2 Government Bond Funds To Buy Now

by: Zacks Funds

IMF Seeks to Change Sovereign Bond Contracts after Argentina Fiasco

A staff paper titled Strengthening the Contractual Framework to Address Collective Action Problems in Sovereign Debt Restructuring by the International Monetary Fund [IMF] had recommended governments to revise their way of drafting sovereign bond contracts. IMF said that the standard clauses in the bond contracts that are entered into by governments and creditors must be revisited to help restructuring after a country defaults.

The paper, published in October, noted that this is required to "achieve orderly sovereign debt restructurings, particularly in light of recent developments". The recent development particularly refers to the Argentina debt default earlier this year. In this case, a certain "holdout" creditors threatened the restructuring after demanding full payment.

Before looking into the Argentina debt default in detail to find out what how these events affect mutual funds, let’s look into the IMF recommendations.

The 3 Recommendations by IMF

The staff paper recommends primarily three recommendations, which were derived after 18 months of consultation with issuers and market participants. This included consultation with International Capital Market Association. The three recommendations according to the IMF paper are:

  • First, the staff paper proposes a modification to the pari passu clause (equal treatment clause)in international sovereign bonds to make clear that it does not require the issuer to pay creditors on an equal or ratable basis.
  • Second, the paper discusses the inclusion of an enhanced collective action clause (NASDAQ:CAC) that includes a more robust “aggregation” feature to address collective action problems more effectively.
  • Third, the paper considers the role that the Fund can play in promoting the use of these modified provisions in future issuances of international sovereign bonds, while noting the transitional risks created by the existing stock of bonds that do not contain such modified provisions.

In case of Argentina debt default, the contract had allowed holdouts to claim the 100% payment on the back of the pari passu clause. Now, the change would not replicate the similar remedy provided to the holdout creditors.

Argentina Debt Default

In June, Argentina had 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.

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; taking significant losses. This helped the economy recover from its crisis in the following years.

The remaining "holdout" investors or "vulture funds" – led by NML Capital, a subsidiary of Paul Singer-led Elliot Management Corp. – had refused to accept the terms and took Argentina to court to obtain the full value of the securities. Hedge funds demanded 100% payment on the $1.3 billion face value. The U.S. Supreme Court ruled that the country cannot make payments to its restructured bondholders unless it pays off the holdout bondholders. So, Buenos Aires was asked to pay and supported the holdouts’ claims.

Argentina faced its second default this time after it was 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. (NYSE: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 debt in international regions. Moreover, there are several mutual funds that have invested in the country and have a high exposure to Argentine debt of other nations.

For instance, there are funds owned by behemoths like Goldman Sachs and Fidelity Investments with high exposure. Goldman Sachs Emerging Market Debt A (MUTF:GSDAX) has assets invested in Argentine sovereign bonds while Fidelity Series Emerging Markets Debt (MUTF:FEDCX) has invested in the country’s government bonds. Both these funds carry a Zacks Mutual Fund Rank #2 (Buy).

2 Government Bond Funds to Buy Now

Mutual funds investing in debt securities are among the most secure investment options which provide regular income while protecting capital invested. Funds which are part of this category bring a great deal of stability to portfolios with a large proportion of equity, while providing dividends more frequently than individual bonds. U.S. government bonds funds usually invest in Treasury bills, notes and securities issued by government agencies. They are considered to be the safest in the bond fund category and are ideal options for the risk-averse investor.

For investors interested in Government Bond funds, we will pick 2 top-ranked funds here. The following funds carry aZacks 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.

Also, the funds have relatively high returns so far this year and in the last 5 years. The funds carry no sales load and have comparatively low expense ratio.

Fidelity Spartan Long-Term Treasury Bond Index Investor (MUTF:FLBIX) seeks high current income by investing most of its assets in companies listed in Barclays U.S. Long Treasury Bond Index. The fund maintains a dollar-weighted average maturity of at least 10 years. The fund tries to duplicate the Barclays U.S. Long Treasury Bond Index returns by using statistical sampling techniques on the back of interest rate sensitivity and maturity among others.

The fund has returned 20.8% year to date and has a 5-year annualized return of 7.9%. The fund carries an annual expense ratio of 0.20% as compared to the category average of 0.56%. The fund carries no sales load.

Lord Abbett Income F (MUTF:LAUFX) invests 65% of its assets in investment grade debt securities. These securities may be issued or guaranteed by the U.S. government, debt securities of U.S. issuers and non-U.S. issuers among others. The fund may also invest in derivatives.

The fund has returned 8.1% year to date and has a 5-year annualized return of 7.6%. The fund carries an annual expense ratio of 0.68% as compared to the category average of 0.85%. The fund carries no sales load.

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