Argentina's Madcap Century Bond Has Beaten Treasurys
18 May 2018 - 2:49AM
Dow Jones News
By James Mackintosh
When Argentina issued a 100-year bond last year it was taken by
many as a clear case of market froth. Investors could hardly get
more enthusiastic about emerging markets than lending money for a
century to a country that averaged one default every 25 years since
its founding. So with Argentina now asking for an emergency rescue
from the International Monetary Fund it looks like the skeptics
were right. Right?
Not so much. Anyone who bought the Argentine 100-year when it
was issued -- in dollars -- last June has lost 2.5% from the slide
in price, but made a profit when coupon payments are included. By
contrast, buying the U.S. 10 year or longer Treasury bonds at the
same time would have lost money, with the 10-year down 7.1% in
price and the coupon not enough to compensate.
"It's easy to say only an idiot would buy this, but you can make
decent money from this stuff," said Paul McNamara, investment
director for emerging market debt at GAM International Management,
part of Switzerland's GAM Holding. He prefers Argentine local
currency debt, which is shorter-dated but adds currency risk.
Investors who rejected Argentina were right that the country was
far, far riskier than the U.S. What they missed -- at least so far
-- was that investors were pretty well rewarded for that risk last
summer. Buyers of Treasurys were barely rewarded at all for the
substantial but hidden risks they were taking.
Argentina has been trying to get back on its feet after the
catastrophic rule of Cristina Kirchner ended three years ago, and
has made a lot of progress. But the perception that center-right
president Mauricio Macri was backsliding, combined with the large
current-account deficit and low foreign-exchange reserves, left
Argentina vulnerable to the recent souring in sentiment towards
emerging markets. A rising dollar raises concerns about countries
with big current-account deficits, and Argentina is most exposed,
along with Turkey.
In return for these risks investors are currently promised an
8.1% yield on the century bond, up from 7.9% when it was issued
thanks to the fall in price. That's a substantial premium to the
3.1% available on the 10-year Treasury, or 3.2% from a 30-year.
Sensible investors buy assets that offer a decent reward for the
risk taken. In the case of Argentina's dollar bonds, comparing the
reward for different assumptions of risk is pretty simple.
It will take a little over 12 years for Argentine bondholders to
get their money back via coupons, the basis of a bond-market
measure known as duration, which also includes the final repayment
at maturity. If your best guess was that it will be 20 years until
Argentina defaults again, you expect to make your money back plus
eight years of 7.125% coupons -- more than you would get on a
Treasury maturing in 20 years, and with the prospect of recouping
something after the default too. Even better, the money would be
paid earlier thanks to the fat coupons, freeing it up for other
investments.
Of course, if you think Argentina will last less than 12 years
until its next default, then the yield remains too low to consider
the bonds worthwhile, barring a fast recovery from default.
Owners of Treasurys have nothing to fear from default, since the
U.S. government borrows in a currency it can print. But investors
are much more exposed to falls in price if yields rise, and low
starting yields mean it will take longer to recoup any price drop
by clipping the coupon.
Bondholders learned a hard lesson in what they call duration
risk two years ago, after yields on long-dated bonds dropped to new
lows in the aftermath of Britain's vote to leave the European
Union. From its peak in July 2016 the price of the 30-year Treasury
dropped 20% in less than six months. It takes many years to make
back those losses when yields and coupons are low.
Comparing the reward for duration risk is almost as simple as
comparing yields with the number of years until a predicted
default. If the yield of the 30-year Treasury rises 1 percentage
point, the price will tumble 23%. A similar rise in the 10-year
yield will see a loss of 8%, as it has a shorter duration.
Dollar bonds issued by other countries, including Argentina, are
also exposed to duration risk, but swings in views about their
creditworthiness have a much bigger effect on the price.
Duration danger would come from a belief that secular stagnation
was over, and growth and inflation might be sustainably higher,
pushing the Federal Reserve to raise its long-run outlook for
rates. As with trying to forecast the date of a default, long-term
economic forecasting is extremely hard. What we do know is that the
reward for these risks is currently very low, because investors are
convinced that interest rates will be permanently lower.
The dangers are different, but at least in the case of Argentina
they are obvious to everyone.
Write to James Mackintosh at James.Mackintosh@wsj.com
(END) Dow Jones Newswires
May 17, 2018 12:34 ET (16:34 GMT)
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