Bond Investors: Watch Out for Argentina Election

Latin America saw significant political upheaval in 2018 - and this year has more in store. M&G's bond fund manager Claudia Calich is keeping an eye on Argentina

Emma Wall 21 February, 2019 | 7:18AM
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Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and joining me today is Claudia Calich, Manager of the M&G Emerging Markets Bond Fund.

Hi, Claudia.

Claudia Calich: Hello, Emma.

Wall: So, emerging market bonds are one of the few asset classes that didn't get totally decimated in 2018. How much of that was due to the dollar, the US dollar, and its strength or weakness? And looking into 2019, will that be a key component of returns for this year?

Calich: Yeah, I mean, emerging markets actually – I mean, it didn't get decimated at the end of the year. But if you recall, during the summer, we already had quite a big repricing on certain currencies including the Argentina peso, the Turkish lira and so forth. So, I just think that the emerging market repricing happening way before the other credit markets and also the equity markets repricing at the later part of the year.

Also, recall that emerging markets, particularly the bonds in dollars, of course, they do have their US Treasury duration as a component. So, as US treasuries started rallying at the later part of the year as well, that also helped a little bit with the returns. Even though spreads are widening the fact that interest rates are coming lower in the 10-year part of the treasury curve also helped.

Wall: And 2019, will we continue to see that sort of slightly positive environment underlying the asset class?

Calich: Well, one of the key things is in terms of valuations we started the year with much better levels, particularly in terms of spreads on external debt. So, if you look historically, emerging markets external debt has never returned two years of negative returns back to back.

So, to the fact that last year was a negative return, unless history totally changes, this year we are expecting positive return just given the starting point in valuations. But of course, this is also reflecting the greater uncertainty on the global outlook.

So, we have rising trade tensions between the US, China, potentially Europe. We have the global economy now, parts of it are slowing visibly, such as Europe. We also have China slowing as well with more limited policy scope for stimulus. So, all these macro risks finally starting to getting priced in.

On the other hand, currencies also, in my opinion, they are not overvalued. So, this is also an area that repriced a little bit last year. So, my outlook for this year is not necessarily of a dollar strength assuming we are in a more benign environment such as the Fed basically being pretty much signalling they are done in terms of tightening, but also with the US economy still moving along, even though it is late cycle, we are not expecting a recession for this year.

Wall: So, you listed a number of potential flags for emerging market bond investors. But one of the ones you didn't mention is Latin America and I know you have a trip planned for Argentina to see how the elections pan out. How do you take an event like that and translate it into investment decisions?

Calich: Yeah. I mean, Argentina is a critical country because it depends a lot on external funding. The most critical part is actually the upcoming elections in October and that's why, as you mentioned, I would be going to the country in April just to assess the outlook for this election. Because Argentina basically has no room for populist policies. If you have a new administration that comes in and decides to basically walk away from the IMF program, the country basically will be in default all over again.

So, we need to make sure that we call this election right that Argentina continues with existing policies. It's been fearful, the economy has been in a recession. But basically, the best solution would be to continue as opposed to going back to populism, in which case, things will get even worse. So, I'm hoping to learn quite a bit from the trip.

And the other countries to note as well is more matter of implementation. Both Brazil and Mexico, which are also the largest economies in the region, have already new mandates of reformist administrations which are interesting. They are very different in terms of as economic tone, a little bit more populist to the right and populist to the left in both countries, but the execution in both cases will be quite important. So, I'm also following those economies quite closely.

Wall: Claudia, thank you very much.

Calich: Thank you, Emma.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar

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