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Argentine default fails to halt emerging market bond rally

Published:Wednesday | August 27, 2014 | 8:00 AM
President of Argentina, Cristina Fernández de Kirchner. - File

By Vivianne Rodrigues in New York

Back in late December 2001, when Argentina defaulted on nearly US$100bn in debt, it took emerging market bonds just about 48 hours to start staging a rebound, recalls Jerome Booth, a veteran emerging market analyst.

"All it took was a couple of days and most emerging markets bonds started to rise again," says Mr Booth, formerly of Ashmore, an EM specialist fund manager, and now a book author.

Fast forward to 2014, and emerging market bonds are experiencing a troika of bad news: geopolitical instability; sluggish economic prospects in some of the group's largest economies, such as Brazil; and once again, Argentine debt default.

The South American nation defaulted for the second time in 13 years last month, in the latest chapter of its dispute with so-called holdout creditors, which did not participate in the country's two previous debt restructurings.

But, just like in 2001, analysts and investors say the threat of broad contagion stemming from debt woes in one particular country is limited.

Argentina now makes up less than 2 per cent of the JPMorgan emerging markets bond index, an industry benchmark. If anything, analysts say, a sell-off in emerging markets may once more provide investors with an opportunity to buy some EM bonds.

"Back in the 'old days' of emerging markets investing, the potential for contagion was more real. If a country defaulted, the entire group could have been hit," says Kevin Daly, a portfolio manager at Aberdeen Asset Management.

"This time around Argentina just defaulted, and its impact is not being felt even in bonds of countries such as Venezuela," he says.

At the time of Argentina's massive default, EM investment was still mostly dominated by hedge funds and other "hot money" investors. But since then, pension and mutual funds, insurance companies, sovereign wealth funds and even central banks, have become large EM debt buyers.

"What you have now is a pool of emerging markets investors that is much broader than in 2001. It includes large institutional money, and this is not the type of investor that is going to have a knee-jerk reaction to a credit event, such as Argentina's default," says Mr Daly.

"They are much more focused on the medium and long-term horizons."

Emerging market bulls say that in spite of this year's lacklustre economic performance, growth within the 20 largest EM countries, excluding China, is expected to rise in 2015 and get closer to the 3 per cent mark.

The mix of higher growth and lower debt-to-GDP levels than in many developed economies is enticing to many investors. But the lure of higher yields and the potential for higher total returns remain the most potent draw for global investors, who have flocked to EM debt and other high-yielding securities in the past couple of years.

"EM is a diverse set of countries, and for many investors the group is now part of their global asset-allocation mix," says Jonny Goulden, emerging markets strategist at JPMorgan. "EM will remain attractive while people are looking at all available sources of higher yields and additional money."

EM bonds have rewarded investors this year in spite of the negative headlines.

Total return on emerging markets bonds stands at 9.4 per cent this year, according to JPMorgan's indices, with average yields on the securities at 5.1 per cent. That compares with total returns of 3.27 per cent on United States (US) Treasuries, with average yields at 1.42 per cent, according to Barclays.

Even Argentine bonds have been resilient. While the country's dollar-denominated restructured bonds have declined sharply in August in the aftermath of the default, average Argentine debt has returned about 8.1 per cent this year, according to JPMorgan.

The outlook for EM debt, however, is not without challenges.

While Argentina's default and even the escalation of tensions between Ukraine and Russia are expected to have mostly a localised effect, EM bonds sold off last year when the Fed announced plans to phase out its quantitative easing programme.

Higher US Treasury yields could lead to another bout of selling in EM bonds, and boost volatility while sales of sovereign EM debt are running at a record pace, analysts said.

"It remains to be seen what will happen to flows into and out of EM once interest rates start to rise in the United States and major central banks start to withdraw quantitative stimulus," says Mr Goulden at JPMorgan.

"Ultimately, the path of US Treasury yields is important in determining the outlook for EM bonds."

(c) 2014 The Financial Times Limited