The two leading Russia-specialist funds, Prosperity Capital Management and East Capital, that were both founded by Swedes, have billions of euros trapped in the Russian stock market.
PCM mainly deals with institutional investors while East Capital has a lot of Swedish pensioners in its fund, and both have been scuppered by the financial sanctions on Russia and now can’t get their money out.
I know both funds really well as they are both doyens of the market, having set up in the second part of the 1990s and in the good years consistently dominated Morningstar’s ranking of best performing funds in the world, earning several thousand percent returns for their investors. Of course, in the bad years they lost bundles of money, but on balance over the last quarter of a century they have been working and they made a handsome profit.
As we reported, for investors, one of the most frustrating things about the Ukraine war is that Russia’s equity markets were booming until October last year and the leading RTS index was on course to set a new all-time high. 2021 saw a dozen IPOs as the e-commerce sector, in particular, came of age. Company after company came to market seeking to raise say $500mn and coming away from their IPOs with £1bn-plus. There were some 24 more companies in the pipeline for this year. It looked like Russia had finally made it and was going to fulfil its potential. And Russian President Vladimir Putin has thrown that impending prosperity into the toilet.
The Swedes are not the only ones stuck in the market. Institutional international pension funds were heavily exposed to the Russian finance ministry’s OFZ treasury bills market too, as these also offered great returns. But the same sanctions on Russia’s National Depository have likewise trapped that money too; foreigners still hold about 20% of the OFZ, which is worth billions more.
It is not clear what will happen next. While the West sits on the Central Bank of Russia's (CBR's) $300bn of reserves it is clear that Putin is disinclined let that money out. If the EU lifted sanctions on the NDC then this money could probably exit, but Brussels is also not inclined to ease any of the financial sanctions when the other sanctions are working so poorly.
No one cares if institutional investors lose their money – Russia was always a high risk, high return market – but destroying all those pensioners’ investments is a stickier problem as the Swedish state pension fund had nominated East Capital as one of its approved funds. So here too Putin has managed to inflict more pain on the rest of Europe with his pointless war.
Personally, I believe that if he had left things as they were then the huge returns everyone was making from Russia’s capital markets would have given him all the power and security that he wants.
It is said that no two countries with a McDonalds ever go to war with each other (the “Golden Arches Theory of Conflict Prevention” from Thomas Friedman, a theory that has failed but is still appealing as a rule of thumb: Panama vs US in 1989 and Russia and Ukraine both have McDonald’s). However, two countries that are making a lot of money from each other are very reluctant to fight, which is what one of the things behind Germany’s notable reluctance to impose sanctions as Germany, more than any other European country, was profiting from its relations with Russia.
Apropos, the Swedish and Finnish applications to join Nato are supposed to go through in the coming week or so which is a sea-change in Scandinavia’s attitude to Russia.
EM high yielding bonds
In a related piece I took a look at the general appetite for high-yielding EM bonds. Bond traders have suddenly started snapping up these obligations from some of the world’s poorest countries to profit on extremely high returns, this paper pays.
This sudden enthusiasm for these extremely risky bonds is indicative of the general feeling that the worst of the polycrisis has peaked. Inflation and food prices are starting to fall. Tightening cycles are coming to an end. (Hungary and Czechia have already stopped hiking and Poland also left its key rate unchanged last week.) Even more importantly the US Fed says it will slow the pace of tightening, which is always good for EMs.
On top of that the IMF has sprung into action and done deals with Ukraine, Egypt and Tunisia with more in the works, which makes defaults less likely. And global debt is down from its all-time highs.
On top of the macro stuff is a noticeable growing momentum for some sort of ceasefire in Ukraine. Russia’s tactics of taking out Ukraine’s power will be devastating. The problem is not the lack of light or heat, but the fact that the water works don’t work without power. You can put on an extra jumper and light some candles if there is no power, but you can’t go more than a few days without drinking water. And there is nothing to stop Russia continuing to hit power stations with rockets, no matter how fast Bankova fixes them.
At this point my best guess is that some sort of deal is done by spring that leaves the Donbas and the Crimea in Russian hands. We will end up with some sort of very unsatisfactory frozen conflict like North-South Korea or Taiwan-China; or more likely, similar to Turkey’s ongoing occupation of northern Cyprus – who remembers that one these days? The example the Russian scholars give is the Berlin wall, the solution to a very nasty stand-off between the US and the Soviet Union, that was a totally unsatisfactory solution to the crisis, yet persisted for 28 years.
All this has created a window for bond investors to tap the sky-high yields on offer and may lead to some new debt issue by counties like Uzbekistan if yields fall further; thanks to the polycrisis there is huge pent-up demand for some new issues.
But of course, this is probably all temporary as the polycrisis has not gone away and if the war in Ukraine continues into next year we could be facing a fresh energy crisis and more jiggery-pokery with other commodities, including grain. A brief respite then, but caution is advised.