After U.S. move, asset owners are divided on whether opportunity is worth the risk
(updated with correction)
Recent U.S. sanctions against certain companies and individuals in Russia are prompting investors to question whether the country is a sensible investment opportunity.
This month, President Donald Trump's administration levied sanctions targeting a number of Russian oligarchs, companies and government officials. Despite the specific targets, the impact resonated within Russia's currency and equity market. The ruble fell about 10% against the dollar in the days following the announcement on April 6, while the Russian equity market fell around 8%, although it recovered somewhat in the following days.
The market capitalization of Russian equities listed on the Moscow Exchange was $33.5 trillion as of March 31. Russia is 3% of the MSCI Emerging Markets index.
While sources said a move in markets like this — particularly one that already was cheap in terms of valuations and remains supported by higher oil prices — would usually encourage active investors to pick through opportunities, they are split as to whether the time is right to add Russian exposure to portfolios, given the sanctions and more potential targets.
Ilmarinen Mutual Pension Insurance Co., Helsinki, has an almost non-existent allocation to Russia, but the country is in its emerging markets investment universe. Executives at the firm — which manages €39.6 billion ($48.8 billion) in pension assets — are watching the market closely.
"At this moment we think that from the global investor's perspective there are, more than usually, big open questions about Russia. ... Currently we are very cautious" regarding investment in Russia, said Mikko Mursula, chief investment officer at Ilmarinen.
Managers across the globe also are cautious, despite potential opportunities afforded by a dip in the ruble, equity and debt markets.
"We had limited exposure to Russian companies and have further reduced it post the sanctions," said Shamaila Khan, director, emerging markets debt at AllianceBernstein (AB) in New York. "The sanctions that have been introduced by the U.S. government recently are far more serious in scope than the ones used in the past, and therefore we are cautious on Russian exposure and in particular on the corporate sector." Ms. Khan added geopolitical risk will be "the key factor to monitor going forward" when it comes to considering opportunities in Russia.
BlueBay Asset Management LLP's emerging market debt team is also taking a careful look at Russia and the potential spillover of sanctions into other companies in the market. The team was broadly neutral to underweight Russia across emerging market strategies ahead of the sanctions, and was overweight Russian banks in its corporate debt strategies and underweight metals and mining, "the sector where the bulk of the negative price action has been," said Polina Kurdyavko, London-based co-head of emerging market debt.
"Even though the recent sell-off has cheapened Russian assets, we believe a higher risk premium is required to compensate investors from the heightened political risk," she said. "From our understanding, the main concern from the U.S. Treasury about the potential market impact of these sanctions had been not to create broader, systemic risk-off sentiment across other markets. So far there has been limited contagion across the wider asset class and this might embolden them to carry out additional sanctions in this way."
Potential for more
Managers also are weighing the potential for further sanctions across equity exposures.
Aviva Investors reduced exposure to Russia following the sanctions, said Bryony Deuchars, portfolio manager-emerging market and Asia-Pacific equities in London.
"The severity of the new sanctions was surprising," she said. "After careful consideration we took the decision to reduce our exposure to Russia in particular through those stocks that we deemed at highest risk of being affected should the situation escalate further."
Other money managers are looking for a better entry point to the Russian market. Union Investment is underweight Russia credit, both sovereign and corporate, following the sanctions announcement, said Sergey Dergachev, Frankfurt-based senior portfolio manager for emerging market debt.
For Mr. Dergachev, the key issue to monitor is the European Union's move regarding sanctions. "The problem would really be if the U.S. sanctions could be extended to third parties, so if a European entity does business with a sanctioned Russian company, it will be heavily fined by U.S. authorities," he said.
However, some money managers took the opportunity to buy into the Russian market dip as assets cheapened, referencing a supportive backdrop of higher oil prices and that valuations are too cheap to skip. But these managers still reduced their holdings immediately after the sanctions.
"At this juncture we feel that the Russian economy has the strength and resources to easily withstand the latest round of sanctions," said Damien Buchet, chief investment officer, emerging markets total return strategy, at Finisterre Capital LLC in London. Thanks to $460 billion of reserves, less than 15% total external debt to GDP, reduced reliance on external funding and diversified oil transactions across non-dollar currencies, he said, "Russia is well placed to weather any (dollar) funding stress, at a time when oil prices are well supported."
Also balancing the sanctions with potential opportunities is Pictet Asset Management Ltd. "Ahead of the sanctions, Russia had been an overweight," said Kiran Nandra, senior product specialist, emerging equities. "Today is still remains an overweight but this has been pared down, due to a combination of our decision to eliminate specific names as well as market movements."
While equities look "very cheap right now," being selective is essential. "The sensitivity comes from the higher risk premium, which we are very aware of; however, the strength of cash generation within specific companies remains exceptionally strong," she said.
Arjun Divecha, head of Grantham, Mayo, Van Otterloo & Co. LLC's emerging markets equity team based in Berkeley, Calif., agreed Russia has a solid macroeconomic backdrop. "This particular bout of sanctions doesn't rise to the level of something we should be too concerned about," he said, given it was targeted at a specific group of people. "It is not going to have a profound impact on the overall economic prospects of the county. We came to the assessment when we looked at stocks we own in Russia, some became cheaper, and we didn't think it would impact on their potential earnings so were happy to top up our positions."
Restrictions on ownership
What would be more damaging than current sanctions relates to any restrictions on foreign ownership of Russia's sovereign debt, said Paul McNamara, investment director, emerging markets at GAM in London. "That could have quite a damaging impact, (with a) knock-on through the rest of the asset class because Russia is a very big element in hard and local currency indices."
The emerging markets team held some Russian debt.
"We feel now this does open up a bit of value — the ruble dropped about 10% against the U.S. dollar," and with the U.S. "walking back the prospect of extending the sanctions we bought some more ruble, and corporate debt for another account. If (the sanctions) only go as far as already announced, the market has overreacted, Russian assets look cheap ... at the moment I am not inclined to stay out of Russia too much," Mr. McNamara added.
And as some managers are analyzing companies for risks related to further sanctions, Allianz Global Investors also is using analysis and research to find opportunities.
The firm had exposure to Russian fixed-income, ranging between 4% and 7% allocations across portfolios, in the run up to the sanctions, said Greg Saichin, chief investment officer-emerging market debt, in London. The country remains on a positive trajectory, he said. "The new wave of sanctions adds volatility and uncertainty that pose headwinds but should not completely derail this momentum given our expectation for oil and non-ferrous metal prices."
Therefore, any offering from Russia that the team deems "extremely good value could potentially be an opportunity, subject to the evaluation of the sanctions regime and its direct impact on macro stability," he added.
Regarding future sanctions, "it is more likely that we see (any) falling on the corporate sector aimed at individuals who control certain companies and who have close ties to Russia's rulers. However, the uncertainty about the extent of sanctions has had a contagion impact on entities whose risk of getting sanctioned is low," Mr. Saichin said. "This is where we see the biggest opportunity."