March 16, 2018 / 8:15 AM / 4 months ago

ANALYSIS-Russia bondholders happy to hug sovereign as sanctions talk swirls

* Investors don’t expect sanctions on Russian sovereign debt

* Russian Eurobond spreads at widest so far this year

* Ratings upgrade lifted some sanctioned corporates

* Stricter vetting process needed for Russian names

By Claire Milhench

LONDON, March 16 (Reuters) - Global investors are unlikely to start shunning Russia’s sovereign debt even though Russian entities and individuals are seen at risk of further sanctions over a nerve agent attack on a former Russian double agent and his daughter in Britain.

Britain has pinned the attack on Russia and expelled 23 Russian diplomats, while the United States announced more sanctions on Thursday for election meddling.

But asset managers said Russia was unlikely to be shut out of international capital markets.

“In the worst case you might have a sanctions spiral from the UK, U.S. and EU, but this will remain a very negative tail risk ... and not be my base case scenario,” said Sergey Dergachev, functional head of EM corporate debt at Germany-based Union Investment.

The premium investors demand to hold Russian sovereign dollar debt over safe-haven U.S. Treasuries has risen by 13 basis points this week to 175 bps.

That is the widest this year but still well below the highs of 2014, when Russia annexed Crimea and sanctions were imposed on a swathe of Russian companies and individuals.

Russia opened order books on Thursday for a new 11-year Eurobond, providing a test of market appetite.

SAFER OPTION

Many emerging debt managers say they cannot ignore Russia as its inclusion in key benchmarks mean they risk underperforming if they have no exposure.

And holding sovereign debt has been seen as the safer option for managers wanting to avoid the minefield in Russian corporates, where different rules in different jurisdictions can create a compliance headache.

“It (Russian sovereign debt) will be the last to be hit by sanctions if there is a strong escalation,” said Raphael Marechal, head portfolio manager, emerging markets, at Nikko Asset Management.

“A lot of people want to be on the safe side — they don’t want to become forced sellers of Russian assets. If you buy a corporate now, you don’t know if there is a second round of sanctions and then you have to sell your position.”

Most currently sanctioned names have not tapped international markets since 2014, switching mostly to the rouble bond market or domestic banks. This has led to a scarcity premium for some names, although some managers said the valuation effect was negligible.

For many, Russia remains a positive story, despite sanctions on big state-owned firms such as Sberbank and VTB.

“Russia has proven it has extreme resilience regarding the corporate sanctions,” said Viktor Szabo, senior investment manager at Aberdeen Standard Investments. “On the margin it increases the cost of capital, but it is not something Russia cannot live with.”

Sanctions did not prevent S&P Global lifting Russia to investment grade in February, its second such rating, widening its access to capital as Russian debt is now eligible for benchmarks tracked by trillions of dollars worldwide.

CORPORATE UPGRADES

Some Russian corporates have also been upgraded, presenting a problem for passive managers who are trying to avoid exposure to sanctioned names.

“The wide-reaching sanctions from a number of different countries is likely to be an issue for international managers,” said Abhishek Kumar, lead investment manager for emerging markets fixed income beta at State Street Global Advisors (SSGA).

The addition of Gazprom, VEB and Russian Railways to the Bloomberg Barclays Global Aggregate index, which is tracked by an estimated $2-$3 trillion, has helped lift Russia’s weighting to 0.33 percent from 0.17 percent at the start of the year.

From March 29, Russia will also rejoin JPMorgan’s investment-grade EMBI indexes, along with Russian Railways and VEB, with a combined weight of 6.8-8.6 percent.

An estimated $54 billion in assets is benchmarked to these JPMorgan indexes, which are important for conservative investors such as European insurance companies who may be reluctant to hold junk-rated securities.

S&P Global also upgraded Gazprom Neft, VTB and Transneft to ‘BBB-‘. Along with Gazprom and VEB, these are all subject to sanctions in some form.

The ratings agency said most Russian companies and banks had managed to retain adequate liquidity despite the sanctions, implying no immediate rating impact.

Gazprom, for example, is a regular issuer in international markets and sold a 750 million euro Eurobond on Wednesday, despite being under various sanctions from the United States and Canada. There have also been U.S.-imposed restrictions on the provision of financing to Gazprom Neft, Gazprombank, Sberbank, VEB and VTB since September 2014.

“That’s where the problem is,” said Kumar. “Most managers would take a very cautious approach to be on the safe side, investing in bonds issued before September 2014.”

Russian investments go through a much stricter vetting process at SSGA than other bonds, he added: “It’s reputational damage if you end up buying the wrong bond so a lot of scrutiny goes into the purchase.”

Reporting by Claire Milhench and Ekaterina Golubkova; Editing by Catherine Evans

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