Interview with fund manager Ronald Schneider on Raiffeisen-Osteuropa-Rent

Article from 30 October 2023 in Börse Express

Börse Express: As a result of global interest rate hikes, bond funds suffered a terrible year. For Eastern European funds, the Russia-Ukraine conflict was an additional factor, which rendered Russian bonds essentially worthless and also had the effect of holding the Eastern European neighbours hostage to some degree. Your fund is also trading about one quarter below its previous high. A.) How much of this is due to Russia?

Ronald Schneider: It’s true that Raiffeisen-Osteuropa-Rent produced a sharply negative performance in 2022. Generally speaking, bond funds suffered from the massive increases in interest rates and yields last year. And of course, Eastern Europe was particularly impacted by the Russian invasion of Ukraine. In the last 12 months and for the year to date, however, the performance of Osteuropa-Rent has been quite good and significantly better than Western European government bond funds. About one half of the decline can be traced back to Russia, even though we had already sharply reduced our holdings there prior to the invasion and were thus able to limit the negative impacts in the fund.

And B): Looking at most of the major Western central banks, it appears that the peak of the rate hike cycle is at least very close. What about the situation in CEE?

The central banks in Poland and Hungary have already started to lower interest rates, but not the key rate. The steep declines in inflation figures and weak economic prospects suggest that interest rates will fall over a one-year horizon, in Czechia and Romania as well.

This means that the risk factors that are at least visible have probably already been priced in, so let’s move right to what is traditionally the last question: Why should I invest in your fund today rather than tomorrow?

In our opinion, the fund is attractive in light of the higher current yield with lower interest rate sensitivity compared to European government bond funds and the prospects for significant declines in interest rates, as well as the historically high risk premiums on Eastern European bonds. In terms of currencies, there are also prospects for positive contributions, in the event that economic performance is better than the current expectations, or if the EU transfer payments to Hungary and Poland become possible again.

Looking at your portfolio, there is a clear overweighting of government bonds, at more than 90%. Why are you not so interested in higher-yielding corporates?

According to the investment guidelines, the fund concentrates on government bonds in Eastern European currencies or hard currencies. Looking at the situation with local currencies, the Eastern European corporate bond market does not allow for a liquid, well-diversified investment in corporates.

I would also note that the fund’s involvement in Türkiye is also lower than average. Why is this? And the next question: How do you select the portfolio constituents?

Due to the low yields and risk of more weakness for the currency, we take a cautious position when it comes to the return opportunities for Turkish bonds denominated in lira. At 9%, the positioning in Turkish hard currency bonds is actually a bit higher than average for our fund, as the risk premiums are attractive, despite the high refinancing needs and the deterioration in the fundamental data seen in recent years.

How do you decide when it comes to buying a euro tranche or a tranche denominated in local currency for a sovereign issuer? And are foreign currencies viewed as a source of returns in their own right, or are FX risks hedged for euro investors?

Raiffeisen-Osteuropa-Rent invests both in local currency bonds and in bonds denominated in EUR or USD. Only the USD risk is structurally hedged. Whether local currency or hard currency bonds have a higher weighting depends on their relative attractiveness, the assessment of regional and country-specific economic developments, prospects for monetary and economic policy, and general political issues as well. The return expectations for bonds and currencies are formulated taking all of this into account. Although FX risks are partially hedged during certain phases, the fund is mostly exposed to currency developments, resulting in higher volatility. Over the long run, we anticipate that the higher interest remuneration justifies this risk.

Has the coronavirus and the Ukraine war, along with the related supply chain interruptions, and also the EU regulations such as the supply chain directive, opened up new opportunities in the convergence story for Eastern European countries? All of this is certainly easier to control in the part of Eastern Europe that is associated with the EU, compared to Asia...

Clearly, this is a positive factor for Eastern Europe. The planned construction of a chip factory in Poland and the planned development of battery production in Hungary are recent examples for this.

Your fund has a surplus return of around two percentage points compared to German government bonds, about 70% more. How high do you think the justified premium will be over the long run?

At the moment, Osteuropa-Rent has a return of around 6%. Due to the changing composition of the fund and the partially quite divergent developments in the invested countries/markets, it doesn’t make much sense to offer such a projection at the fund level. Although they have declined recently, risk premiums on sovereign bonds in some Eastern European countries are still high by historical standards and clearly offer opportunities, if the risks that have been discounted ease off.

One final question: Raiffeisen Capital Management is transitioning everything it can to ESG branding. Is that move being prepared for your fund as well? Or is that not possible right now due to the lack of volume or supply in Eastern Europe?

Sustainability is a very important aspect for Raiffeisen KAG, and we are constantly working to integrate sustainability aspects more and more into our investment decisions. This also applies to the fund in question, but a more strict approach to sustainability issues is not planned in the immediate future.

Explanations:

ESG stands for environment (E), social (S) and good governance (G).

Ad FX risks: FX refers to foreign currencies.

The Fund Regulations of the Raiffeisen Eastern European Bonds have been approved by the FMA. The Raiffeisen Eastern European Bonds may invest more than 35 % of the fund's volume in securities/money market instruments of the following issuers: Poland, Türkiye, Hungary.