Argentina is suffering a three-year recession with a tremendous debt problem. It is not a small country in terms of GDP; it ranks above Switzerland and Sweden.
The problem lies in its high level of external debt which is much greater in proportion to the size of its economy than many other emerging markets. Unlike some problem markets, such as Turkey, its debt is also more external than internal.
A high level of external debt means the rest of the world has a greater interest in what happens as it is more directly affected. A crisis in Argentina impacts other Latin American countries and beyond – in the euro-zone it particularly affects Spain, although Italy and Germany also have significant exposure.
By looking at the how the Argentine market affects Spanish companies on a corporate level, the impact on funds will become more apparent.
In Spain the trade links with Argentina are relatively small. Latin America accounted for 4% of imports and 7% of exports in 1998, according to the CIA World Factbook but some of the biggest companies in Spain do business there.
The Spanish market is certainly the most vulnerable in Europe as its five biggest companies in terms of market capitalisation are the five companies most affected by the Argentine crisis. As a result in the last two weeks the Spanish market has been the poorest performer in the euro-zone.
The most affected in Spain
These top five are: Telefonica, a telecoms company, Banco Bilbao Vizcaya Argentaria (BBVA) and Banco Santander Central Hispano (BSCH), both banks, Endesa, a utilities companies and Repsol which operates in the oil sector. According to some analysts, this year practically 40% of the profits from these companies will come from Latin America. These firms represent almost 65% of the IBEX - the principal Spanish index.
For Telefonica the risk is concentrated in Brazil, where its alliance with Portugal Telecom makes it the biggest telecom operator. Globally, the Latin American region represents 45% of the earnings before interest, tax, depreciation and amortisation are removed and 20% of its total assets.
In the case of BSCH and BBVA the level of dependence on Latin America is also high. The analysts estimate that respectively 50% and 30% of their total profits come from this region. At BBVA, for example, Latin America represents practically 35% of its total assets.
Endesa controls 15% of electricity generation in Argentina and 20% of electricity distribution (which represents 10% of its total profits). Latin America contributes nearly 30% of its profits.
Finally, in the case of Repsol YPF, the situation is not so dramatic. Even if more than half of profits come from Argentina, all its transactions (oil extraction, production and distribution) are made in dollars. However, the growth decline in Latin America (not only in Argentina) will certainly have a deep impact on its results.
Impact on the UK
UK investors should be aware that the performance of their European funds could be affected by the problems in Argentina and the rest of Latin America through their investments in Spanish firms. Funds that invest in the larger Spanish companies are more likely to be affected than those with investments in smaller Spanish companies. Larger firms typically possess more investments abroad while smaller ones tend to focus on the domestic market.
The UK domiciled funds listing the largest investment in Spain, based on the most recent portfolio information available are:
Fund |
Percent |
Portfolio
data as of |
|
Dresdner RCM European Smaller Companies Trust |
14% |
January 31st 2001 |
|
Artemis European Growth Fund |
12% |
June 29th 2001 |
|
Dresdner RCM European Trust |
11% |
January 31st 2001 |
|
Newton Continental European Fund |
11% |
January 31st 2001 |
|
Framlington European Fund |
10% |
January 31st 2001 |
|
Aberdeen European Growth Trust |
10% |
March 30th 2001 |
|
Investec European Portfolio Trust |
10% |
April 30th 2001 |
|
Threadneedle European Growth |
9% |
April 30th 2001 |
|
Martin Currie European Fund |
9% |
March 31st 2001 |
Marco Ricci, the manager of the Deutsche Europa fund, said, “Smaller companies are affected to a much smaller degree than big blue chip companies, to the point that what is happening in Latin America is not so relevant to our investors at the moment.”
Stuart Gilmartin, a co-manager of the SocGen European Growth unit trust, said the fund is currently invested in only one Spanish company that has exposure to Latin America, having sold the others in recent months.
Mr Gilmartin said, “We sold out of Telefonica some time ago as we were concerned both with the telecoms service sector and Argentina. We’re underweight exposure to that area. Overall we have taken a bit of action quite a few months ago because we were concerned. We want to wait and see. Argentina represents a very important [part of emerging market debt] but we don’t know at the moment whether a big devaluation or default on debt are in the pipeline. I couldn’t say today whether that is going to happen but it is on a knife edge.”
Potential buying opportunity
Jeremy Podger, a fund manager at Investec Asset Management, said, “A lot of [the effect] has already been absorbed in the share price of the banks and Telefonica. There will probably be a final leg-down if there is a default. I think you will find that some people will be looking at that as an entry point.”
“I am reasonably comfortable with our position in this area. We are below benchmark exposure to the Lat-Am sensitive names in Spain and Portugal. We might actually increase that on a default if prices come down.”
The world’s financial markets are all interlinked and what happens in one country tends to affect others to a greater or lesser degree. Investors should be aware that their exposure to economic ups and downs through their fund investments may be indirect as well as direct.
It is sensible to know what countries a European fund is invested in and to read the literature of the fund management company to see how the managers are reacting to the problems in Latin America and whether they believe it will hit performance.
Fernando Luque, the senior financial analyst at Morningstar Spain, contributed to this analysis.
