MSCI EM Upgrade, volatility and the vagaries of politics
By Hamlin Lovell, NordicInvestor
Since 2009 – when MSCI downgraded the country from emerging market to frontier market status – the Merval stock-market index has appreciated more than ten times in local currency terms. Argentina’s equity market hit an all-time high in January 2018, and its currency marked a new all-time low of 27.7 per dollar as of June 21st 2018.
Over the same period, persistent inflation has contributed to currency depreciation by a factor of nearly 8, from 3 per dollar in 2008 to today’s level, wiping out much of the equity market gains. (Interest rates are so high that hedging the currency for long periods would have been very expensive, and has anyway been subject to heavy restrictions imposed by the government, and politically controlled central bank).
A trader’s market
Historically, Argentina has not been a “buy and hold” market but rather a trader’s market where politics can be a key factor. For shorter term investors who are good at timing the market, it is possible to make 100% or more in a year or two (in local currency terms). The Merval, measured in Argentine Pesos, doubled in 2014, and tripled between 2016 and early 2018, after Mauricio Macri was elected on a market-oriented agenda in 2015. Macri removed currency and capital controls, settled disputes with hold-out investors in government debt, cut subsidies, abolished capital gains tax, and took steps to foster the growth of the local mutual fund industry.
Some asset managers have been able to opportunistically participate in this rally. Though until very recently, Argentina belonged to the MSCI Frontier Markets index, and Mirae Asset Management’s emerging markets equity strategy is benchmarked against the MSCI Emerging Markets index, Mirae has an absolute return objective and was able to invest in Argentina. “We often look to frontier markets as off benchmark investments, as we believe they present overlooked opportunities, a dislocation between price and fundamentals, and are often attractive backdrops for growth” says Mirae Asset Global Investments portfolio manager, Malcolm Dorson. “We held an off-EM benchmark position in Argentina for the past year, which benefitted from President Macri’s push for economic reform and financial orthodoxy. The thesis was reinforced by the success of Macri’s Cambiemos party in the mid-term elections” he adds
However, Mirae has now booked profits on the trade. “We recently took gains and closed our position on account of currency vulnerability and general volatility ahead of the MSCI EM index inclusion decision in June 2018” says Dorson, (who has rotated into other frontier markets, such as Romania and Vietnam, and used the volatility as an opportunity to add to emerging markets exposure).
Politics, taxes and subsidies
He elaborates: “the Argentine peso (ARS) has depreciated by roughly 20% this year, driven primarily by today’s external scenario – US 10-year treasury yields climbing above 3% in combination with a stronger US dollar environment. With pressure on the currency, the Central Bank was forced to hike interest rates over 1,200 basis points to 40%. Argentina carries both fiscal and current account deficits around 5% of GDP and these twin deficits make the ARS particularly vulnerable in today’s environment. To a lesser extent, we believe that the currency was pressured by (i) implementation of the withholding tax on bond gains for foreigners leading to an unwinding of fixed income instruments and (ii) recent political uncertainty due to an initiative aimed at bringing back old utility subsidies, which signaled a road block to fiscal reform”.
MSCI EM Index
MSCI announced, on June 20th 2018, that Argentina will be reincluded in the MSCI Emerging Markets index. This might allow some pension funds and other investors to allocate to Argentina, and would guarantee inflows from the $300 billion or so of ETFs tracking the MSCI EM index. (The stockmarket gains seen in Pakistan in 2016, and Dubai and UAE in 2013, are seen as examples to gauge the impact of MSCI EM Index inclusion).
Multi-country or single country?
Investors who want to delegate geographic asset allocation decisions to a fund manager, could consider an emerging market fund – such as Mirae’s – or a general Latin America fund. Some of these also have very little exposure to Argentina. For instance, Aberdeen Latin America Income fund had just 4% in Argentina as of the end of April 2018.
Investors who are confident about making single country allocations, and who expect Argentina’s stock-market to recover from its 15% drawdown at the time of writing, could look at stock-picking or single country vehicles.
Some 24 Argentinian companies have ADRs listed in the US. There are five financial services companies, four real estate firms, four utilities, four in oil and gas, two steel firms, two in agriculture, two in telecoms and one in eCommerce: local “Ebay” firm Mercado LIbre, which is the largest weighting in Argentina ETFs.
Argentina is the largest country weighting, at around 20%, in many Frontier market ETFs, such as the iShares MSCI Frontier 100 ETF, and other ETFs focused only on Argentina exist.
The Global X MSCI Argentina ETF [ticker: ARGT] and the iiShares MSCI Argentina and Global Exposure ETF (ticker:AGT) are benchmarked against the same index: the MSCI All Argentina 25/50 Index. This includes companies with sales in Argentina, as well as those listed on the local stock-market. Only 46% of holdings are listed in Argentina, with the rest in the US, Italy, Chile, Canada, Spain and elsewhere.
The largest holdings for both ETFs are information technology at 25% (mainly Mercado Libre at 22%), financials at 23% and energy at 22% (of which the largest company is oil services group, Tenaris, at 15%). Both vehicles have an expense ratio is 0.59%.
Neither Mercado Libre nor Tenaris belongs to the Argentine Investible Markets Index (IMI) and Mercado Libre gets less than a quarter of its sales from Argentina. Therefore, other stocks, such as bank, Grupo Financiero Galicia [GGAL] or Telecom Argentina [TEO] may be closer to “pure plays” on Argentina.
Shale oil and gas
Some investors are upbeat on the potential for Argentina’s energy industry. Norway’s Statoil (which is changing its name to Equinor) has a joint venture with YPF to explore for shale oil and gas in the Vaca Muerta formation, which has the world’s second largest reserves of non-conventional gas (after the Eagle Ford in Texas), and the fourth largest oil reserves, according to the EIA. David Tawil of Maglan Capital highlighted oil and gas E&P company, Madalena energy, [ticker MVN], listed on Canada’s venture exchange, as his best idea for 2018.
Dorson is more cautious short term: “even with the current higher oil prices, it will take considerable time and infrastructure investment to fully benefit from Argentina’s rich natural resources. Even if the government can materially expand its partnerships (i.e. share costs and know-how), it will take several years for Argentina to unlock its full potential in energy, in our view”.
Whatever the bottom-up story for individual stocks, and regardless of the MSCI upgrade, macroeconomics and politics – inside Argentina and elsewhere – will continue to be important market drivers. The country has secured a $50 billion bailout from the IMF, yet yields on Argentinian sovereign debt made fresh highs in mid-June. Still, Argentina has signed a letter of intent committing to making its central bank independent. If this materialises, it might remove at least one element of politics from the equation. Investors might also warm to inflation targets of 17%, 13% and 9% for 2019, 2020 and 2021 – if they are met. If Argentina can slay its inflationary dragon, the vicious circle cycle of currency depreciation, inflation, defaults and IMF rescues might perhaps be broken.
DISCLAIMER: Mirae’s views views expressed represent an assessment of market conditions at a specific point in time, are opinions only, and are subject to change without notice.