A bet on exotic Ukrainian debt warrants held by Morgan Stanley Investment Management is offering some of the biggest returns across emerging markets in the space of three months.
(Bloomberg) — A bet on exotic Ukrainian debt warrants held by Morgan Stanley Investment Management is offering some of the biggest returns across emerging markets in the space of three months.
A short-lived mutiny in Russia lifted Ukrainian assets this week on bets that any disarray among Russia’s top brass could benefit President Volodymyr Zelenskiy’s efforts to support the economy and carry out a counteroffensive. That upswing in prices included the GDP warrants — originally born from a 2015 debt restructuring — which Morgan Stanley has been holding, according to a disclosure earlier this year.
The $3.2 billion in August 2041 notes, whose payouts are linked to economic growth, jumped to 40 cents on the dollar this week from 27 cents at the end of March. The bonds were quoted at 38 cents on Tuesday. Morgan Stanley bought some of the notes according to quarterly ownership data on Bloomberg dated March 31.
A New York-based Morgan Stanley Investment Management spokesperson declined to comment on the purchases and whether it has sold some of the notes after the rally.
Ukraine’s sovereign dollar bonds beat other emerging markets and as a whole have returned more than 30% this quarter, with most of the gains registered in June, according to data compiled by Bloomberg. Corporate bonds also generated the best returns in their category. Emerging-market sovereign dollar debt returned 1.8% in the same period.
Economic Outlook
Even aside from the fallout from the uprising in Russia at the weekend, Ukraine’s economic outlook has started to look slightly less bleak than a few months ago.
While trading in Ukraine’s markets has been illiquid after the government froze foreign-bond payments on its $20 billion debt pile until 2024, bonds have been supported by the prospect for more western financing, as well as an initiative to use frozen Russian assets to pay for reconstruction.
“All those points have caveats that investors are aware of, but they are positive,” said Fedir Bagnenko, a managing director for fixed-income trading at Dragon Capital in Kyiv. “Last weekend’s events in Russia added to optimism in the medium-term.”
The International Monetary Fund raised its 2023 growth outlook for Ukraine to up to 3% in May, from a previous range that saw 1% expansion at best or a contraction. Goldman Sachs Group Inc. went even further, upgrading its growth projection to 5.5% in a June 9 report.
Payment Conditions
That has repercussions for the holders of the GDP warrants, whose payouts were linked to specific nominal GDP levels as well as a condition that real growth must be 3% or higher. Ukraine’s growth rates would suddenly jump during a potential reconstruction, with strong base effects after the devastation from the attacks.
“If those forecasts are correct, this will trigger a payment,” Bagnenko said of the projections for up to 5.5% growth.
A separate report by London-based Morgan Stanley strategists James Lord and Neville Mandimika on Monday listed Ukraine among the credits the bank likes, citing positive risk-reward on recovery values and expectations of stabilization in its economy and debt.
“Ukraine emphasizes the need to keep the private sector on its side due to the need for new financing,” the strategists wrote on the assumptions behind their recommendations, adding that uncertainty remained high.
The flip side is that the potentially large payday for investors also presents a risk for Ukraine’s cash-strapped government, so last year’s deal with creditors capped and deferred some of the payments.
“In addition to the horrific humanitarian toll, Russia’s invasion of Ukraine continues to have a devastating impact on the economy,” the IMF report said. “Despite this, the Ukrainian economy has shown remarkable resilience.”
–With assistance from Tasos Vossos.
(Updates with EM bond returns in the 5th paragraph, late afternoon pricing for Ukraine debt in 3rd paragraph.)
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