Argentina Debt Default: Are Funds in Trouble?

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Last month, Argentina defaulted for the second time in 13 years on debt payments to “vulture fund” bondholders. After hours of negotiations on Jun 30, Argentina’s court-appointed mediator said Argentina would “imminently be in default” on debt obligations worth roughly $20 billion. This was the result of the decade-long legal battle between Elliot Management and the Argentine government. Argentina failed to pay interest payment of $539 million.

Daniel Pollack, a court appointed mediator, stated: “Default cannot be allowed to lapse into a permanent condition or the Republic of Argentina and the bondholders – both exchange and holdouts – will suffer increasingly grievous harm.”

Default in 2001

Extreme pressure of public debt forced the economy to suffer default and devaluation of its currency. The third-largest Latin American economy announced sovereign default of around $100 billion, the biggest default so far. The situation was resolved only through large-scale debt restructuring.

In an effort to restructure, the Argentine government offered the bond holders to exchange older bonds for newer issues, which were valued at a fraction of those issued earlier. About 93% of the bond holders accepted the terms. This helped the economy recover from its crisis in the following years.

Recent Default

The remaining ‘holdout’ investors or ‘vulture funds’ – led by NML Capital, a subsidiary of Paul Singer-led Elliot Management Corp. – refused to accept the terms and took Argentina to court to obtain the full value of the securities. The U.S. Supreme Court ruled that the country cannot not make payments to its restructured bondholders unless it pays off the holdout bondholders.

As a result, Argentina faced its second default after it has been forced to terminate the interest payment of $539 million to the bondholders. In June, the country deposited the money with The Bank of New York Mellon Corp. (BK), Argentina’s trustee bank for its disputed bonds.

What Happens to Mutual Funds?

The intertwined nature of the global financial markets makes this kind of incident alarming for others. There are several hedge fund managers holding Argentine debt. Moreover, there are several mutual funds that have invested in the country and have a high exposure to Argentine debt.

In fact, there are funds owned by behemoths like Goldman Sachs and Fidelity Investments with high exposure. For example, Goldman Sachs Emerging Market Debt A (GSDAX) has 4.6% of its assets invested in Argentine sovereign bonds while Fidelity Series Emerging Markets Debt (FEDCX) has 2.8% invested in the country’s government bonds. While GSDAX carries a Zacks Mutual Fund Rank #1 (Strong Buy), FEDCX holds a Zacks Mutual Fund Rank #3 (Hold).

Threat to the mutual funds having high exposure in the region cannot be ruled out. The sovereign bonds of Argentina are high-risk bets. Debt price may trend up if Argentina finds a solution soon. However, a failure to do so will make the scenario murkier for the funds and related investments. Failing to negotiate with creditors in the near term will inflate Argentina’s bond yields while prices will plunge.

Moody’s: Argentina Funds Face Limited Loss

Meanwhile, Moody’s Investors Service, a unit of Moody's Corporation (MCO), stated that “Argentina's mutual fund industry has experienced little fallout from the government's latest sovereign default on 31 July”. However, the statement says that “local investors have continued to put money into mutual funds, which have limited exposure to the defaulted government securities.”

Thus, the portfolio composition of funds should be looked into. International Bond funds with limited exposure to Argentine bond issues are safe picks in this context. This is particularly relevant, because if fund portfolios hold only a small percentage of Argentine securities, the impact of the sovereign default is minimal. At the same time, they provide exposure to Latin American markets, which offer the potential for impressive returns.

3 Safe International Bond Funds to Buy

The following funds carry a Zacks Mutual Fund Rank #1 (Strong Buy) as we expect the funds to outperform its peers in the future.

Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.

Fidelity New Markets Income (FNMIX) invests most of its assets in securities from emerging markets and other investments economically related to emerging markets. The main objective of this fund is to seek a high level of current income with a secondary objective of capital appreciation.

The top 10 holdings do not include any direct investment in Argentine bonds. The top holdings include iShares MSCI Brazil Capped, iShares MSCI Emerging Markets, US Treasury Bond 3.375%, Russian Fedn 12.75% and iShares China Large-Cap.

The fund holds 274 bond issues. Of these, top 10 holdings by country make up 61% of the portfolio and Argentina does not feature among them.

The fund has returned 10.6% year to date.

MainStay Global High Income A (MGHAX) seeks high current income by investing in high-yield debt securities of non-U.S. issuers. Capital appreciation is a secondary objective. The fund invests primarily in high-yield debt securities issued by governments as well as their agencies and authorities, and corporations in a minimum of three countries, principally emerging markets.

The top 10 holdings do not include any direct investment in Argentine bonds. The top holdings include Majapahit Hldg B V 144A 8%, Bolivarian Republic Venezuela 9.25%, Poland(Rep Of) 5.75%, Peru Rep 7.35% and Sri Lanka Govt Democratic 6.25%.

The fund holds 74 bond issues. Of these, top 10 holdings by country make up 50.4% of the portfolio and Argentina does not feature among them.

The fund has returned 8.4% year to date.

JPMorgan Emerging Markets Debt A (JEDAX) invests a lion’s share of its assets in emerging market debt securities. The fund invests in debt securities with potential of high return from countries with less developed bond markets. The fund may invest in junk bonds.

The top 10 holdings do not include any direct investment in Argentine bonds. The top holdings include Russian Federation 7.5%, Pemex Proj Fdg Master Tr 6.625%, Lebanon(Rep Of) 8.25%, Philippines Rep 7.75% and Russia Fedn Ministry Fin 4.875%.

The fund holds 258 bond issues. Of these, top 10 holdings by country make up 61.5% of the portfolio and Argentina does not feature among them.

The fund has returned 8.2% year to date.

About Zacks Mutual Fund Rank

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Read the analyst report on FNMIX

Read the analyst report on MGHAX

Read the analyst report on JEDAX

Read the analyst report on BK

Read the analyst report on MCO

Read the analyst report on GSDAX

Read the analyst report on FEDCX


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