The Big Idea
Argentina | Diversification from market beta
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Few if any resilient credits have made it through the latest round of risk aversion in emerging markets. It has been a one-two punch of equity and Treasury weakness across both high yield and investment grade credits. Argentina has been the stealth outperformer so far this year mostly due to the positive total returns of the quasi-sovereign and corporate credits. The off-benchmark credits have provided diversification with a lower correlation to external risk. The favorable technical in these credits also offer a clear benefit amid scarce opportunities elsewhere in emerging markets.
The quasi-sovereigns enjoy a long list of supportive technicals and defensive characteristics. Most importantly, it’s the attractive valuations and low volatility that offer a combination of low beta and high carry returns. The favorable positioning risks also discourages sellers at a mature phase of divestment that leaves core buy-and-hold investors with a longer-term investment strategy. The “unloved” status may not invite new buyers into Argentina but it’s also a mature phase of divestment with the remaining investors adopting a longer-term view. This discourages opportunistic or activist trading that lowers the volatility and correlation to market risk. This then allows investors to benefit from high carry returns, with the majority of the quasi-sovereigns and corporates offering extra spread premium for the “guilty by association” to the sovereign. The sovereign remains at distressed bond prices near 30 but under a slow transition towards effective policy management with the anchor of a flexible IMF program and the marginalization of radical Kirchnerismo. The high-yield status also immunizes against the US Treasury weakness that has been the primary constraint for the investment grade credits.
Ranking the year-to-date performance of the Argentina EMUSTRUU index, the off-benchmark credits are the notable outperformers. Amherst Pierpont this year has preferred the relative value of quasi-sovereigns with alternatives ranging across credit quality, liquidity, and yields. YPF stands out as the clear outperformer as the obvious expression of the positive oil shock, but all of the quasi-sovereigns have delivered positive total returns. Despite the “benchmark size” liquidity of BUENOS’37A at $6.2 billion, this bond was still able to eke out positive year-to-date returns of 0.95%. This compares favorably against EMUSTRUU index year-to-date losses of -12.9%. This reflects the combination of the tight trading range for bond prices at 40-44 and the high current yield of 9%-10%. There has been firm support at price lows of 40 with the IMF offering a de facto anchor while the higher relative coupons at 3.9% versus 1%-2% for the sovereign.
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