We've lost track of the number of times Argentina has defaulted on its debt over the last century, and it's only a year since the country just settled lawsuits on its most recent $95B default.
That didn't stop investors this week from gobbling up $2.75B in 100-year bonds reportedly price to yield 7.91%.
The sale comes after a major capital markets turnaround for Argentina over the past year, with the country's debt now yielding an average of just 400 basis points more than similar-maturity Treasurys (it was well over 1000 bps four years ago).
The sale also comes amid a very hot run for emerging market debt in which prices have gone up and funds have added $38.6B during 20 straight weeks of inflows.
The conventional thinking not long ago was that investing in developing markets needed the nimbleness of active managers able to respond to sudden shifts in political risks. The numbers don't back that up: Over the last five years, the iShares JPMorgan USD Emerging Market Bond ETF (NYSEARCA:EMB) has outperformed active peers by an average 74 basis points, according to Morningstar.
Investors, in turn, are flocking to it. The EMB became the largest emerging-market debt fund year ago, and has doubled assets to more than $10B in the last 12 months.
In ETFs, the large tend to become larger as investors prefer the better liquidity, and greater assets allow lower fees - at 45 basis points, EMB currently has the second-lowest fee among all emerging debt funds.
"U.S. policy predictability has diminished," says the agency, citing disruption in trade policy, weakened international capital flows, limits on migration, and the confrontational nature of the new president as the primary risks to growth, and in turn, sovereign credit ratings.
The agency does allow that just maybe the Trump administration could be good for growth if it follows through with infrastructure spending and tax and regulatory cuts.
On balance though, it says, the risks point to a "less benign global outcome."
Those with the closest economic ties to the U.S. are most at risk: China, Canada, Germany, Japan, Mexico
Amid the panicky action in stocks to end last week, investors rushed to the exits on the previously red-hot iShares JPMorgan USD Emerging Markets Bond Fund (NYSEARCA:EMB), which suffered its largest-ever one-day withdrawal of funds.
Some estimates put the amount of global bonds trading with negative yields as high as $10T, so who could fault an investor for turning to emerging market paper as a way to eke out some income, says Brown Brothers Harriman.
The team notes portfolio investment flows into EM have been positive in four of the last five months, with the early signs pointing to a continuation of the trend in August.
While Brown Brothers sees more gains for EM credit, it waves the yellow flag: "A purely liquidity driven model of investing will work ... until it doesn't. We caution investors against getting too optimistic about EM, as fundamentals are lagging the price action."
The iShares JPMorgan USD Emerging Market Bond Fund (NYSEARCA:EEM) is higher by 10.7% YTD, while yielding north of 4%.
Holders of long-dated U.S. paper could see losses of more than 1% annually for the next five years, says the asset manager's Global CIO Richard Turnill.
What's a fixed-income investor to do? Higher returns are to be found in the debt of hard-currency emerging markets and high yield. For Turnill and team, EM debt is particularly attractive when compared to Treasurys over the next half-decade.
AUM at the iShares JPMorgan U.S. Dollar Emerging Market Bond Fund (NYSEARCA:EMB) surged to $6.5B last month, pushing it past the largest mutual fund in that category.
While the appeal of low-cost, passive funds is obvious in developed economies, their rise in emerging markets can be labeled at least somewhat surprising, thanks to the idea sharp managers should be able to more easily find and exploit profitable opportunities.
The reality though, is that active managers struggle to outperform, no matter the market.
"We’ve been outright reducing risk in some of the higher-risk, or more volatile, segments of the market,” says Pimco CIO Dan Ivascyn. “The emerging-market region has significant near-term challenges. From a shorter-term perspective, we’re much more cautious."
Emerging market bonds in April fell to 9.4% of assets at Pimco's Total Return Fund (MUTF:PTTRX)/ That's down from 28.9% just last August, and the lowest proportion since August 2014. Like other risk assets, emerging market paper has put in a whale of a rally since mid-February.
The Bloomberg USD Emerging Market Sovereign Bond Index is up 7.2% this year.
U.S. government paper holdings make up about 36% of the fund.
"Hazard ahead: The emerging market credit cycle has turned down," is the title of a recent JPMorgan report, arguing credit markets will tighten as the Fed boosts rates.
A shoe not yet dropped, says the team, is that debt to GDP ratios are not decreasing.
"Remember that a lot of the credit growth in emerging markets is no more than the flip side of easy money in developed markets," and as the Fed normalizes, this can reverse, though Europe and Japan keeping their feet on the gas pedal should mitigate the turn.
The ratio of broad emerging market nonfinancial private credit to GDP hit 128% of GDP in Q1, up 51 percentage points from 2007. Exclude China, and the numbers are not nearly as gaudy, but still frothy, and the moves resemble those from that of developed markets in the years leading up to the global financial crisis.
Foreign inflows are set to halve to $548B this year and outflows are expected to come in at $540B. With local outflows accelerating, net flows will turn negative.
The flight from emerging markets "has been driven primarily by internal factors, basically reflecting a sustained slowdown in EM growth and amplified by rising uncertainty about China’s economy and policies," the IIF says.
EMs have also been hit by the commodities rout, to which many are exposed. Weak currencies and political turmoil in countries such as Brazil and Turkey are increasing the risks.
While those risks remain high, there is little incentive for investors to return to EMs.
Back in 1988, net capital market outflows were $9B, and they've been positive ever since. This year, according to the Institute of International Finance, net outflows are set to return to the tune of a whopping $540B.
Meanwhile Federated Investors portfolio manager Ruggero de'Rossi thinks now is the time to buy the dip in emerging market government bonds. The yield spread between sovereign EM debt and comparable U.S. Treasury paper has widened to 420 basis points from a recent low of 250 bps. He likes the risk/reward across a diverse array of EM countries. He's not so bullish on EM corporate debt, however, as many companies have not fully hedged exchange rate exposures.