Until recently, Russian stocks and exchange traded funds such as the Market Vectors Russia ETF (NYSEArca: RSX) had been this year’s star BRIC performers. Next year could bring opportunity for another Russian asset class investors once avoided: Bonds.
There was a time when Russian bonds were an avoidable asset class. That time was last year. In December 2014, Standard & Poor’s placed Russia’s sovereign debt on CreditWatch with negative implications. In April of that year, Standard & Poor’s lowered its rating on Russian sovereign debt to BBB-, the lowest investment grade. It was the first time the ratings agency has downgraded Russia since 2008. Russia’s BBB- rating is the same as fellow BRIC members Brazil and India, but it looks like Russia is the most vulnerable to being lowered to junk status. [Russia ETFs Slide After S&P Downgrade]
Also in December 2014, Russia’s Central bank boosted its benchmark interest rate to 17% from 10.5%. The rate hike was the second since the previous Thursday and in the span of less than a week Russian borrowing costs more than doubled from 8%. The drastic move by Russia’s central bank spurred speculation it was not done moving to save the flailing ruble and that future moves could include capital controls.
Bond ETFs with exposure to Russian debt include the ProShares Short Term USD Emerging Market Bond ETF (BATS: EMSH) and the Vanguard Emerging Markets Government Bond ETF (NasdaqGM: VWOB).
Now, some investors see value in Russian bonds.
“Where to find potential value: The key thing when buying Russian debt is to look at the relationship of the issuer with the Russian government Larson believes. Given the degree of political management of the economy, investors are better off being closer to the government, so it could be better to buy a company that is government owned or has close government relations. In the corporate space, that could mean the bonds of companies that are strategically important to the Russian government or are state controlled,” according to a BNY Mellon note posted by Dimitra DeFotis of Barron’s.
The iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEArca: EMB) and the PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY), the two largest emerging markets bond ETFs, also feature modest allocations to Russian debt.
Vanguard Emerging Markets Government Bond ETF
Tom Lydon’s clients own shares of EMB.