(Bloomberg Businessweek) -- Wall Street doesn't usually let moral dilemmas get in the way of making money. There's almost always a bidder for whatever security is on offer, no matter how dodgy the issuer, how funky the structure, or how unpleasant the circumstances. Russian President Vladimir Putin's invasion of Ukraine is no exception.
Even before the missiles started raining down on Kyiv, the financial opportunists who prey on market dislocation were already hunting for bargains in Russian bonds. They had plenty to choose from. Almost all of Russia's debt, both sovereign and corporate, remains open for trading under U.S. economic sanctions. And, because demand has collapsed, the yields on all that paper are now among the highest in the world.
One government bond that matures in September 2023 was recently quoted at 48¢ on the dollar. If Russia honors its foreign debt—and so far it has—anyone who buys today stands to earn a return of at least 108% in only 18 months.
Needless to say, there's no small amount of risk involved. The battle for Ukraine may drag on for months, if not years. The theater of war may expand to include NATO members. Putin may resort to chemical or nuclear weapons. But what if buying Russian debt is a risk worth taking? While the world recoiled in horror at the sight of bombed-out hospitals and civilians sprawled dead in the streets, many hedge fund managers asked that question and salivated at the thought of a payday so huge it could be the biggest in a generation.
That's the cold calculus of investing in so-called distressed debt—buying the beaten-down, unloved, sometimes toxic securities that no one else is willing to touch and then holding on with unwavering conviction to crystallize a fat profit. Often that involves messy litigation, accusations of vulture-like behavior, and contentious court rulings. Occasionally it becomes an international incident, like when Elliott Management, a hedge fund in New York known for its bare-knuckle tactics, seized a navy vessel during a 15-year battle with Argentina.
In the U.S., distress is mostly a business of legal maneuvering for control of bankrupt (or almost-bankrupt) companies. It's different in emerging markets. There, borrowers are largely governments, and creditors have to accept the ethical trade-offs of, say, profiting from a humanitarian crisis or negotiating with a dictator. Yet even veterans of fraught situations such as Venezuela and Sudan are drawing a red line around Putin's war.
“This is just too grotesque for me,” Hans Humes, the chairman and founding partner of Greylock Capital Management, said in an interview from Caracas, where he was meeting with the Venezuelan vice president—herself a target of U.S. sanctions. “The cliché is you buy when there's blood in the streets. Not literally.”
To Bill Browder, the anti-Kremlin activist and former manager of what was once the largest hedge fund in Russia, there is no quandary. “It's like asking if you should buy German equities during the Holocaust,” he tweeted on March 6.
For other investors—even those who can disassociate the hunger for profits from the misery of Ukraine's people—it's not a matter of choice. They've been instructed by pension plans including the New York State Common Retirement Fund and the Public School Employees' Retirement System of Pennsylvania to divest from Russian assets as soon as possible.
There's a cost to that restraint. Russia still has plenty of available cash and sources of income, even under sanctions so severe they've largely cut it out of the global financial system. And Putin may keep servicing the country's debt, hoping perhaps to preserve access to foreign capital in the postwar future. Anyone who chooses not to invest while Russia's bonds are priced for default is consciously forgoing any potential upside.
Plus, Russia has already proven some doubters wrong. Jay Newman, the architect of Elliott Management's victory in the Argentina case, predicted on Bloomberg Television that the Russian government would fail to pay interest due in mid-March and called its sovereign bonds worthless. Yet Russia made the payment on schedule.
Of course, there are investors with no qualms about buying Russian debt. Two hedge fund managers, speaking to Bloomberg Businessweek on the condition they remain anonymous, say they'd placed bets on Lukoil, Russia's No. 2 oil producer. Another says he passed on Lukoil but made similar wagers on several other companies. Meantime, trading in Russian corporate debt has soared to the highest level in at least two years, topping $250 million a day through mid-March.
The rationale, they explain, was simple. Some bonds, such as those issued by Lukoil in the Netherlands, fit the distressed playbook perfectly. They're denominated in dollars, governed by British law, and backed in part by assets in Bulgaria, Italy, the U.S., and other “friendly” countries. If Lukoil defaults, bondholders can pursue claims in international court and, in theory, win control over operations outside the Russian Federation. Or maybe the bonds trade up when everyone else realizes they're too cheap. “We've done this kind of thing a bajillion times,” says one of the buyers.
Furthermore, the argument goes, letting borrowers such as Lukoil fail to honor their obligations only undermines the West's efforts to punish Putin. His cronies are needlessly rewarded, and Russia gets to keep the precious hard currency that would otherwise leave the country in debt payments.
Whether it's right or wrong, betting on Russia is not something these investors are willing to discuss publicly. There's just too much headline risk. No one wants to be the next “Vampire Squid,” the nickname Rolling Stone gave Goldman Sachs Group Inc. over its rapacious role in the global financial crisis. As one hedge fund allocator, the manager of a multibillion-dollar family office, puts it, “people will be judged for years to come.”
Greylock's Humes says there's only one scenario in which he'd consider investing in Russian debt: “If someone takes out Putin, then maybe.”
Read next: Broke Oligarch Says Sanctioned Billionaires Have No Sway Over Putin
©2022 Bloomberg L.P.
Essential Business Intelligence, Continuous LIVE TV, Sharp Market Insights, Practical Personal Finance Advice and Latest Stories — On NDTV Profit.
