Russia's troubles highlight emerging-markets bond fund risk.
The holidays are usually a period of relative quiet for investors, but the opening weeks of December were anything but calm. One of the biggest stories was the dramatic drop in the value of Russian debt and the ruble, which took its toll on broad emerging-markets bond indexes and a number of funds dedicated to the space. We take a look at what drove Russian debt prices to plummet and examine what that means for some of the largest emerging-markets bond funds and, more broadly, what lessons investors can take away from the recent turbulence.
A Perfect Storm
Years of weak growth in Russia's oil-dominated economy left it particularly vulnerable to sanctions announced earlier this year. But the key destabilizing event in 2014 was the rapid fall of the price of oil, which had a negative impact on Russia's fiscal budget and trade balance, as well as the value of the ruble.
The situation intensified on Dec. 15, when the ruble tumbled 10% in one day, prompting the Bank of Russia to raise its key interest rate to 17.0% from 10.5%. The main culprit was a murky transaction between the Central Bank of Russia and Russia's largest oil firm. The central bank indirectly provided $11 billion to Rosneft to fund external debt repayments due before the end of the year. That stoked fears about the ability of Russian firms caught up in U.S. and European sanctions to repay or refinance the billions of foreign currency debt due in the next two years. These firms, along with a number of local banks, are currently unable to issue debt on Western capital markets. If sanctioned firms are forced to repay (instead of refinance) their external debts, a large outflow of U.S. dollars would result in additional downward pressure on the ruble.
Russian Debt Exposure and Fund Performance
Coming into December, Russian debt comprised roughly 8% of the hard-currency-focused JPMorgan Emerging Market Bond Index Global Diversified, 6% of the local-currency JPMorgan Government Bond Index-Emerging Markets Global Diversified benchmark, and 5% of the JPMorgan Corporate Emerging Markets Bond Index Broad Diversified, a corporate-only bogy.
Within the emerging-markets debt landscape, Russian sovereigns and corporates were already some of the hardest hit for the first 11 months of the year when the bonds, and the ruble, experienced steeper slides in the opening weeks of December. The following table shows the five emerging-markets debt funds that shed the most for the trailing month through Dec. 19, as well as the aforementioned benchmarks and category average return.