MFS Losing Faith in Argentina as Default Vultures Circle

MFS Investment Management, manager of the oldest U.S. mutual fund and an ally of the Argentine government in its legal fight against disgruntled creditors, is reducing holdings of the South American nation’s debt.

MFS has sold about $194 million of its dollar-denominated Argentine government bonds issued as part of the nation’s debt restructurings since November, when Chief Operating Officer Robin Stelmach said the firm owned over $390 million in principal of the notes, according to Feb. 28 company filings compiled by Bloomberg. The notes have lost 0.3 percent since the end of October, compared with an average 2.8 percent gain for emerging-market bonds, according to JPMorgan Chase & Co.

The company located in Boston is part of the Exchange Bondholder Group, an alliance of investment firms that also includes BlackRock Inc. and Gramercy Funds Management LLC that joined the nation in challenging a U.S. court order that would reward holdout creditors with face value and accrued interest. MFS is cutting back ahead of the U.S. appeals court ruling that could trigger further losses in the bonds.

“The current bondholders are essentially being used as cheese to bait the mousetrap,” Matthew Ryan, who helps manage $18 billion of emerging-market debt at MFS, said in a telephone interview from Boston. “This is a risk that’s much more difficult for a real money investor to assess.”

Potential Default

Ryan and MFS spokesman John Reilly declined to comment on the firm’s holdings or the outcome of the litigation.

The legal battle risks a potential default on the restructured notes because the lower court also blocked the government from servicing those securities without making the $1.3 billion payment to investors. Billionaire Paul Singer’s hedge fund Elliott Management Corp. is among creditors that refused to take part in restructurings after the government defaulted on $95 billion of debt in 2001 and are demanding compensation from the Argentine government.

Alfredo Scoccimarro, an Argentine presidential spokesman, didn’t reply to an e-mail seeking comment on the potential for default or support from bondholders.

MFS, which is owned by Toronto-based insurer Sun Life Financial Inc. and manages about $349 billion, bought Argentina’s defaulted debt before the first restructuring in 2005, according to Ryan. The firm accepted the new bonds in a swap that was valued at about 30 cents on the dollar.

MFS Holdings

Fourteen of MFS’s funds held a total of about $390 million in principal of Argentina’s restructured bonds in the week after a U.S. federal appeals court in New York said on Oct. 26 that Argentina must treat all of its bondholders equally. The most recent company filings show that nine of those funds still own the securities, which total about $196 million in principal.

The funds sold about $54 million in principal of so-called discount bonds due 2033, $121 million of bonds due 2038 and $18 million of global bonds due 2017, according to the filings.

The notes plunged 11 percent on Feb. 28, the day after Argentina’s attorney, Jonathan Blackman, told the appellate judges the nation would not “voluntarily obey” an order to pay holders of defaulted bonds in full, spurring concerns the nation would opt to default on its outstanding notes.

The dollar-denominated restructured bonds have an average yield of 13.54 percent, and investors demand an extra yield of

11.41 percentage points to own the notes over U.S. Treasuries, the most among 55 developing nations in JPMorgan’s EMBI Global index.

Sell Recommendations

JPMorgan and Bank of America Corp. recommend investors sell the bonds and remain underweight in their portfolios.

“Argentina’s morphing from an indexed real-money investment to an off-index hedge-fund investment because of the volatility and risk profile,” Siobhan Morden, the head of Latin America fixed-income strategy at Jefferies Group Inc., said in a telephone interview from New York. “MFS and these other bondholders are still held accountable to their own investor base and they have to limit their mark-to-market risk.”

Thomas Wagner, co-founder of New York-based hedge fund Knighthead Capital Management LLC, part of a separate group of exchange bondholders in support of Argentina that hold euro-denominated bonds, said on April 5 that the nation’s debt is undervalued.

“The legal battle notwithstanding, it looks like it’s extraordinarily mispriced relative almost to any sovereign in the world,” Wagner said on Bloomberg Television’s “Market Makers.”

Debt Burden

Argentina’s public debt is equal to 41.6 percent of the country’s gross domestic product, compared with 54.9 percent in Brazil, which pays an average interest rate of 3.7 percent to borrow abroad, according to data compiled by Bloomberg and JPMorgan.

AllianceBernstein LP, which also joined the exchange bondholder group, sold $70 million of euro-denominated discount bonds in its Global High Yield Portfolio since the beginning of November, according to the most recent company filings compiled by Bloomberg. The firm added about $1 million in principal of dollar-denominated restructured bonds in that period through its Emerging Market Debt fund and High Income Fund, filings show.

As Argentina’s legal battle persists, bondholders will see attractive returns should the court rule in Argentina’s favor or should the U.S. Supreme Court agree to hear the case, said Jack Iles, who helps oversee about $2 billion in emerging-market debt at Manulife Asset Management.

‘Potential Upside’

Discount bonds have fallen 20 cents since the day before the October court ruling to 60.25 cents on the dollar, according to data compiled by Bloomberg. Bonds due 2038 have lost 3.3 cents to 34.53 cents on the dollar, and global bonds due 2017 have lost 21.4 cents to 78.24 cents on the dollar.

“The potential upside is definitely outweighing the downside,” Iles, who helps oversee about $2 billion in emerging-market debt, said in a telephone interview from Boston. His funds sold their Argentine sovereign debt holdings, he said. “If you get any kind of positive news these bonds will pop and that’s probably why people won’t sell a whole position but sit on a certain balance of it.”

The cost to protect $10 million of Argentine debt against non-payment during five years with credit-default swaps rose 206 basis points to 2,159 basis points on April 12, according to data compiled by CMA Ltd. The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

‘Very Weak’

Money managers invested $6.3 million in Argentine bonds in the seven days ended April 10, 34 percent of the amount in the last week of October, according to Cambridge, Massachusetts-based research company EPFR Global. Weekly inflows into emerging-market debt funds were $729 million, EPFR data show.

MFS is being prudent, according to Diego Ferro, co-chief investment officer at Greylock Capital Management LLC.

“Evidently, from a purely legal perspective, Argentina’s position seems very weak,” Ferro said in a telephone interview from New York. “One thing is to support Argentina, another is to think it’s going to win.”

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