For proof that monetary stimulus is driving yield-starved investors further from the mainstream, just look at the rally in one of Europe’s more obscure debt securities: Ukrainian GDP warrants.
The notes, tied to economic growth in the war-torn nation that negotiated a $15bn debt overhaul less than two years ago, have surged more than 50% since JPMorgan Chase & Co recommended them to investors in late March. Analysts at the bank say the rally has a lot further to go.
Investors are willing to take on the risks for the rare chance to hold debt that’s sheltered from both developed-world central-bank policy and commodity prices, the double threat that plagues most high-yield bond markets. Unlike traditional debt securities that are tied to interest rates, payouts on GDP warrants are linked to the economic growth of the issuer. “Investors are naturally looking for assets that have a valuation story and it’s been difficult in the current investment climate to find those,” said Jonny Goulden, who heads local emerging-market debt research at JPMorgan in London. “We are seeing new investor appetite.”
Persistently low interest rates have pushed traders away from the realm of conventional debt markets in search of returns. Argentina convinced investors to buy 100-year debt in June, Iraq last week tightened pricing on a $1bn Eurobond sale after orders were oversubscribed, while Mongolia and Ethiopia are among the best-performing dollar-debt issuers in emerging markets this year.
Goulden and his colleagues fuelled appetite for the warrants in late March with a 25-page report concluding that payouts, while difficult to determine, are likely to far exceed current pricing. Back then, the warrants traded below 30 cents on the dollar. Now they trade at 46 cents and JPMorgan estimates their fair value is closer to 80 cents.
The warrants have a stamp of approval from Franklin Templeton chief investment officer Michael Hasenstab, who has held onto the securities since he received them as part of Ukraine’s 2015 debt restructuring, despite paring holdings of the nation’s Eurobonds. Franklin Templeton remained by far the biggest holder of the notes, according to data compiled by Bloomberg.
Analysts at Bank of America Merrill Lynch are less convinced. The warrant rally reflects “complacency on risks” and “too much optimism” on Ukraine’s growth outlook, Gabriele Foa, a London-based analyst at the bank said in a research note published in late July. Payments to Ukraine from a $17.5bn bailout from the International Monetary Fund have been delayed as the country makes slow progress in reforms, while separatist fighting near the border with Russia continues to weigh on the economy.
Investors who hold the notes can receive a payout twice a year between 2021 and 2040, with the amount determined by the pace of gross domestic product growth in Ukraine. The former-Soviet nation isn’t required to make any payouts until its economy climbs to $125.4bn from $93.27bn at the end of last year, and unless economic growth climbs above 3%.
The International Monetary Fund estimates the nation’s GDP will increase enough to breach the pay-out level in 2021, while BofA says cashflow from the notes is unlikely before 2025. JPMorgan’s Goulden disagrees, saying slowing inflation and faster growth in the second quarter could push GDP to $105bn this year.
The Ukrainian economy probably expanded 2.5% in the first half of the year as the country adjusted to a trade blockade in its eastern territories, according to preliminary data published on the Economy Ministry’s website. Economists polled by Bloomberg see growth slowing to 1.4% by the fourth quarter before accelerating to 3% next year.
The securities climbed for a seventh day to 46.24 cents on the dollar on in Kiev on Thursday.
“Current economic performance and the data are actually pointing to the country getting closer to the initial thresholds over the next couple of years,” Goulden said. “We still recommend investors buy the warrants.”
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