Russian assets look cheap, but could get cheaper

If financial markets are anything to go by, the toughest economic sanctions against Russia since the end of the Cold War have been a damp squib.

The Micex, a share index based on the 50 most traded large Russian companies, closed the week roughly where it started on Monday. Bond markets also appeared to take the news in their stride: benchmark Russian government borrowing costs ticked up to 9.5 per cent but remain just below year to date highs. This is probably not what western policymakers had in mind when Barack Obama, the US president, pledged that the enhanced measures would have "an even bigger bite".

The sanctions, which came into force on Friday, bar state-owned banks and key companies from issuing long-term debt or equity on EU or US capital markets, traditionally big conduits of Russian finance. Short-term debt - up to 90 days - is still permitted while there are no restrictions on Russian government bonds. Similarly there is no bar on buying existing Russian shares or bonds in circulation.

For global investors the question is whether they should be selling out or whether this is the time to buy.

"A lot of people are jumping on the bandwagon of panic - that creates an opportunity," says Michael Ganske, head of emerging markets at Rogge Global. "You have dislocation of market pricing with people trading on headlines, so it's a good time to invest in such a country if you're a long-term, strategic investor."

Russian shares, trading at an average price to earnings ratio of five times, are the cheapest among major emerging markets according to analysts. In fixed income assets, bond prices could also look cheap on some measures. Insurance on Russian bonds, for example, has risen 13 per cent in a week according to figures from Markit. Comparable insurance on Turkish and South African debt is some 50 basis points less.

"It's a two-way street at the moment - a lot of investors are seeing this as an opportunity to buy and others are selling," says Mr Ganske. "I'm investing on the long-term basis that some kind of resolution is the most likely scenario with regard to Ukraine and EU sanctions are due to be reviewed in October."

It is hard to be optimistic. Markets may have shrugged but plenty of companies, especially Russia's banks, have felt the chill of sanctions.

Over the past week Sberbank, Russia's largest bank, has seen its funding costs increase by 16 per cent according to Markit. The price for insuring Sberbank's bonds against default, a good proxy for funding costs, rose to €324,000 per €10m worth of bonds, more than triple the European bank average. Other major banks, such as Russian Agricultural Bank and VTB, also saw big increases.

Meanwhile large Russian companies are pivoting towards Asia - and taking their cash with them. Megafon, Russia's second-largest mobile phone operator, said it has converted 40 per cent of its cash reserves into Hong Kong dollars at Chinese banks.

Wider economic fallout is expected. City bankers in London warned that initial public offerings for Russian companies are likely to dry up entirely.

European companies reported a drop in Russian business, led by sportswear group Adidas and car-makers Volkswagen. Meanwhile S&P Dow Jones has asked clients if it should remove sanctioned Russian firms from its closely watched financial markets indices.

"There are many questions about the state of corporate governance generally [in Russia]," says Andrew Milligan, head of global strategy at Standard Life Investments. "The economy was already seeing slow growth and pressures on the rouble have forced the central bank to raise interest rates three times this year."

Sanctions also have the effect of deterring business with legitimate Russian companies.

"You make sure you go through the approvals before you do a trade," says a senior London-based debt banker. "It's fair to say you think twice."

If tensions continue to escalate and sanctions bite prices could tumble yet further.

"It's a brave investor who says we've seen the bottom," says a senior syndicate debt banker.

"If you take the longer-term view then, given events on the ground, there's a good chance you'll get a cheaper point of entry."

Amid rising violence in Ukraine part of the conundrum for investors is assessing whether the worst is already over. Even long-only buyers agree that the only certainty at present is of more uncertainty to come.

"Russia now falls into the classic description of an emerging market economy," says Mr Milligan. "Potentially the returns are high - but so are the risks. If you put your money into some assets, there may be a problem getting it out."

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