November 10, 2013 / 12:00 PM / 6 years ago

Russian corporate bonds: easier to trade but no free lunch

* International settlement due in January

* BofA ML includes Russia in new EM non-sovereign index

* Lack of liquidity or yield pickup seen as a drag

By Maya Dyakina

Nov 10 (Reuters) - Foreign investors quintupled their holdings of Russian treasury bonds as reforms opened up the local market, and from January they will get easier access to rouble-denominated corporate paper traded in Moscow.

But investors may be cautious about tapping the wider pool of debt, which will include quasi-sovereign issuers in addition to the $105 billion government bond market where rising foreign holdings may soon approach saturation point.

Although Russia’s inclusion in a new non-sovereign emerging markets bond index will attract some new buyers, analysts and investors do not predict a new rush of inflows - in part due to tight pricing and a lack of liquidity.

“From our perspective as international investors, we are not being paid enough to invest in that (corporate rouble) market,” said Angus Halkett, portfolio manager at Stone Harbor Investments.

“Liquidity is a lot less good than in the government bond market and with corporate names, the risk premium that you are receiving tends to be less attractive when you look at the same credit in dollars,” he said.

Investors also need to set Russia’s low sovereign debt relative to GDP (gross domestic product) against the chronic sluggishness of its economy. This week the government slashed its long-term forecast to an annual 2.5 percent pace, the lowest in the BRICS group of big emerging markets that includes Brazil, India, China and South Africa.

But foreign investors have developed a taste for OFZ treasury bonds thanks to reforms to clearing and settlement that took effect this year. OFZs will from next March be included in the Barclays Global Aggregate Index, a benchmark tracked by some institutional investors.

Further upgrades to Russia’s market infrastructure and tax laws will make local-currency corporate and municipal debt accessible to large foreign funds with strict compliance rules from next January.

Reflecting that, Bank of America Merrill Lynch has included Russia in its new Diversified Local Emerging Markets Non-Sovereign Index, which covers more than two-thirds of the bonds settled by the main international clearing houses.

Russia’s share is nearly 15 percent in the $120 billion index, making it a major component, said Inna Meggs, index and portfolio strategist at Bank of America Merrill Lynch. “While hard currency is still a primary choice ... there are investors who are considering broadening their coverage,” she said.

The effective yield on the Russian part of the index, which now mostly comprises rouble Eurobonds but should in future include domestic corporate bonds, is 8.052 percent. Local corporate bonds yield 7.74 percent on average.

BALANCE SHEET STRENGTH

Russia’s petrodollar revenues mean it still has low sovereign debts of just 10 percent of GDP, making the rouble an interesting alternative to countries in debt trouble.

It also means that the government debt market is small - and with foreign holdings of OFZs rising to 25 percent from 4 percent in the 20 months to September, some players are concerned that the best bargains are already gone.

Russian government bonds have earned 4.3 percent in the year to date, according to the MICEX RGBI Total Return Index - not enough to offset a decline of over 6 percent in the rouble’s exchange rate against the dollar. The RGBI index returned 14.7 percent in 2012.

For those willing to look further, the BofA ML index offers exposure to state-controlled banks Sberbank, VTB, Gazprombank and Rosselkhozbank, and AHML, a state agency that fulfils a role similar to U.S. government-backed mortgage lenders.

These all have investment-grade ratings, as do bonds from Russian Railways and the Federal Grid Company. Rushydro, privately-owned gas firm Novatek and mobile phone operator Vimpelcom are rated below investment grade.

The likely addition of domestic bonds to the BofA ML index may boost Russia’s weighting next year after the reform, said Jan Dehn, head of research at Ashmore Group.

Yet Russian corporate bonds currently trade at lower yields than their rouble-denominated Eurobond peers, capping the potential upside for buyers, said Raiffeisenbank fixed-income analyst Denis Poryvai.

For example, Alfa-bank’s rouble Eurobonds offer an 83 basis point yield pickup over their domestic bonds. That means that, in terms of value and ease of trading, they are more attractive than the local market.

Russian banks and companies, mostly export-oriented, have actively tapped foreign debt markets, placing $47 billion in Eurobonds in the year to date versus some $31 billion of bonds on the domestic market.

The $150 billion corporate debt market is more attractive for those firms who wish to borrow using the same currency in which they earn their revenues.

“The emergence of Euroclear and Clearstream in Russia, is a factor that is certainly positive,” said Sergey Nazarov, a managing director at Standard and Poor’s in Russia and CIS, referring to the clearing houses that now settle rouble bonds.

“But its importance should not be overstated, and, of course, any increase in investment appetite for Russia will be determined by other factors.” ($1 = 32.5515 Russian roubles) (Reporting by Maya Dyakina, Additional reporting by Sujata Rao,; Editing by Douglas Busvine/Ruth Pitchford)

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