Russia, Back From The Brink

&l;p&g;&l;img class=&q;dam-image ap size-large wp-image-8826b5df9ebe4a128cf458ead3f1d1dc&q; src=&q;×0.jpg?fit=scale&q; data-height=&q;702&q; data-width=&q;960&q;&g; Cheers, president Putin. Vladimir Putin toasts with laureates of the Presidential Prize in Science and Innovation for young scientists in the Kremlin on Thursday, Feb. 7, 2019. (Mikhail Klimentyev, Sputnik, Kremlin Pool Photo via AP) photo credit: ASSOCIATED PRESS

Russia, the bad guy of all bad guys, whose president is probably more universally disliked (at least in Washington, London and Brussels) than Joaquin &q;El Chapo&q; Guzman.&a;nbsp; The preferred home nation of James Bond villians and unruly oligarchs who will slander you and ruin your life for a bad business deal may be returning from the brink. Moody&s;s gave them their coveted investment grade rating back on Feb. 10.

All three American credit rating agencies have Russia at investment grade again, which means U.S. bond funds that are mandated to only invest in investment grade debt can now get back into Russia.

&q;I was surprised it took Moody&s;s so long,&q; says Katherine Renfrew, a fund manager for TIAA-CREF. They manage around $13 billion in emerging market debt and own Sberbank and Gazprom bonds. Although those companies have been sanctioned by Washington, their bonds are free to trade so far. Threats have been made to sanction those bonds, but nothing has happened yet.

Russia has had a pretty good month.

&l;p class=&q;tweet_line&q;&g;The VanEck Russia (RSX) exchange traded fund is beating the MSCI Emerging Markets Index year-to-date, up 11.3%.&l;/p&g;

&l;a href=&q;; target=&q;_blank&q;&g;&l;img class=&q;size-full wp-image-57734&q; src=&q;; alt=&q;&q; data-height=&q;700&q; data-width=&q;1171&q;&g;&l;/a&g; The VanEck Russia ETF is beating the MSCI Emerging Markets Index. Look at Oleg Deripaska&s;s stock. Sanctions reprieve makes for huge gains in En+Group and Rusal, one of the largest aluminum producers in the world.

A Senate committee looking into Russian support of then presidential candidate Donald Trump came up empty, meaning Vladimir Putin looks right when he and his cohorts did not orchestrate a coup against Hillary Clinton to elect Trump president.&a;nbsp; The Special Counsel investigation into Russia collusion also looks to be tapping water from a stone.

Russian billionaire Oleg Deripaska&s;s most important entity, aluminum powerhouse Rusal, got sanctions reprieve. The company&s;s British chairman and former Tory politician, Greg Barker, managed to convinced Deripaska to relinquish some of his controlling interests in the company. Deripaska is sanctioned as an individual, but his company is not. Even if Deripaska had to give up some of his shares, they are worth a heck of a lot more on the London Stock Exchange since the deal with Treasury went through. En+Group, the holding company that owns Rusal, is up 61.8% in pounds. Rusal shares, listed on the Hong Kong stock exchange, are up 51.7%.

&l;img class=&q;dam-image ap size-large wp-image-a8cb9c4b3b6a4e1d90cecb967e4f4dc4&q; src=&q;×0.jpg?fit=scale&q; data-height=&q;674&q; data-width=&q;960&q;&g; Russian metals magnate Oleg Deripaska had to relinquish control of some of his prized possessions. But it freed two of his biggest money making firms from U.S. sanctions. (AP Photo/Alexander Zemlianichenko, File) photo credit: ASSOCIATED PRESS

&q;The scale of this deal was unprecedented,&q; says Mike Dobson, part of the legal team at Morrison &a;amp; Foerster. Dobson was a Senior Sanctions Policy Advisor in the U.S. Treasury Department&a;rsquo;s Office of Foreign Assets Control (OFAC), where he was one of the U.S. government&a;rsquo;s leading sanctions officials in the development and implementation of U.S. sanctions policy toward Russia. He left in November.

&q;Oleg divested himself down to around 44. 9% and took steps to sever his control over En+Group. In exchnage for that, there are no sanctons on Rusal now,&q; Dobson says.

&l;p class=&q;tweet_line&q;&g;Russia is one of the emerging markets least susceptible to international volatility from trade wars and European political dramas.

Make no mistake, the powers of Europe are in lockstep with the U.S. foreign policy view that Russia is a hostile player in world affairs. They continue to kick the Russians out of the club.

As a result, Russia has had to innoculate its economy. They have put into practice a number of macro-economic policies that have helped insulate Russia from external matters like sanctions. Putin also passed highly unpopular pension reform to lower the state&s;s pension burden, and raised the VAT tax.

&l;img class=&q;dam-image ap size-large wp-image-ed71b8ad1ef44c73b86fca90093f6fa6&q; src=&q;×0.jpg?fit=scale&q; data-height=&q;671&q; data-width=&q;960&q;&g; Russia&s;s finance minister Anton Siluanov says the country will work to make Russia more attractive for investors now that it is investment grade again. (AP Photo/Pavel Golovkin)&a;nbsp; photo credit: ASSOCTIATED PRESS

The central bank has also allowed the ruble to free-float since the fall of 2016. And Putin&s;s economic team, led by Anton Siluanov in the Finance Ministry, has been successful in their conservative fiscal approach to running the show. Government debt in Russia is basically non-existent. It is equal to just around 10% of its GDP.

&q;Russsia has also been on a different business cycle than the rest of the globe because of sanctions,&q; says Roland Nash, chief investment strategist for the Specialized Research and Investment Group, or Spring, a Russian hedge fund manager.

Interest rates are rising in Russia and towards the end of the year, when inflation is expected to come down, monetary policy will be in easing mode.

&a;ldquo;Russia is one of the markets that is most insulated from the end-of-cycle trends we are seeing elsewhere,&a;rdquo; Nash says.

Besides the equity market for retail investors, most of the institutional money is in Russian bonds.&a;nbsp; The only fear is Washington slapping sanctions on them. Markets have to be one step ahead.

Corporate bonds are cheap, but sanctions threats might keep them that way. The yield is good for investors who want to hold over a longer period, such as until maturity.

&q;We were overweight last year. The sanctions threat keeps as neutral,&q; says Philip Torres, co-head of emerging markets for Aegon Asset Management.

Even so, as Russia pulls back from the brink, its economic growth is not as exciting as other BRIC countries. Brazil is early in its cycle too, and has a more diverse economy with similar bond yields for the fixed income investor.&a;nbsp; Russian GDP growth is similar to Brazil&s;s, growing at 1.8% in 2018.

Higher interest rates and the VAT means growth won&s;t be much better this year. Nash at Spring thinks it is lucky to hit 1.5%.

&q;In 2020, I think things improve much more for Russia&s;s economy,&q; Nash says. &q;You will have interest rates coming down and that means levarege can increase.&q;


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