Emerging Market Debt: Russian sanctions and a possible U.S./China trade war

• No direct exposure to Russian companies on sanctions list
• Russian news effect on the relative portfolio performance is expected to be minimal
• U.S./China trade war risk has increased
• Impact on GDP from trade wars tends to be relatively small, much smaller than suggested by the media. Though it could influence investor behavior or outlook.

Sanctions on Russia

Over the weekend, the U.S. imposed sanctions on Russia, severely impacting the value of some Russian assets. The sanctions affect a handful of oligarchs and their corporate holdings as well as a limited number of companies. Rusal, one of the world’s largest aluminum producers, has been the primary target, the U.S. actions leading the company to be retired from bond benchmarks shortly.

Previous sanctions restricted U.S. entities from participating in the primary equity and debt market for Russian companies. This time, U.S. entities are prohibited from doing business with Rusal (and the sanctioned entities) and required to sell all their holdings within 30 days (7 May 2018).

As is often the case in emerging markets when political risk materializes, many investors dive for cover and their knee-jerk reactions create pricing overshoots, which is what we saw happening early this week. Investors are concerned that other Russian corporations could face the same type of sanctions as Rusal. While initial price action has been severe, we have already seen some bounce back.

Understandably, investors in our Vontobel Fund- Emerging Markets Debt would like to know what impact these events have on our portfolio. The Fund has an exposure to Russia of around 4%, representing a small NAV overweight, whilst Russian duration is flat to benchmark. None of our holdings are directly exposed to the new sanctions. Therefore, we expect any impact on our relative performance of the portfolio to be moderate.

A broad market selloff provides opportunities for bottom-up credit selectors like us. Our approach has always relied on taking advantage of political events driven by news headlines allowing us to pick high-quality credits at a discount. This strategy has served our investors well since the inception of the Fund in 2013.

Therefore, we remain calm and confident in the current turmoil and are already looking at bonds that we consider oversold. Indeed, as many of our out of scope Russian bonds in our 4% exposure have outperformed, relatively speaking, we are taking some profits here to reposition on some bonds which we consider to have suffered unduly and excessively.

On the subject of emerging sovereign bonds, but local currency this time, Russia is excluded from the Vontobel Fund - Emerging Markets Local Currency Bond due to sustainability criteria. This absence has been a driver of significant excess relative performance in light of the selloff in the rouble and Russian local rates. 

U.S./China trade war

Comments made by President Xi of China on Tuesday (10.4) regarding the lowering of trade barriers were positively received by the markets. Even President Trump set a conciliatory tone, tweeting “Very thankful for President Xi of China’s kind words on tariffs and automobile barriers”. Despite this burgeoning bonhomie, the risk of a trade war remains.

Getting lost in all the noise is that global trade is still increasing. A trade war would undoubtedly hinder growth and impact market sentiment, but trade wars rarely have a significant effect on GDP. Therefore, while an all-out trade war would be detrimental, it is unlikely to result in a U-turn in global growth.

We are not currently repositioning the Vontobel Fund - Emerging Markets Debt to respond to trade issues between the U.S. and China per se. However, as described above with the Russian situation, we would look to hoover up cheap bonds from other investors’ downside overreaction, should this come to pass.