Thursday, November 21, 2013

One Brave Fund Manager Is Investing In Argentina!!!

November 21, 2013 9:14 am

Frontier bonds ride out Fed debt squalls

Kyle Bass, a hedge fund manager who made a fortune betting against Greek bonds and US subprime, dropped a bombshell at a conference in September.
He is investing in Argentina, Latin America’s perennial problem child and a nemesis of hedge funds.





Mr Bass is unfazed by the country’s reputation, and confidently predicted that pro-business politicians would take over after presidential elections in 2015. “Argentina’s problems can be fixed in two years,” he argued. “Now is the time to start investing.”
The US hedge fund manager is not the only one intrigued by the investment opportunities of Argentina. The Merval stock market index has rallied almost 50 per cent in US dollar terms this year, as a smattering of intrepid fund managers have put money into the Argentine bourse.
Indeed, Argentina is part of a broader phenomenon. While many emerging markets have disappointed investors in recent years, so-called “frontier markets” have on the whole performed well. Even the US Federal Reserve’s plans to scale back its monetary stimulus – which triggered turmoil across the developing world last summer – only dented this year’s returns.
The MSCI Frontier Markets index has risen more than 17 per cent this year, compared with the 2.9 per cent loss of the bigger MSCI Emerging Markets gauge.
Ironically, frontier markets’ lack of size, depth and maturity is a major reason behind their resilience.
Low liquidity means positions are often small and difficult to sell, so many fund managers focus on trimming bigger holdings in mainstream markets in times of stress, says David Grayson, chief executive of Auerbach Grayson, a brokerage. “Unless you’re liquidating your entire portfolio you tend to leave your frontier positions.”
Sven Richter, head of frontier markets at Renaissance Asset Managers, says the gains are also a result of past losses being clawed back. While frontier markets have performed well over the past year, they remain almost 50 per cent below their pre-credit crunch peak. Emerging markets are down less than a fifth.
But frontier market bonds – which unlike equities have performed well since the financial crisis – have also proved unexpectedly sturdy in the face of the Fed’s plans to “taper” its quantitative easing programme.
Despite the summer squall, JPMorgan’s Nexgem index of frontier bonds has returned 4.6 per cent this year. In contrast investors have lost 5.4 per cent on the dollar bonds of mainstream emerging markets, and 5.5 per cent in local currency debt.
Frontier and emerging bond markets are converging. The average spread, or difference, between JPMorgan’s flagship EMBI index of mainstream emerging markets and a frontier bond gauge constructed by Exotix, a brokerage, recently went below 100 basis points for the first time.
“You would think that talk of Fed tapering and the flight from risk would hit frontier markets, but they have kept on tightening,” says Gabriel Sterne, an economist at Exotix.
The lack of liquidity has been an even bigger factor in insulating frontier debts markets. Some bonds are almost impossible to shift even with a deep discount, so investors have no choice but to stick to their positions.
Benoit Anne, head of EM strategy at Société Générale, argues that it was “more luck than smarts” that got frontier markets through the testing summer, but predicts that the future looks bright. “They managed to get through the storm and now things are looking up,” he says.
Many fund managers are now staying in safer, more stolid markets such as South Korea or Mexico, in the expectation that the Fed will reawaken the summer’s turbulence by moving to scale back its $85bn-a-month bond purchases.
But Brett Diment, head of emerging market debt at Aberdeen Asset Management, argues that some of the frontier bonds will, counter-intuitively, perform better when the Fed finally tapers – as they did in the summer.
Mr Diment points out that frontier bonds generally have shorter maturities and higher yields than more mainstream, typically investment grade emerging market bonds. That makes them less vulnerable to shifts in US Treasury yields, the underlying pricing benchmark.
Still, frontier markets are considered esoteric for a reason. When they do slump they tend to slump precipitously. Valuations are now beginning to look punchy. Some analysts fret that consumer company stocks look particularly frothy.
Other asset managers stress that frontier bonds provide high returns because the creditworthiness is low. Rising Treasury yields may be less of a risk, but that will be of little solace if the country decides to skip any payments.
“Frontier markets should not be the hot new thing,” Mr Grayson warns. “It’s not for everybody and should only be seen as a long-term investment.”