How did the best bond managers handle the Russian-Ukrainian war?
A relatively small portion of most bond fund managers’ portfolios has captured the bulk of their attention in recent weeks, with the war in Ukraine and the stifling of Western sanctions causing utter turmoil in the Russian economy and markets. global financials. On February 24, 2022, the day of the invasion, the MOEX Russia Index, which tracks the stocks of the 50 largest and most liquid Russian companies, lost 32% that week; it has been closed since February 28. Simultaneously, Russian and Ukrainian bond yields soared (Charts 1 and 2). Crude oil and commodity prices rallied and assets often used as safe havens, such as gold and high-quality developed market government bonds, strengthened.
The tumult had serious ramifications for the world’s 11th largest economy and the investors who were directly or indirectly exposed to it. The ruble crashed to less than one US cent (exhibit 3) as the Russian central bank raised interest rates by 1,050 basis points to 20% on February 28; Russia has kept local stock markets closed until at least March 4. Local sovereign debt remains non-negotiable and its prices uncertain. Russia would have paid interest on its bonds, but the sanctions prevented investors from collecting. It is not clear whether the bonds are in default.
Meanwhile, Ukraine’s ability to make payment of around $300 million in Eurobond coupons last week shows the country may still be able to meet its obligations, the team says. TCW’s emerging market debt.
Russian and Ukrainian bonds are not common holdings in most fixed income portfolios; most investors have little exposure to it unless they hold emerging markets funds or Morningstar non-traditional bond categories.
Still, Morningstar analysts spoke to managers of bond strategies with some of the largest country holdings to see how they fared. Global bond indices have negligible exposure to Russia and Ukraine, but global emerging market debt benchmarks such as the JP Morgan Global EMBI Diversified Emerging Markets Denominated Sovereign and Quasi-Sovereign Bond Index in US dollars or “hard currency” and the JP Morgan GBI-EM Global Diversified Index, a popular local currency debt benchmark, had modest weightings for Russia and Ukraine at the end of February 2022 due to depreciation (Figure 4). Old plans to add Ukraine to the local benchmark at the end of March are on hold.
In recent years, many active emerging market bond managers have kept more money in Russia than the JP Morgan EMBI Global Core Index (Figure 5) due to the country’s tight fiscal policy, low debt government, central bank strength and high commodity prices. . Other managers, however, reduced their exposure as they were wary of rising tensions in Ukraine. Here’s how several emerging market bond strategies reacted to the evolving conflict.
TCW Emerging Markets Income (TGEIX) has had little exposure to Russia in recent years, but has been overweight Ukraine in a mix of sovereign debt and US dollar-denominated corporate debt. The 0.7% of Russian sovereign credit default swaps and 2.3% of Ukrainian sovereign and corporate debt denominated in US dollars as of February 23 had fallen to zero and 0.7%, respectively, by March 2.
The same team made similar moves at TCW Emerging Market Local Currency Income (TGWIX). Heading into 2022, the strategy had 7.1%, about as much as the benchmark, in local Russian sovereign debt and 1.0% in local Ukrainian sovereign debt. The team reduced its Ukrainian debt in January and sold it in early February as the prospect of a conflict with Russia grew. The team also reduced its Russian holdings but remained close to the benchmark at 6% on February 23. The local bond market has been closed since Feb. 28 and bonds are priced for default and not expected to change anytime soon.
MFS Emerging Markets Debt (MEDIX) was slightly overweight at the end of January on Ukrainian debt, with 3.2% of sovereign and quasi-sovereign debt. The fund has, however, been underweight Russia relative to the benchmark for some time, with around 1.2% in Russian government and corporate bonds. Throughout January, the team shrewdly reduced the fund’s exposure to emerging Europe, where it felt valuations had not sufficiently reflected a potential conflict. The team also used options for broader portfolio insurance.
Pimco Emerging Markets Bond (PEBIX) started the year with a modest overweight in Ukraine. The team hedged this with an underweight in Russia and a tactical short position in the Russian ruble. The Russian debt market remains severely dislocated and there could be more ripple effects, such as the effect of higher energy prices and the likely decline in Russian and Ukrainian tourism on Turkish assets. Managers do not expect the contagion to spread to other emerging markets, however, noting on Feb. 25 that Latin America has so far been relatively untouched.
MassMutual Emerging Markets Debt Blended (BXEYX), under-advised by Barings, was one of the few strategies to overweight both Russia and Ukraine heading into 2022. The team had about 4% Ukrainian debt at the end of February, an overweight of 2 percentage points against JP Morgan’s EMBI. in a mixture of sovereign and quasi-sovereign bonds in hard currencies. Exposure to Russia was 5.8% (also an overweight of 2 percentage points) and included sovereign bonds and a handful of corporates. The managers have held both overweight allocations for some time based on their views on valuations and fundamentals, but continue to assess the situation.
Assess the risks
There have been plenty of scary headlines and volatility, but most investors with diversified portfolios have limited exposure to Russian and Ukrainian stocks, which should limit losses from geopolitical unrest. That said, funds that held more Russian and Ukrainian stocks fared significantly worse than their benchmarks and category peers this year. Recent events are a stark reminder that emerging market debt is subject to idiosyncratic and geopolitical risks, and fund investors should favor strategies with experienced and knowledgeable management teams following repeatable investment and risk control processes.
Morningstar analysts Giovanni Cafaro, Jeana Marie Doubell, Evangelia Gkeka, Shannon Kirwin and Saraja Samant contributed to this report.