By Karin Strohecker
LONDON (Reuters) - A wave of new year optimism toward emerging markets lifted Ukraine's sovereign bonds to multi-month highs just weeks before a closely fought presidential election, but foreign funds are already cashing up and are keen to sit out the poll.
Ukraine holds the first round of its presidential election on March 31. If no candidate wins 50 percent, the top two contenders will face each other in a run-off on April 21. Comic actor Volodymyr Zelenskiy, a political novice, is ahead in the polls, causing jitters among investors.
One of the top performing bond markets in 2019, the Ukraine component of JPMorgan's EMBI hard-currency total return index has risen nearly 10 percent since the start of the year to the highest level in nearly 14 months. The broader index gained 6.1 percent in 2019.
Some of those gains represent catch-up after uncertainty over the outlook for Ukraine's International Monetary Fund (IMF) program and slow progress on reforms saw bonds underperform over the past 12 months. A new $3.9 billion IMF stand-by agreement in late December added fresh momentum.
(GRAPHIC: Ukraine flying high - https://tmsnrt.rs/2UKK71I)
Yet some major Western asset managers say they have in recent days cut back their exposure amid uncertainty over how the election, with Zelinksiy extending his lead over incumbent Petro Poroshenko in the opinion polls.
"Poroshenko is a case of 'better the devil you know' - he is a known quantity for markets, we know what he has done and what he hasn't done," said Zsolt Papp, emerging market debt investment specialist at JPMorgan (NYSE:JPM) Asset Management.
Critical for investors is what the election outcome means for Ukraine's continued cooperation with the IMF, which has propped up the country through war and recession since 2014.
"Ukraine was one of the consensus overweight calls at the beginning of the year... By now the overweight has been scaled back to a more neutral position," he said, adding this was also broadly reflecting JPMorgan AM's position.
Fund managers are wary over the 41-year-old Zelenskiy's lack of an economic plan, should he be elected, though they expect him to stick with the IMF program.
Former prime minister Yulia Tymoshenko has also emerged as a key challenger to Poroshenko. She has pledged to reverse IMF-backed gas price hikes if she wins the election, though she wants Ukraine to stay in the IMF program.
(GRAPHIC: Ukraine bond roller coaster - https://tmsnrt.rs/2ObRtJ9)
INCONCLUSIVE ROADSHOWS
Fund managers have been meeting a number of Ukraine's power brokers as the election race nears the finishing line.
Speaking in London this month, Ukraine's respected former central bank governor Valeria Gontareva painted a stark picture of what would lie ahead if Zelenskiy wins, asset managers said.
Former finance minister Oleksandr Danylyuk, who was sacked in June 2018 after a spat with the prime minister and is associated with Zelenskiy's campaign, met asset managers in London in another crowded meeting.
Yet the meetings did little to allay investors' concerns about the prospect of the wild card comedian coming to power.
"He lacks political and public administration experience, and that is where the market reacts with its feet," said Kevin Daly, investment director at Aberdeen Standard Investments.
Daly ascribed many of the recent gains in Ukraine's dollar bonds to valuations, a benign environment for emerging markets and spread compression across single B-rated countries.
Adding to momentum since the start of the year has also been the first tranche of IMF aid totaling $1.4 billion as well as 500 million euros worth of assistance from the European Union, received by Kiev in late December.
Yet Daly said his firm had cut holdings to neutral after a visit to Kiev in February and being overweight for two years.
"The risks are skewed to the downside, because on a Poroshenko win you probably have a mild rally and if you get Zelenskiy or Tymoshenko, you'll have a much larger sell-off," said Daly.
Ukraine's economic backdrop has raised more questions. While inflation stood at just below 10 percent by end-2018, gross domestic product is expected to grow by 2.9 percent this year compared to 3.2 percent expected for 2018, according to a Reuters poll.
"Of course politics is important, but at the end of the day you will always return to fundamentals, and once the political noise is over, markets will look back and ask: what is the financing framework...and - most importantly - what is the current account deficit doing," said JPMorgan's Papp. "That's where we really need to see an improvement."