miércoles, 23 de abril de 2014

miércoles, abril 23, 2014

Markets Insight

April 21, 2014 9:02 am

Risks in buying Russian bonds on dips

By Mohamed El-Erian

Strategy has worked so far but chance of disruption is rising


Credit markets today are excessively fuelled by a yield-at-any-price mentality. When this happens investors’ increasingly indiscriminate appetite for credit risk leads to significant reductions in credit risk premiums, particularly for lowly rated securities. Narratives develop to rationalise overcrowded trades, providing a basis for morealbeit ultimately reversibleprice overshoots. And rather than signalling turbulence, pullbacks are seen as buying opportunities.

Today’s yield-hungry investors rightly draw comfort from two factors: a generally stable to slightly improving global economy, and the commitment of central banks to suppressing interest rate volatility. But as they stretch far and wide to meet return targets, their investment decisions are increasingly driven by the relative price of credit (credit spreads) as opposed to value (overall yield).


Tight credit spreads are increasingly justified by over-optimistic assessments of both default probability and market volatility. And investors downplay liquidity risks (ie, the eventual cost of repositioning portfolios should circumstances change).

All this helps to explain several notable developments in the credit markets in recent weeks – from Greece issuing more than $4bn in five-year bonds at just below 5 per cent, and only two years after it imposed large losses on investors, to Italian sovereigns setting record low yields.

Venezuela model

In such an environment, investors also tend to pay too much attention to the longstanding advice to “buy on dips”. Sell-offs are embraced as an opportunity to add credit exposures, particularly where securities are deemed vulnerable to “noise that is unrelated to the underlying creditworthiness of the borrower, such as particular emerging market bonds.

Being part of a narrower and technically more vulnerable asset class, emerging market bonds offer a yield pick-up over their corporate brethren in investment grade and high yield. And being prone to a lot more domestic social and political noise, some of them also provide more opportunity for mixing tactical and strategic investment decisions.


For years, Venezuela was the model in this regard. Savvy investors ignored the populist anti-west rhetoric of former president Hugo Chávez, focusing instead on the country’s solid oil revenues and its relatively comfortable international reserve levels. Moreover, given the global networks associated with energy supply chains, they correctly attached only a low probability to the likelihood of Venezuela defaulting, not because of an inability to pay, but an unwillingness to do so.

More recently, Russia has been treated as an attractive candidate for the buy-on-dips trade. At about $475bn, international reserves are a large multiple of the country’s outstanding external debt. Monthly oil revenues provide it with significant liquidity management flexibility. And, like Venezuela, integration into the global energy network supports the country’s willingness to service its external debt obligations in a timely manner.


Cycle of disruption




With the Ukrainian crisis developing in unexpected ways , international investors have been given ample opportunity to buy Russian bonds on dips. And the strategy has worked, as spreads have repeatedly narrowed after initially widening in response to the latest set of geopolitical developments.

Yet the underlying risks in this Russian trade are becoming quite different from those in Venezuela. While the spread disruptions have not been part of a direct internal deterioration in Russia’s willingness and ability to pay its external creditors, they are part of a process that is bringing the country ever closer to the risk of serious economic and financial disruptions being imposed from outside.


The more Russia is seen to interfere in eastern Ukraine – as is clearly the perception in the west – the more Europe and the US will be urged to add sanctions targeting sectors to those against individuals. And the closer these new sanctions get to two areas in particular – energy and financethe greater the cost for Russia and the higher the probability of retaliatory steps that could fuel a vicious cycle of economic, financial and payments disruptions. Should this occur, investors would face a significantly different credit paradigm.

Rather than react to noise-induced spikes in yields, Russian investors are now underwriting a higher level of actual credit risk on account of externally induced disruptions. The trade may still work; but it now requires a quicker and more meaningful de-escalation of the Ukrainian crisis.


Mohamed El-Erian is chief economic adviser to Allianz, chair of President Barack Obama’s Global Development Council, and author of ‘When Markets Collide


Copyright The Financial Times Limited 2014.

0 comments:

Publicar un comentario