance.”

Emerging-market local-currency bonds have lost 5.7 percent this month. Brazil’s and Russia’s each fell 3.4 percent during the period, according to JPMorgan Chase & Co. indexes.

Brazilian and Russian sovereign bonds are still among the world’s best performers this year. Lawmakers suspended Rousseff while she faces a trial in the Senate on allegations she doctored fiscal accounts. Michel Temer took over as acting president on May 12, naming a new finance minister and central bank president.

Oil, Russia’s largest export, has rallied 74 percent from its 2003 low in late January, pushing Goldman Sachs Group Inc. to UBS Group AG to raise its forecasts for the commodity price.

“I think this is one of the best ways almost in the world to play a recovery in oil prices, and we definitely see a turn in oil prices,” Barrineau said. “You have to be exposed in Brazil, because the benefits of doing so would be so large.”

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