Barings welcomes direct settlement of Russian government bonds

Baring Asset Management says that Russia’s move to introduce direct settlement of trading in government debt via Euroclear Bank is another key step towards opening up the country’s capital markets.

From Thursday 7th February, Euroclear Bank will start the direct settlement of Russian rouble-denominated government bonds, so-called OFZ (Obligatsyi Federal’novo Zaima or Russian Federal Loan Obligations) treasury bonds. The market for OFZs is valued at around US$100bn, though ownership by foreign investors is still relatively small at around 6%.

The first stage of the settlement is for over-the-counter transactions, while on-exchange deals are expected to follow in March and, later, corporate and municipal bonds.

In our view, this liberalisation, which forms part of a long-awaited upgrade of Russia’s financial markets, is a step in the right direction, primarily in generating anticipated wider participation from foreign investors.

We also believe as a result of direct settlement, we should continue to see a compression of yields on Russian treasuries, reducing the cost of capital for Russian corporates and the government. In fact, in the last eight months in anticipation of the liberalisation, the yield on long-dated OFZ bonds has declined by over 200 basis points.

In terms of the impact on the Russian equity market, we argue improved and broader market access should have a positive effect, namely in helping to improve the price of lower-valued Russian equities.

Separate to the Euroclear announcement but part of the overhaul of Russia’s financial system, we think that proposed changes to the local pension fund system should, amongst other things, increase activity in Russian equities, particularly from a private pension fund perspective where participation remains relatively low.

Other recent financial market improvements include new regulations which oblige Russia’s state-owned companies to pay at least 25% of their net profits as dividends in an attempt to attract more investment. From where we stand, these types of enhancements will help to strengthen the investment case for Russia in the medium and long-term.

So, looking at Russian equities at this point, the MSCI Russia 10/40 Index is up 6% since the start of the year, in US dollar terms. Perhaps more impressive, we believe, is that ahead of the volatility experienced in the market during most of last year, Russian equities have still come out 18% higher (since the start of 2012, in US dollar terms)*.

Our investment strategy is based on what we see as a favourable combination of company valuations and strong earnings growth. Russian equities, generally, remain attractively valued relative to other parts of emerging Europe, in our view.

We continue to see strong government finances, unlike in the majority of cases in the west, so the state has the capacity to support infrastructure spending, for instance. We also believe corporate governance is generally improving, both in state-controlled and private sectors.

In terms of our sector exposure, we prefer Financials over Telecoms and Utilities. We also continue to believe Russia harbours substantial potential in terms of consumption, especially in the likes of new car sales which compared to other markets such as Poland is still low.

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