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9 April 2012

The head of VTB Group’s Russia- leading bond funds is buying debt of state companies due within three years on expectations prices will rise as investors recognize their credit quality.

“Issuers such as Russian Railways, VTB, Federal Grid Co., Gazprom and some others look stellar,” Vladimir Potapov, who helps oversee 78 billion rubles ($2.7 billion) as head of portfolio management at VTB Capital Investment Management, said in an interview in Moscow last week. “Many have a good spread,

100 basis points or higher, over the OFZ curve.”

Ruble-denominated bonds that can be sold back to OAO Russian Railways in January 2015 yield 7.98 percent, or 97 basis points above similar maturity sovereign ruble bonds, known as OFZs. The spread was as narrow as 31 basis points in October.

The state rail monopoly’s 2017 dollar bonds yielded 4.37 percent, 1.989 percentage points more than bonds from Union Pacific Corp., the biggest U.S. railroad by sales, data compiled by Bloomberg show.

Russia’s ruble debt has rallied since the start of the year as improved access to the securities and falling inflation lured overseas investors. Consumer prices rose 3.7 percent in March from a year earlier, matching February’s post-Soviet record low.

With short-term, high-grade corporate debt offering yields of

7.5 percent to 9.5 percent, Russia is a “rare market” in the world, offering positive real interest rates, Potapov said.

‘Very Interesting’

“We would be very happy if such inflation were to persist,” said Potapov, 29, who joined VTB in September 2010 after seven years at Troika Dialog, the investment bank now owned by OAO Sberbank. “It’s something that could really make Russian fixed-income instruments very interesting for overseas investors in the long term, and not only Russian fixed income, but equities and other investments into Russia.”

Bank Rossii has the tools to keep inflation within its full-year target of 5 percent to 6 percent, even as price pressures increase in the second half, Alexei Ulyukayev, first deputy chairman of the central bank, said April 3 at an economic conference in Moscow.

So-called natural monopolies such as OAO Gazprom, which runs Russia’s gas pipelines, and Russian Railways will be able to raise prices from July 1 after annual increases were delayed at the beginning of the year. Higher tariffs and seasonal effects from last year’s favorable harvest will cause inflation to accelerate in the second half, Potapov said.

“We look at it as being under control, as inflation targeting is one of the key central bank policies,” he said.

“I would look for some 5 percent to 6 percent, or maximum 7 percent inflation for this year.”

Fund Performance

Potapov oversees investments, including VTB’s Treasury Fund and Bonds Plus Fund, which ranked as Russia’s two best- performing bond funds for the three years ended Dec. 31, according to Forbes Russia. The Treasury Fund returned 112 percent, followed by a 109 percent gain for the Bonds Plus Fund.

Russian sovereign and corporate domestic debt advanced 4.2 percent in the first three months of this year, besting China and India, according to JPMorgan Chase & Co. indexes. The ruble had the biggest quarterly gain against the dollar at 9.2 percent, according to data compiled by Bloomberg.

The ruble lost 0.1 percent to 29.4675 per dollar yesterday.

Non-deliverable forwards, or NDFs, which provide a guide to expectations of currency movements and interest-rate differentials and allow companies to hedge against currency changes, showed the Russian currency at 29.8375 per dollar in three months.

International Investors

The Finance Ministry said March 30 it would increase the amount of OFZ bonds on sale in the second quarter by 32 percent to 330 billion rubles. Foreign ownership of OFZs may climb to 25 percent from about 3 percent once the market is fully opened to direct purchases on July 1, Konstantin Vyshkovsky, head of the ministry’s debt department, said April 3, citing a central bank estimate.

“We’re already seeing big steps toward the local market becoming a broader investment base, and we highly appreciate it,” Potapov said. “We would expect that after all of the technical issues are resolved, the corporate and municipal ruble segment will also open up for overseas investors.”

Notes putable in 2014 from Federal Grid Co., operator of Russia’s high-voltage power network, yield 8.05 percent, 129 basis points above state debt. Gazprom ruble bonds due February

2014 yielded 78 basis points yesterday over a similar maturity OFZ, down from 138 a week earlier.

Bonds Fall

Russia’s dollar bonds due 2020 fell, pushing the yield up 4 basis points to 4.024 percent. The yield on Russia’s ruble Eurobond maturing in 2018 was 4 basis points higher at 7.002 percent. The price of the country’s ruble notes due August 2016 was little changed, leaving the yield steady at 7.38 percent.

The cost of protecting Russian debt against non-payment for five years using credit-default swaps rose 7 basis point to 193 yesterday, down from 278 at the end of 2011, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

The swaps cost 44 basis points less than those for Turkey.

Russia is rated BBB by Standard & Poor’s, while Turkey has a BB rating. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements.

The extra yield investors demand to hold Russian debt rather than U.S. Treasuries increased 3 basis points to 270, according to JPMorgan EMBIG indexes. The difference compares with 189 for debt of Mexico and 181 for Brazil.

Short Duration

Potapov said his portfolio’s average duration was 1.5 years, with an average yield of about 9 percent, because of concern inflation and global interest rates will increase.

“Interest rates on the global markets remain at historical lows due to accommodative central bank policies, which in our view have only one way to go: up,” said Potapov said.

While a rally on the local market may continue in the short term, there are longer-term risks for fixed-income investors, he said.

“Higher inflation, commodity risk and uncertainty with the future direction of global rates prescribe a short-duration strategy,” he said. “The current absolute returns of 7.5 percent to 9.5 percent available on the local market are very attractive in absolute terms.”
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