Investors are starting to buy Ukrainian and Russian bonds that have fallen at discounted prices, betting that they will recover if the war between the two countries ends.
The trade is high risk, given the uncertainty over what Ukraine will look like after the war and how long the financial cordon around Russia will last. It also poses reputational risks due to the human cost of the conflict and the growing reluctance of many financial institutions and corporations to be associated with Russia in any way.
The Gramercy Funds Management LLC investment team held a special meeting on Saturday February 26 to discuss the impact of the invasion on the macro economy and the company’s portfolio. Mohamed El-Erian, chairman of Gramercy and former senior executive at Pacific Investment Management Co., participated alongside Gramercy founder Robert Koenigsberger, who played a role in Argentina’s government bond restructurings.
One of the ideas the company considered was to buy Ukrainian government bonds, which had fallen to around 45 cents on the dollar. The company had the ability to buy because it had sold all of its Russian and Ukrainian bonds about a month earlier.
Ukraine would likely remain independent in some form after the war and would receive massive financial aid from Europe and the United States, Gramercy analysts believed. But they weren’t sure how much debt bond investors would be asked to write off as part of a possible restructuring and decided to wait given the uncertainty.
“We had to be careful not to buy too quickly,” Koenigsberger said.
Ukraine paid interest, issued a new bond and told investors it planned to service its debt, but prices continued to fall as the Russian military advanced. Bonds in the country fell to 22 cents on the dollar on March 2, and Gramercy, based in Greenwich, Conn., started buying.
Prices could fall further, but the risk of missing a rebound is greater, Koenigsberger said. “When it’s really scary, you always have to plan the trade and trade the plan.”
Now is the time to start buying Ukrainian bonds, but many clients are reluctant to participate, said another emerging-markets fund manager who has been buying bonds from the country in recent days. “In fact, two of our biggest investors have contacted us to say no to Russia and maybe not to Ukraine, because it could be part of Russia,” he said.
Gramercy and the emerging markets fund manager said they are not considering buying Russian government debt, but others are diving into it, or at least trying to.
Sovereign bonds denominated in Russian dollars were quoted at around 17 cents to the dollar on March 2, down from 95 the previous week. That’s well below what investors are likely to receive in a restructuring if Russia defaults, even if it takes years to be repaid, said a US hedge fund manager looking to buy. The problem is locating the bonds, the hedge fund manager said. , which only found $5 million worth of bonds to buy.
Many pension funds, insurers and fund managers are looking to get rid of their Russian debt, but trading has all but ground to a halt after Western sanctions cut the country off from global banking systems. The sanctions do not apply to transactions involving existing Russian government bonds, but most investment banks that normally trade the debt do not sell.
Some banks want the bonds to clear trades involving Russian credit default swaps, or CDS, the hedge fund manager said. Others do not trade at all, out of concern for restrictions imposed by Western and Russian authorities. Current sanctions do not prohibit trading in Russia’s existing government debt, but traders fear they will be included in future iterations, causing prices to fall further.
US and European authorities have banned trading in new Russian government bonds, frozen Russian foreign exchange reserves and recently banned several Russian banks from the Swift financial messaging system. Russia’s central bank responded by temporarily banning payments on its ruble-denominated bonds to international investors in a bid to protect its currency.
This has had a chilling effect on clearing houses that keep the financial system plumbed. Euroclear said it would no longer settle transactions in ruble-denominated securities. The Depository Trust and Clearing Corp., or DTCC, said it would stop processing transactions involving a dozen dollar-denominated Russian government bonds.
Trading is mostly between international banks and investors in dollar-denominated government and corporate debt, fund managers said. Measures imposed by Western and Russian authorities blocked ruble-denominated debt transactions involving Russian counterparties.
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