T. Rowe Price T. Rowe Price Trusty Logo

Quantifying Oligarch Risk

Samy Muaddi, Portfolio Manager, Emerging Markets Corporate Bond Strategy

Executive Summary

  • Governance risk has always been central to emerging market (EM) credit analysis but, given recent sanctions developments, Russia’s corporate landscape currently presents its own set of challenges.
  • For bond investors, putting a price tag on “oligarch risk” calls for assessments of both the business risk and the sanctions risk associated with these billionaire businessmen.
  • Building sanctions risk into fair value for Russian bonds helps compare local issuers, but it can also help evaluate Russian issuers against opportunities elsewhere in the world. 

In April this year, aluminium producer Rusal’s bonds plunged more than 60% after the US Treasury announced sanctions against seven high-profile Russian businessmen and 12 of their companies. Emerging market (EM) corporate bond investors are no strangers to governance risk, but Russia’s corporate landscape brings a set of challenges all its own. How should analysts think about building “oligarch risk” into their models? 

Oligarchies and corporate governance issues are by no means unique to Russia, but recent developments in Specially Designated Nationals (SDN) sanctions by the US Treasury have brought Russian governance into sharper focus. Analysis of sanctions risk is increasingly relevant today as the US has become more proactive in imposing sanctions, notably also on Turkey and Venezuela.

The objective of this analysis is not just to avoid tail risk, but also to try and put a price tag on risk and make relative valuation judgments—both among Russian companies and between opportunities in Russia and other regions. We recently did an exercise that combined both qualitative and quantitative information in a systematic framework, seeking to arrive at a risk-adjusted fair value for nine Russian companies. 

STEP 1: PROFILING THE OLIGARCHS

Russian president Vladimir Putin has effectively put 25 oligarchs in control of 80%-85%1  of corporate Russia. For investors, it’s important to understand who these influencers are, and to what extent their interests are aligned with those of bondholders. We scored each oligarch on several criteria:

  1. Political connections. Business benefits tend to accrue to members of Mr. Putin’s inner circle. How close is his connection to Mr. Putin? Is it family, business, political? Or, like Gennady Timchenko2, is he a judo sparring partner?
  2. Historical behaviour. Information about how oligarchs climbed the ladder and dealt with competitors—notably the winners of the Siberian Aluminium Wars of the lawless 1990s—can tell us something about how emotionally invested they are in their companies’ survival.
  3. Capital allocation. Are investors all treated fairly, or is there an imbalance? Is the sponsor using the business as a cash cow to fund his own needs? In 2015 the Kerimov family, which had a 40% stake in Polyus Gold, took the company private3. The loan financing made them dependent on dividends from the company to service their debt, which left little scope for improvement in the company’s credit metrics.
  4. Net worth and asset diversification. The larger and more diversified the oligarch’s asset base, the more able he will be to extract funds from other businesses if the company needs a cash injection.  Two who score well on this are Severstal’s Alexei Mordashov and USM’s Alisher Usmanov.
  5. Other information. This includes qualitative measures such as: how extravagant is the oligarch’s lifestyle and how erratic or risky is his behaviour? For example, Mikhail Prokhorov’s flamboyant lifestyle has been perceived as one of the contributing factors to the divestment of his stake in Norilsk Nickel.4

STEP 2: ASSESSING SANCTIONS EXPOSURE

While our first assessment focuses on business risk – essentially how bondholder-friendly the individual is – Russia’s unique environment calls for a second filter based on sanctions-specific factors. For example, being close to Mr. Putin may historically have been good from a business perspective, but in today’s environment it carries a higher sanctions risk.  We ranked oligarchs based on factors that tend to come up on the US Treasury’s radar or have previously been a trigger for sanctions.

  1. Political connections. Mr. Putin’s inner circle includes names such as Chelsea football club’s Roman Abramovich, who is seen as an influencer and dealmaker among the oligarchs and close adviser to Mr. Putin. Those with lower profiles include NLMK’s Vladimir Lisin.
  2. Ownership. Does the oligarch fall foul of the Treasury’s Office of Foreign Assets Control (OFAC) 50% rule? Alexei Mordashov scored highest on our scale of bondholder-friendliness, but his 77% stake in Severstal makes him a potential sanctions target. Vladimir Lisin is also at risk, with an 85% stake in NLMK.
  3. Fraudulent activities. In April, one of the US Treasury’s seven designated oligarchs was Polyus Gold’s Suleyman Kerimov5.  OFAC cited his detention in France for allegedly failing to pay taxes and laundering funds through the purchase of villas (France has since dropped the charges.)
  4. Cost of sanctions to the US. As we’ll discuss shortly, sanctions on some companies would increase commodity costs for US businesses, while others would have less impact.
  5. Facilitating Cronyism. For example, Severstal’s Alexei Mordashov controls 6% of Bank Rossiya, which was one of the firms sanctioned in April and is sometimes referred to as “Putin’s bank”6.  Bank Rossiya has been associated with the illegal transfer of funds from the Russian state for the benefit of senior officials.

STEP 3: SCENARIO ANALYSIS

Can anecdotal and qualitative information be incorporated into bond valuations in a meaningful way? For nine companies, based on our analysis of their sponsors so far, we did an exercise in which we assigned a probability to a Rusal-type scenario where sanctions escalate. The table in Figure 1 shows an edited extract from the study.

In the first example, we believed Company A, a large and growing commodity producer, faced relatively low sanctions risk, largely because of the potential impact on the price of that commodity.  In our assessment, the bonds were slightly cheap at the time of the study (June 2018).

By contrast, we concluded that the bonds of Companies B and C were not correctly pricing in sanctions risk. Both are more than 50% owned by their sponsors. If OFAC decides to classify the sponsors as Specially Designated Nationals (SDNs), all holdings in which they own more than 50% will automatically be classified as SDN7

For Company C, its sponsor’s connection with another firm that has been sanctioned adds an additional layer of risk by being a potential target for OFAC sanctions. When the higher probability of being sanctioned was incorporated into the analysis, we didn’t believe investors were compensated for the risks involved. At the time of the study we thought Company C was trading about 13.5% higher than it should have been.

Figure 1. Scenario Analysis of Oligarch-Sponsored Companies

As of June 2018

Source: T. Rowe Price. For illustrative purposes only

THE GLOBAL CONTEXT

Building governance factors into relative valuations helps assess opportunities within Russia, but it also helps give regional perspective.  We concluded that a number of the  Russian companies in our study were not fully pricing in the governance risks. Comparing these companies with peers in other regions (Latin America or Asia) at the time, we found a number of firms with similar credit ratings and balance sheet fundamentals, offering similar yields, but without the corporate governance concerns.

For example, the chart in Figure 2 compares the price returns of the bonds of a Russian metals company with those of a comparable Latin American peer since March this year. Both bonds are rated BBB- and both mature in 2023. Since March, The Russian company has been far more volatile, suffering two bouts of sanctions-risk jitters and underperforming the Latin American company by about 4 percentage points.

Figure 2. A Tale of Two Metals Companies

Past performance is not a reliable indicator of future returns.

As of August 22, 2018

Source: Bloomberg - Bloomberg Finance L.P. Used with permission.

Today, despite the recent volatility and negative news flow, we still believe that Russian corporate bond valuations are underpricing sanctions risk. This is largely due to technical support: limited new issuance means that supply has been shrinking, with the result that tail risk is not being fully priced in. Against this backdrop, we are maintaining minimal exposure to corporate Russia.

The specific securities identified and described above do not necessarily represent securities purchased or sold by T. Rowe Price.  This information is not intended to be a recommendation to take any particular investment action and is subject to change.  No assumptions should be made that the securities identified and discussed  above were or will be profitable.

Key Risks  - The following risks are materially relevant to the strategy highlighted in this material: Transactions in securities denominated in foreign currencies are subject to fluctuations in exchange rates which may affect the value of an investment. Returns can be more volatile than other, more developed, markets due to changes in market, political and economic conditions. Debt securities could suffer an adverse change in financial condition due to ratings downgrade or default which may affect the value of an investment

Important Information

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. 

It is not intended for distribution to retail investors in any jurisdiction.

DIFC—Issued in the Dubai International Financial Centre by T. Rowe Price International Ltd. This material is communicated on behalf of
T. Rowe Price International Ltd. by its representative office which is regulated by the Dubai Financial Services Authority. For Professional Clients only.

EEA—Issued in the European Economic Area by T. Rowe Price International Ltd., 60 Queen Victoria Street, London EC4N 4TZ which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.

Switzerland—Issued in Switzerland by T. Rowe Price (Switzerland) GmbH, Talstrasse 65, 6th Floor, 8001 Zurich, Switzerland. For Qualified Investors only.

T. ROWE PRICE, INVEST WITH CONFIDENCE and the Bighorn Sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc. All rights reserved.

201808-590318

Dismiss
Tap to dismiss

Download

Latest Date Range
Audience for the document: Share Class: Language of the document:
Download Cancel

Download

Share Class: Language of the document:
Download Cancel
Sign in to manage subscriptions for products, insights and email updates.
Continue with sign in?
To complete sign in and be redirected to your registered country, please select continue. Select cancel to remain on the current site.
Continue Cancel
Once registered, you'll be able to start subscribing.

By clicking the Continue button, I acknowledge that I have read and accepted the Privacy Notice

Continue Back

Change Details

If you need to change your email address please contact us.
Subscriptions
OK
You are ready to start subscribing.
Get started by going to our products or insights section to follow what you're interested in.

Products Insights

GIPS® Information

T. Rowe Price ("TRP") claims compliance with the Global Investment Performance Standards (GIPS®). TRP has been independently verified for the twenty one- year period ended June 30, 2017 by KPMG LLP. The verification report is available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm's policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation.

TRP is a U.S. investment management firm with various investment advisers registered with the U.S. Securities and Exchange Commission, the U.K. Financial Conduct Authority, and other regulatory bodies in various countries and holds itself out as such to potential clients for GIPS purposes. TRP further defines itself under GIPS as a discretionary investment manager providing services primarily to institutional clients with regard to various mandates, which include U.S, international, and global strategies but excluding the services of the Private Asset Management group.

A complete list and description of all of the Firm's composites and/or a presentation that adheres to the GIPS® standards are available upon request. Additional information regarding the firm's policies and procedures for calculating and reporting performance results is available upon request

Other Literature

You have successfully subscribed.

Notify me by email when
regular data and commentary is available
exceptional commentary is available
new articles become available

Thank you for your continued interest