The Flip Side of Argentina's Bond Sale
Debt investors should be a little nervous that Argentina received such a warm welcome back to the world’s debt market this week.
The South American country, which was returning to global capital markets for the first time since its 2001 default, easily sold $16.5 billion of bonds, the biggest one-day issuance of a developing nation on record. It could’ve probably sold twice that amount. It certainly got good rates, which were lower than similarly rated debt.
The sale was so successful that other developing nations are lining up to get a piece of the frenzied investor interest.
Here’s the problem: A lot of this demand is being driven by a broad-based desire for higher-yielding sovereign debt without much analysis about the specific countries seeking money. Investors who measure their performance relative to benchmark indexes bought Argentina’s bonds in anticipation of their inclusion in those gauges, according to a Bloomberg News article by Carolina Millan and Katia Porzecanski.
“If you get it wrong, that’s a huge performance gap,” Jean-Dominique Butikofer said in the article. “It’s like poker. Sometimes you have to pay up, even if you think you might lose,” said Butikofer, who oversees $3 billion in debt as head of emerging markets at Voya Investment Management in Atlanta.
Argentina’s sale demonstrates great faith in Argentina’s new leader, Mauricio Macri, who has pledged to resurrect the nation’s reputation after a history of repeated defaults on its external debt. But perhaps more important, it demonstrates the all-or-nothing mood of bond investors right now. They either love borrowers and can’t buy enough of their debt, or they hate them and won’t lend at all.
This is because most foreign holders of emerging-markets sovereign debt go through global asset managers, who often make investing decisions based on benchmark indexes. The amount of assets benchmarked to JPMorgan's emerging markets bond indexes has more than tripled since 2007, to $624 billion as of 2014, according to JPMorgan data compiled by the International Monetary Fund.
"A high share of benchmark-driven investors may result in capital flows that are more sensitive to global shocks and less sensitive to country factors," according to a December IMF paper prepared by Serkan Arslanalp and Takahiro Tsuda.
In other words, all developing countries may find it easier to borrow in good times, especially as low-rate policies prompt investors to take more risk in return for any yield at all. And all of these nations, especially the riskiest of them, may struggle to raise cash amid times of global uncertainty, regardless of their fundamental health. A nation like Argentina may suffer disproportionately in such a time if it doesn't improve its credit rating because fund managers may also choose to allocate more money into safer developing nations amid turmoil.
Right now, investors love risky countries. Sovereign debt of developing nations has gained 6.8 percent this year, the most for a similar period since 2009, according to JPMorgan index data. But this can flip on a dime. In May and June 2013, the debt plunged 8.3 percent on fears that the U.S. yields would rise faster than expected.
It’s great for Argentina that it raised enough to pay back existing creditors and still have some left over. Maybe this time the nation won’t default. And maybe all the other speculative-grade countries now thinking of selling debt will also meet their obligations and provide investors with hefty returns.
But there’s also a risk that at some point, another macroeconomic shock will send foreign investors running away from developing nations in mass, yanking money from indexed funds. This means money will flood away from all countries included in these benchmarks, including Argentina, leaving fragile countries with loads of debt and fewer ways to pay it back and frenzied investors with losses.
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