Russia’s US$63 billion of investment-grade corporate bonds may find a new buyer in Rogge Global Partners if they follow the sovereign in getting downgraded to junk.
Rogge may consider adding OAO Lukoil notes if the credit rating of Russia’s second-largest oil producer is also lowered to Ba1 at Moody’s Investors Service, said David Newman, the head of global high-yield debt at Rogge, set up in 1984 and managing $55 billion in at least 12 funds. According to Newman’s calculations, Russia’s share in the Bank of America Merrill Lynch Global High Yield Index may rise to as much as 5.5 percent from 1.9 percent once its corporate bonds are downgraded.
“Clearly the big names are coming down, so Russia will become a bigger part of a global high-yield benchmark,” Newman said by email on Wednesday from London. He said he usually looks to keep his portfolio within 10 percent of the Merrill Lynch gauge. “If you are a benchmark hugger, there will be demand,” he said.
Newman’s comments highlight how a downgrade to junk can have a silver lining. As buyers of investment-grade debt pull out, a new investor base moves in that offsets some of that lost money. Russian debt faces as much as $4.5 billion of outflows from funds that track Barclays Plc’s investment-grade Global Aggregate Index, the index provider said this week. Standard & Poor’s cut Russia to junk in January.
BofA Merrill didn’t immediately respond to an emailed request for comment on whether it plans to increase Russia’s weighting in its high-yield gauge. About 36 percent of Russia’s foreign-currency corporate bonds, issued by companies including OAO Gazprom and OAO GMK Norilsk Nickel, are rated investment-grade by Moody’s, data compiled by Bloomberg show.
Even for investors chasing higher returns, the risk that Russian companies could face stiffer sanctions as the crisis in Ukraine drags on makes them wary about buying. The U.K. last year floated the idea of blocking Russia’s access to SWIFT, the messaging system for most international money transfers.
While companies like Lukoil are good investments based on their financial performance, “the other issue is whether sanctions step up and stop the payment mechanism for me to receive coupon and principal,” Newman said.
The yield on Lukoil’s dollar-denominated securities due in April 2023 climbed 22 basis points since the day before the Moody’s cut to 7.27 percent by 6:57 p.m. in Moscow. That compares with an average yield on the BofA high-yield index of 6.11 percent.
Some investors with appetite for speculative debt already took positions in Russian bonds after the escalating crisis in Ukraine and a rout in oil pushed bond yields to more than 250 basis points above Treasuries.
That’s the spread Azhar Hussain, the head of global high yield at Royal London Asset Management Ltd., uses to decide on holdings in his portfolio. Lukoil’s dollar bonds due April 2023 yield 519 basis points above Treasuries.
“We already look at Russian credits as part of our global high-yield mandate,” Hussain said by email on Feb. 24. “The issue is pricing the impact of future political developments on these companies, especially sanctions, as from a balance-sheet perspective the companies look like great investments.”
Companies that were once investment-grade rated and have since plunged into junk territory are offering some of the best returns in U.S. credit markets. So-called “fallen angel” securities have gained 8.1 percent in the past 12 months, and 3.5 percent in 2015 alone, according to BofA Merrill index data.
The securities beat the overall U.S. corporate-bond market by about 2 percentage points in the last year. When broken out by ratings, fallen angels bested both investment-grade and high-yield notes.
“Russian debt can now be in junk bond funds too, so it closes off a relatively large pool of investors, but it opens up new ones,” Neil Shearing, the London-based chief economist for emerging markets at Capital Economics Ltd., said by phone on Feb. 23.
–With assistance from Katie Linsell in Madrid and Lisa Abramowicz in New York.