Bondholders Eye Russia’s Expulsion From $842 Billion Club

(Bloomberg) -- Investors are bracing for more losses in Russian debt as expulsion from key indexes in the wake of President Vladimir Putin's invasion of Ukraine hits an already trampled market.

Russia's government and corporate bonds have been removed from the closely-followed JPMorgan Chase & Co. suite of emerging-market bond indexes, known as EMBI, leaving some money managers whose funds track the gauge with little choice but to sell or write down their holdings. JPMorgan also scrapped the sovereign and quasi-sovereign debt of Belarus from its indices.

Russia's $3 billion in bonds due in 2029 have fallen more than 70 cents since before the invasion to be quoted at just 18 cents on the dollar, according to indicative pricing compiled by Bloomberg. While other countries have seen their assets booted from key gauges in the past, Russia's expulsion underscores risk as an estimated $842 billion in assets tracks JPMorgan's gauges.

“While this happens from time to time in the emerging-market debt universe -- like with Egypt in 2011, Nigeria in 2015 or Argentina in 2019 -- none of these were of the same magnitude as it is with Russia,” said Antoine Lesne, head of ETF strategy and research for State Street's SPDR, which owns Russian bonds across its funds. He declined to specify how State Street is managing those holdings.

There was an estimated $415 billion in assets tracking the EMBI index as of Feb. 28, according to JPMorgan data, plus $245 billion following the JPMorgan Government Bond Index-Emerging Markets gauge, called GBI-EM. Along with the bank's Corporate Emerging Markets Bond Index series, which had $140 billion tracking it, the benchmarks have become standards for the industry.

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A number of other index providers including Bloomberg Index Services Ltd., FTSE Russell, MSCI Inc. and S&P Dow Jones Indices have also moved to pull Russia from their gauges. Bloomberg LP, the parent of Bloomberg News, is also the parent company of Bloomberg Index Services Ltd.

Such exclusions are sure to have an impact for global money managers from State Street to Blackrock Inc. and Vanguard Group, which have index-tracking, passive funds that recently held Russian government and corporate bonds, according to data compiled by Bloomberg.

Blackrock's iShares EM Local Government Bond UCITS ETF owned a number of Russian local government bonds, or OFZs, as of March 30, according to the fund's website. A Blackrock spokesperson declined to comment and Vanguard did not immediately respond to a request for comment.

“Since liquidity is virtually non-existent in Russian bonds, there is hardly any possibility to wind down positions in Russian risk assets,” said Egor Fedorov, an emerging-markets analyst at ING. “In the case of default, or series of defaults over time, investors will need to recognize a complete loss in their profit & loss statements.”

While the volume of Russian corporate-debt trades is at a two-year high, many investors are still struggling to find buyers, especially for local-currency debt.

Still, JPMorgan has wound down its weighting of Russian assets, which accounted for just 0.69% of the EMBI Global Diversified gauge and 1.84% of the GBI-EM Global Diversified index, as of March 2.

The extra yield investors demand to hold emerging-market debt over U.S. Treasuries fell by 39 basis points on Thursday to 399 basis points, according to JPMorgan data, the biggest drop in risk premium in two years. They extended their decline by four basis points on Friday.