Fund managers brace for Argentina default fallout

More than 600 funds have exposure to Argentina's debt, but consequences may be limited for investors

Jul 30, 2014 @ 11:44 am

By Trevor Hunnicutt

Argentina's failure to appease creditors on Wednesday has pushed the country's fragile economy into its second default in 13 years in a move that could hit mutual fund investors with exposure to the country's debt.

The default was largely expected after a judge ruled the country can't pay most of its creditors unless it also pays a group of hedge funds that refused to accept terms of a restructuring offered by the government in 2005 and 2010.

The impact of the country's second default since 2001 could be felt among everyday investors. A total of 635 mutual funds and exchange-traded funds include exposure to bonds issued by the country, according to Morningstar Inc.

And the exposure isn't limited to just emerging market funds.

A range of other funds have taken on the country's debt, including core bond holdings like Fidelity Total Bond Fund (FTBFX), which has a tenth of a percent exposure to Argentina's debt, unconstrained bond funds like Putnam Diversified Income (PDINX), with 1.68% exposure, and index funds like the Vanguard Emerging Markets Government Bond Index ETF (VWOB), with 0.85%, according to Morningstar.

"Because it's an index fund, we just closely match the benchmark," said Yan Pu, the portfolio manager for Vanguard's index fund, which tracks a dollar-denominated Barclays emerging markets government index. "We try to replicate the index and not take any active views."

Sophie Launay, a spokeswoman for Fidelity Investments, said none of the Argentine bonds its funds held, as of last month, are the kind that would be subject to a default. Putnam Investments did not respond to a request for comment.

(See also: Why U.S. investors are buying foreign stocks)

But some fund managers said they have hopes Argentina's valuations and upcoming elections will still produce an upside for investors. President Cristina Fernandez de Kirchner, who has referred to the hedge fund holdouts as “vultures,” is constitutionally restricted from seeking a third term in elections expected next year.

Eric Fine, a portfolio manager for Van Eck Global, said Argentina can and will pay its debts, but that the negotiations with the hedge funds will have to conclude before any investors can be paid interest, leading to the default.

His firm's Unconstrained Emerging Markets Bond Fund (EMBAX) held 5.68% exposure to the country at the end of March, according to Morningstar.

“We've liked Argentina — it's been a good performer for us,” said Mr. Fine. “It offers good upside relative to the downside. We want to have exposure. However, because we think it's a bumpy path, we want to do two things: one, have some portion of our investment invested tactically and to avoid the most volatile bonds that are the most directly affected by the court rulings.”

(Related: Where to find yield for investors)

Doing so won't be easy. Most creditors agreed to the restructuring, and the secondary market for those bonds is volatile, Mr. Fine said.

“The fundamental underpinnings of Argentina are quite strong,” said Ethan Powell, a chief product strategist at Highland Capital Management, citing the country's oil shale and other natural resources. He said prices of bonds that could see a default are trading up. “The market is signaling that a resolution is hopefully impending … It's not in anybody's interest to have Argentina lose access to the capital markets," Mr. Powell said.

The $531 million Highland Global Allocation Fund (HCOAX) has an 18% allocation to Argentina's debt.

U.S. District Court Judge Thomas P. Griesa ruled in 2012 the country cannot pay bondholders who agreed to debt restructurings offered after the 2001 default until it pays a small group of hedge funds that have fought to preserve the original terms of their contracts with the country.

An appeals court upheld that decision, and the U.S. Supreme Court refused to hear an appeal last month.

But some fund managers think the impact of a default would be limited. Dan Fuss, portfolio manager at Loomis Sayles & Co., which does not own the debt, said the prospect of the country's second default in 13 years is “very rare in this day and age.”

“As a matter of fact, I don't think it's a big deal, but I do feel bad for the people who live in Argentina,” he added.

That's a sentiment that was reflected by some American advisers who have lived in the Latin American country.

“When I was growing up I remember Argentina was the jewel of South America and it was the model of not only democracy,” said Marta L. Shen, principal at Spring Street Financial, a Commonwealth Financial Network affiliate in Atlanta.

Ms. Shen, an American citizen, is the daughter of Taiwanese emigrants to Buenos Aires, the Argentine capital.

“When I saw it a couple years ago it was depressing to see the graffiti, the streets not being repaired,” said Ms. Shen. “It seems like the government had given up on improvements on it, and then inflation has been a rampant issue.”

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