For the bravest, most risk-tolerant investors out there – shops like Franklin Templeton and Pimco – the Argentine trade the past few years was to dive into the local market and scoop up peso-denominated bonds. Paying out interest rates of up to 75 percent, it was a cash-generating machine.
But now, amid a collapse that has put the country on the verge of default once again, it is these bonds that have taken the worst of it. Not only have they plunged in value just like the country’s dollar notes, but they have also been hammered by a 25-percent drop in the peso and gotten ensnared by capital controls the government imposed this week. That move, which came in a desperate bid to stabilise the peso, effectively blocked investors from taking money out of the country through traditional foreign-exchange markets.
Which leaves many bond firms nursing losses and searching for alternative ways out. One method has immediately jumped to the fore, the same one used for years to skirt controls during the previous rule of the leftist version of Peronism that now appears poised to retake the presidency next month. It’s called the blue-chip swap and it’s predicated on the purchase – with pesos – of certain types of shares or bonds in the local market and the subsequent sale of those securities abroad for dollars. It’s not cheap, though: The effective peso exchange rate is currently about eight percent weaker than the going price in the foreign-exchange market.
“Old veterans who used to trade local-currency bonds from beforehand know the score,” said Edwin Gutierrez, London-based head of emerging-market sovereign debt at Aberdeen Asset Management, who said he used the parallel rate during the capital controls implemented by Cristina Fernández de Kirchner’s government. “It’s a return to the bad old days.”
Beforehand means before President Mauricio Macri, a free-market reformer determined to return the slumping, state-controlled Argentine economy to normalcy, swept into office in 2015. One pledge was to overturn capital controls, and he achieved it in his first week in office. He assembled a star cabinet with Wall Street veterans to settle lawsuits with creditors and return Argentina to foreign bond markets.
Over the next two years, finance officials sold enough local bonds to build a peso bond curve amid the promise of slowing prices. After jacking up rates to among the highest in the world – the benchmark is now at 86 percent – they lured foreign investors like Franklin Templeton’s Michael Hasenstab to place long-term bets on the peso bonds. The money manager kept his bullish stance even as the peso tumbled 50 percent last year amid growing concern about the outlook for growth and inflation.
Argentina’s carry trade, the practice of buying local notes with borrowed dollars, offered a modest return in 2017 before the rout in 2018. Its performance in the first half of this year was among the world’s best, though it’s now negative for the year.
Some foreign investors, most notably Pacific Investment Management Co., latched onto local floating-rate bonds that track the country’s monetary policy rate, making them the world’s top-paying bond.
Fund managers including T Rowe Price to VanEck were also among top foreign holders of local currency bonds. The peso notes have underperformed overseas dollar bonds since the currency controls were announced last Sunday.
“Many investors thought Argentina was on its way to becoming Chile or Colombia – stable, investment grade,” said Leo Chialva, a partner at Buenos Aires-based consulting firm Delphos Investment. “Those large funds are horrified by the latest measures.”
It’s hard to know exactly how things worked out for Franklin Templeton or Pimco, and neither firm would discuss how it fared in detail. While Argentina makes up just a small portion of Franklin Templeton’s assets, the Templeton Emerging Markets Bond Fund had its biggest drop since the 2008 financial crisis the day after Argentina’s primary round results. One silver lining: the fixed-rate peso bonds that have Franklin Templeton as the top holder won’t be part of a debt reprofiling plan the government is now proposing.
While Argentina was always a very small part of Pimco’s total assets, the fund manager diversified its holdings in the country “with more downside protection in an extreme market event” and “avoided larger exposures with greater losses that have impacted other major investors,” spokesman Michael Reid said last month.
Under the rules Argentina announced Sunday, exporters must repatriate foreign currency from overseas sales within five days. Corporations will need authorisation from the Central Bank to buy dollars in the foreign-exchange market, except in cases of international trade. Individuals, meanwhile, will be limited to buying no more than US$ 10,000 a month.
“The aim is to protect exchange stability and savers,” Guido Sandleris, the head of the central bank, said the day after bringing back the controls.
The gap between the official exchange rate and the blue-chip swap rate, which was sometimes as large as 40 percent during the Kirchner years, won’t exceed 10 percent this time around, Chialva said. That’s because the controls aren’t quite as stringent as they were in the past, especially for individuals. Plus, after dropping 20% since the primaries, the peso is at a fair value given the likelihood of a leftist government winning the presidential ballot next month, he said.
As the blue-chip swap comes back, local brokerage firm Portfolio Personal Inversiones sent out a note for the benefit of newcomers to explain how the system works.
It’s “an expensive but fluid way to convert this trash cash into greenbacks,” the note said.
by Carolina Millan, Sydney Maki & Aline Oyamada, Bloomberg