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Russian assets remain dangerous but not untouchable

Lars Ruecker | Getty Images | Getty Images

Sanctions-hit Russian assets, weighed further by this year's collapse in energy prices and subsequent ruble slide, remain dangerous territory for many global investors but they are not seen as untouchable and some are scouting opportunities.

Effectively an investor pariah since the March annexation of Ukraine's Crimea led to Western sanctions on several companies and individuals, Russian bonds, stocks and currency have performed worse this year than most other markets.

That, to many, seems justified, given the risk of more sanctions that could lead to fresh market falls, economic recession and even corporate debt defaults.

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But some fund managers attending Reuters' Global Investment Outlook Summit this week also see opportunities, regardless of political risk.

They note Russian share prices measured against future earnings are among the world's cheapest, and one-year government bond yields of 10 percent.

Such valuations are "compelling", Anne Richards, CIO of Aberdeen Asset Management told the summit in London.

"We are more likely buyers than sellers," Richards said. Richards acknowledged risks to the Russian trade but said investors needed to look closely at companies' business models to gauge whether they would survive the political crisis.

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"People still wash their clothes and need washing powder, people still wash their hair and need shampoo, people still drink beer. There are lots of things people will still do regardless of whether Russia invades Ukraine," she added.

Bulls will note that returns on Russian stocks and bonds since 2000 far exceed those in most other markets.

And even sceptics reckon Moscow will not want to escalate the Ukraine crisis further. So risk/reward on ruble assets is "more balanced than three months ago", according to Andrew Wilson, Europe CIO for Goldman Sachs Asset Management.

There is also the danger of missing out on any recovery - Russia's dollar-denominated equity index jumped 40 percent between March and July when some calm returned to Ukraine.

Wilson said he was cautious about adding to Russian positions but he is currently neutral, meaning his fund's holdings equal Russia's weight in debt and equity indexes.

Bond investors will point to Russia's public debt levels of 10 percent of annual economic output - among the world's lowest - and hundreds of billions of dollars in reserves as a reason why current bombed-out valuations make no sense.

Russia pays a far higher yield premium over U.S. Treasuries on its dollar bonds than Brazil or Turkey whose credit ratings are lower and debt levels much higher. Its debt spreads have blown out 1.7 percentage points this year, more than five times the move in the underlying emerging bond index.

"We still like Russia believe it or not," Greg Peters, who helps manage over $534 billion at Prudential Fixed Income told the summit in New York. "They have very little external debt, and you really have to see the current account crater in a way that's hard to foresee."

"It's going to be volatile for sure, but I still think it's money good, and we still like it."

Ruble debt is a more risky proposition but 10 percent yields may prove tempting, especially if the currency stabilises after its free-float earlier this month.

Asset manager Lombard Odier for instance is overweight Russia in a fundamental-focus benchmark, based on criteria such as debt levels, balance sheet strength and political stability.

"It's time to do math on Russian fundamentals and think less on geo-politics," Lombard Odier global fixed income strategist Salman Ahmed said.

"Almost everything is in the price."

To be sure there are many who will balk at buying into such a volatile market, which remains driven by geo-politics rather than valuations or fundamentals. Hedge fund star Michael Hintze of CQS, for instance, branded Russia an investment "black hole".

But index-tracking funds must remain invested in Russia, which comprises around 5 percent of MSCI's emerging equity index and nearly 10 percent of debt benchmarks run by JPMorgan. Given sanctions affect only some new securities, existing Russian bonds and stocks continue in passive portfolios.

Northern Trust for instance holds Russian assets in passive funds, Wayne Bowers, the asset manager's Europe and Asia CIO said, though he said the state of the economy would make him cautious about actively adding exposure.

The biggest deterrent, especially for more conservative managers, is the prospect of a deeper crisis that leads to more sanctions, potentially trapping them in a free-falling market.

George King, portfolio strategist at RBC Wealth Management said the mid-year bounce had led clients to question if another rebound could be in the offing should political noise abate.

"We have had people ask us about it....is it time to play for a positive bounce in Russia?" he said. "Our answer is: it's a very dangerous game to play."