Why investors keep coming back to Argentina
When the country first issued the $2.75bn of debt in June 2017 with an annual yield of 7.9 per cent, investors rushed to own it. The outsized demand attracted much scepticism and at times, derision, with many singling it out as a sure sign of market froth.
The main issues were firstly that Argentina was a serial defaulter on its debts and secondly, that it was no stranger to an IMF bailout. Two years on the sceptics appear vindicated. Argentina is currently mired in economic turmoil ahead of all-important presidential elections in October, despite the backing of a record $56bn IMF programme.
But a closer reading of history suggests a different ending for today's stricken Argentine bondholders. According to a paper published earlier this year by academics Josefin Meyer, Carmen Reinhart and Christoph Trebesch, countries that default more frequently on their debts offer higher total returns for investors. Of course, the trade-off is that volatility is also much higher.
To come to this conclusion, the researchers compiled and studied a database of 220,000 individual foreign-currency bonds from 91 countries since the Battle of Waterloo in 1815. They also put together a separate database tracking more than 300 sovereign debt restructurings since 1815.
Through this massive endeavour, they found that countries like Ecuador, Mexico and Columbia, which have defaulted nine or more times on their debts since the 19th century, have paid out returns to investors that are on average three times higher than those from the US, UK and Canada:
Foreign currency government bonds have returned an average 7 per cent over the past two centuries, three percentage points higher than US Treasuries and UK Gilts. That's even including years when there were periods of default, war and other crises.
What's more, the return-advantage of serial defaulters like Argentina, Brazil, Greece and Ukraine over US Treasuries and UK Gilts has been consistent since the mid-1800s:
Investing in countries prone to default is not for the faint of heart, however. The researchers find that cumulative returns drop by about 15 per cent around the time of a default event before stagnating for a few years.
After about four years, investors that scooped up the country's debt two years prior to the default tend to break even. A lucky 25 per cent of all defaults see investors almost doubling their investment five years after the event, while an unlucky 25 per cent end up deep in the red after six years:
The researchers point out that almost all of the defaults that ended in distressing, drawn-out losses occurred prior to WWII. Indeed, only two bond defaults since the 1990s produced comparable losses for creditors: Argentina in 2001 and Ecuador in 2008. Due to a very specific set of difficult circumstances involving vulture funds, a legal gambit and little appetite for compromise, investors waited 15 years to break even in Argentina. In Ecuador, it took roughly five years.
That being said, Meyer, Reinhart and Trebesch convincingly show that higher risk does equal higher reward for emerging market debt investors. So for now, those holding Argentina's century bonds should breathe a small sigh of relief. History, it seems, is on their side.