Investors trim risk ahead of Argentina's ‘coin toss’ primaries

Investors are pulling back from Argentina before a primary election this weekend that will set the stage for October’s presidential vote, with the potential for a boom or bust ahead.

Aberdeen Standard Investments recently reduced its stake in local-currency debt, while Credit Suisse told investors to lighten up positioning ahead of the Sunday primary. JPMorgan Asset Management says even the currency’s juicy carry trade isn’t as appealing anymore as long-term returns could evaporate depending on the ballot’s outcome.

With polls seen as particularly unreliable this year, the primary may be the most accurate predictor of the presidential race. The main risk for investors is the potential for a result that shows opposition candidate Alberto Fernández and his running mate, former president Cristina Fernández de Kirchner, attracting significantly more support than President Mauricio Macri’s coalition. That would be seen as a sign the country may return to policies such as currency and capital controls, steering away from Macri’s more market-friendly positions.

“The asset reaction on either outcome will be quite large, so you have a very large negative tail, or very positive tail if you see the government taking the lead,” said Diana Amoa, who helps oversee $2.1 billion at JPMorgan Asset Management. “Investing into this would be a bit of a coin toss.”

Amoa says she’s staying neutral on Argentina until after Sunday’s vote. Risk is too great in the peso, which has dropped the second-most this year among more than 140 currencies tracked by Bloomberg.

Getting out

Aberdeen backed off an overweight in Argentine local-currency debt last month in anticipation of “a period of prolonged volatility,” Edwin Gutierrez, the firm’s head of emerging-market sovereign debt, said in an interview.

He isn’t alone. About US$6.2 billion flowed out of Argentina in the second quarter as local investors geared up for the vote, according to Martin Castellano, the head of Latin American research at the Institute of International Finance in Washington.

“We could see more outflows ahead of the election,” he said. “It could be US$22 billion for the whole year, which is very high even in an election year.”

Argentine markets have already seen plenty of volatility this year. Bonds, stocks and the currency tanked in April when Fernaández de Kirchner’s candidacy seemed to be gaining momentum – and her surprise announcement that she would instead run for vice-president did little to settle investors’ nerves. The reaction to Macri’s VP pick, an opposition leader, was clearer: The peso rallied as Miguel Ángel Pichetto was seen as potentially broadening Macri’s appeal and boosting his chances of re-election.

Macri, a clear favourite for investors who want him to pursue overhauls they see as needed to steer the economy out of recession, faces a tough road to victory amid high borrowing costs, double-digit unemployment and annual inflation of more than 50 percent.

The first round of voting is scheduled for October 27, followed by a potential runoff vote between the top two candidates November 24.

Exposure

Investors should have only light exposure to floating-rate bonds or longer-term peso-denominated government bonds, and hedge the currency risk, according to Credit Suisse’s Buenos Aires-based head of Latin America sovereign credit strategy, Daniel Chodos. If the government performs well, he said he would look for opportunities to increase bond holdings.

Luiz Ribeiro, the lead portfolio manager for Latin American equities at DWS Group in São Paulo, is more optimistic. His regional equity fund outperformed 94 percent of peers in the past year as he’s built up holdings in Argentina, where he said valuations can be attractive.

“We have a positive view on the outcome,” especially as inflation continues to fall and the economy recovers, Ribeiro said in an interview. He says his fund has about 12 percent of its assets in Argentina, an overweight stance compared to the benchmark. His main bets in the country are banks, utility and energy stocks, as well as some consumer companies.

Whitney Baker, founder of New York-based Totem Macro, is maintaining the bullish Argentina position she’s had since September, counting on macro fundamentals to come back to the forefront after political uncertainty passes.

“This trade will be influenced pretty decisively by the political outcomes, but we are hopeful they’ll turn out well,” she said.

There’s “huge downside risk” with no clear indication of how the primary will play out, said Louis Lau, a fund manager who oversees nearly $6 billion in emerging-market assets at Brandes Investment Partners in San Diego.

Lau stopped buying Argentine assets earlier this year.

“The market seems to think if Macri wins the election, that’s sort of the panacea, the cure-all. But the country still has a lot of issues to overcome,” he said. “If the market has a huge rally on Macri being re-elected, we may actually sell.”