Schroders EM bond duo take bet on Argentinian debt

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Schroder ISF Emerging Market Bond manager James Barrineau has been buying Argentinian sovereign debt despite ongoing legal proceedings against the country over previous debt defaults.

Barrineau, who runs the $28 million fund alongside Schroders Asian head of fixed income Rajeev de Mello, has around 4% of the fund invested in short duration local Argentinian debt, and argues that the country, along with Venezuela, is currently offering the best risk-adjusted returns on debt of any emerging market.

The fund has an overall exposure to Argentina of around 6.1%

Barrineau told Citywire Global that ‘there was certainly a risk’ attached to holding Argentinian sovereign bonds, but that the country’s relatively favourable near term debt profile and attractive yield made it a risk worth taking.

He said: ‘There are ongoing legal proceedings against Argentina which are hard to predict, but very little of its debt matures until 2015.

‘There is one small [maturity] in 2013 and nothing due in 2014 so we are comfortable to hold some exposure and there is also a decent chance of a positive surprise.’

Barrineau said the bonds were currently yielding 13% and cited Venezuela as a positive example of what could develop.

‘There is risk with Argentina but we are getting paid 1% a month to hold it. Venezuela was yielding 10% just two months ago but it has had a rally and its bonds are now trading on 8-9% yields which leaves Argentina as a huge outlier.’

He added: ‘At a time when investors are scouring the globe for yield we think holding Argentinian debt is a risk worth taking and there are very few other options among emerging markets which offer that kind of yield.’

‘In non-investment grade emerging market (EM) sovereign bonds we are holding the shortest possible dated debt. Some of this debt is yielding 8% and if you don’t think a country will default you should be happy to hold it.’

Optimistic on Venezuela

Some 10% of the fund is exposed to Venezuelan sovereign debt, and Barrineau is optimistic that political change, sparked by the gradual demise of President Chavez, will be positive for the country’s debt and equities market alike.

‘Venezuela has $60 billion of debt outstanding and there are lots of opportunities to generate returns. We think that it will be very hard for Chavez’s supporters to avoid an election and we think there will be a devaluation of the currency.’

Barrineau also stressed that 2014-dated Venezuelan bonds are less volatile than 10 year Brazilian bonds.

‘You are getting 8% to hold two year Venezuelan debt and 3.25% to hold 10 year Brazilian debt which we believe is a mis-priced position.’

Barrineau and De Mello were avoiding most of the EM new debt issues in 2012, including issues from Zambia and Serbia, which Barrineau said had come in at tight spreads due to current large amounts of global liquidity.

‘If they run up in price very quickly, we will probably let them go.’

Half the fund is in emerging market corporates and Barrineau said that in non-investment grade companies, the managers were diversifying risk with a basket of corporates across a range of sectors, primarily in BB and B rated companies, as they remain wary of liquidity risks.

‘[EM corporates] were in an air pocket in 2011 but not during 2012 so people quickly forget that they can become illiquid very quickly.’

They also believe that the strong inflows into the asset class which accelerated in the second half of 2012, made it more comfortable for them to take on more risk.

‘We believe EM corporates are still a pocket of value as they still trade at a discount to developed market corporates.’

He thinks the optimism over EM local currency debt may also be slightly overdone.

‘People are very enthusiastic because it had a great 2012 but most of the gains came from rates not currency and from Eastern European currencies as the euro stabilised. In Asia and Latin America we are unlikely to see these rate cuts so don’t see significant gains.’

After a stellar year for emerging market fixed income last year, Barrineau admits that returns are likely to be harder to come by in 2013, and he expects EM corporates to be the best performers this year, predicting a return of between 7 and 10%.

He expects local currency bonds to post between five and 9% and sovereign debt between four and 6%.

‘Local currency did 14% and emerging market corporates 16% in 2012 but returns will be much more modest this year. We see a modest global opportunity this year and the key issue remains [abundant] global liquidity.

‘If that is the case we are relatively optimistic that emerging market debt will continue to outperform developed market debt.’

Since launch in July 2012, the fund has returned 7.8% compared to 6.1% by the JP Morgan EMB index.