Last Friday, equity-based Russia exchange traded funds, such as the Market Vectors Russia ETF (RSX) , fell to their lowest levels in five weeks after Standard & Poor’s lowered its rating on Russian sovereign debt to BBB-, the lowest investment grade.
It was the first time the ratings agency has downgraded Russia since 2008. Russia joins Brazil and India as BRIC nations with credit ratings just one step above junk. That does not mean investors should run away from emerging markets bonds ETFs that features sizable allocations to Russian debt. [Russia ETFs Fall After S&P Downgrade]
After all, the Vanguard Emerging Markets Government Bond ETF (VWOB) and the ProShares Short Term USD Emerging Market Bond ETF (EMSH), two of the ETFs with largest exposures to Russian debt, only closed modestly lower Friday, outperforming equity-based Russia ETFs in the process.
Those ETFs and others offer an avenue to a potential value opportunity with Russian bonds as rating Russia just one level above junk status and on par with more fiscally challenge Brazil appears too harsh in the eyes of some.
“The only numbers worth considering when making investment decisions on Russian debt are solid ones such as current debt levels, foreign reserves and the fiscal position. Russia, now rated by S&P on a par with Brazil, has a government debt of 7.9 percent GDP, compared to Brazil’s 59.2 percent,” writes Leonid Bershidsky for Bloomberg.
As Bloomberg notes, Russia has $420 billion in foreign currency reserves, the third-largest total in the world. Brazil had $352.7 billion in currency reserves as of February, according to the International Monetary Fund.
Dollar-denominated Brazilian and Russian debt combine for almost 12% of the iShares J.P. Morgan USD Emerging Markets Bond ETF’s (EMB) . With an effective duration of almost 7.1 years, EMB is up 3.1% this year despite the ratings downgrades to Brazil and Russia, hyper-inflation in Venezuela and a sometimes turbulent monetary policy outlook in Turkey. Turkey and Venezuela combine for over 10% of EMB. [Brazil ETFs Deal With Ratings Downgrade]
Comparing Russian and Brazilian bonds shows a possible pricing anomaly that could favor bond funds with heavy Russia exposure.
“The fact that Russian five-year, dollar-denominated bonds yield 4.1 percent, compared to 2.7 percent for Brazilian ones, is a signal to buy underpriced Russian debt while the weight of political guesswork is pulling it down,” writes Bershidsky.
The Market Vectors Emerging Markets Aggregate Bond ETF (EMAG) has an 8.4% weight to Russian bonds, making Russia the ETF’s third-largest country weight. The majority EMAG’s Russian issues are dollar-denominated, though some are ruble-denominated.
EMAG sports a 30-day SEC yield of 4.63% and a modified adjusted duration of 5.1 years. The ETF is up 2.3% over the past 90 days. [Emerging Markets Bond ETFs Perk Up]
iShares J.P. Morgan USD Emerging Markets Bond ETF
Tom Lydon’s clients own shares of EMB.