Argentina Nerves Drag Distressed Bonds to Weakest in a Year

Investors in emerging-market distressed bonds are facing the weakest quarter in a year amid Argentina’s default and political crises in Russia and Ukraine.

Returns fell 2.1 percent since June 30, including a 0.02 percent decline in July that was the least since a 4.97 percent loss in January, according to a Bank of America Merrill Lynch index of dollar-denominated bonds sold by borrowers in emerging markets. The gauge hasn’t had a negative quarter since the three months through June 2013 when it slumped 12.1 percent.

Argentina last week failed to make a $539 million interest payment on its bonds, prompting Standard & Poor’s and Fitch Ratings to declare the country in default for the second time since 2001. Speculation about higher U.S. borrowing costs also unsettled the market in July. Meanwhile, tensions in Russia escalated amid sanctions as the U.S. and Europe pressured Vladimir Putin for backing rebels in Ukraine.

“Performance will suffer in the next two quarters, more in Russia than other emerging markets, if the situation in Ukraine isn’t resolved,” Roman Dmitriev, the Moscow-based head of fixed-income trading and asset management at Ooo Spectr Invest, said by phone yesterday. “That will coincide with fears of rising rates in the U.S. We’d keep to shorter-maturity debt” until there’s clarity in the coming months, he said.

Biggest Losers

The Bank of America Merrill Lynch index tracks 86 distressed bonds in 14 emerging markets, valued at $43.4 billion as of Aug. 5. Such notes typically yield more than 1,000 basis points over Treasuries. Global speculative-grade dollar bonds fell for the first time in 11 months in July, a separate index compiled by the lender shows.

Bonds issued by Russian shipper Far East Capital Ltd. and Argentina’s renewable energy group Industrias Metalúrgicas Pescarmona SA were among the biggest losers in July, while Indonesian coal mining company PT Bumi Resources led declines among Asian debt.

Far East Capital’s $325 million 8.75 percent bonds due May 2020 slumped 12.7 percent in July, the steepest monthly loss since their April 2013 sale, and fell 0.1 cents to 71.426 cents on the dollar today, according to Bloomberg-compiled prices. IMPSA’s $390 million 10.375 percent notes maturing in September 2020 decreased 8.5 percent, and have plunged 30.8 percent in August to 30 cents.

Fed Outlook

Bumi’s $700 million of 10.75 percent notes due October 2017 declined 4.5 percent last month, bringing losses this year to 22.5 percent. They dropped for a third day to 45.832 cents today. The Jakarta-based miner faces an Aug. 12 deadline to redeem or restructure $375 million of 9.25 percent convertible bonds, after an attempt in June failed.

The Federal Reserve last month reduced its monthly bond purchases to $25 billion from $35 billion, staying on pace to end the stimulus in October. The economy will expand 3 percent in 2015 from 1.7 percent this year as unemployment declines, according to Bloomberg surveys.

While Argentina and Russia reminded investors of risks in chasing yields, the decline in distressed bond prices in July may be a case of “gradual repricing” rather than a sharp selloff, according to Idan Shani, a senior distressed debt analyst at New York-based hedge fund Antarctica Asset Management Ltd.

“Rising rates reflect higher costs of doing business, a negative that can lead to distress,” Shani said in an e-mail interview today.

Default Risks

Antarctica Asset favors buying distressed debt and notes of companies involved in refinancings, and shorting junk bonds that have rallied this year, he said. As interest rates rise in the coming years, more companies may face difficulties, creating a fresh supply of distressed debt, Shani said.

This year, 28 companies globally have failed to meet their bond obligations including 15 in the U.S. and eight in emerging markets, Standard & Poor’s said on July 24. Bankruptcy filings drove 12 of the defaults, it said.

More money managers expect defaults to rise over the next year, according to a July survey by the New York-based International Association of Credit Portfolio Managers, compared with the level in an April review, the industry body said last month.

“The geopolitical issues are much less predictable than the economic ones,” Som-lok Leung, an executive director at the association, said in an e-mail today. “They will be the most challenging elements for portfolio managers to deal with in the second half of the year.”

Hedge funds specializing in distressed bonds globally had losses in July, limiting this year’s advance to 4.6 percent, according to an index compiled by Eurekahedge Pte. The gauge generated a 16 percent gain in 2013, the most since 2010.