As of July 30, Argentina is in default on its sovereign debt despite a willingness to make payments to all but a very small group of holdouts from its 2005 and 2010 debt restructurings. While the next few months are likely to be replete with legal and political drama surrounding the unique situation of its bonds governed under New York law, our view is that all involved parties will reach an agreement sometime in the first quarter of 2015. Therefore, we plan to maintain our very low exposure to bonds governed under Argentinian (local) law in Oppenheimer International Bond Fund, and continue to monitor the situation for opportunities to potentially add to that exposure.
A Very Unique Default on NY Law Bonds
July 30 marked the end of a 30-day grace period for Argentina to make a debt payment or face entering default. No payments were made, thereby putting Argentina in its second default in thirteen years.
At the surface, this is unique because Argentina is certainly not out of money (even going as far as depositing $539 million at the Bank of New York Mellon for the full payment). To understand why this occurred, it is important to remember Argentina’s last sovereign debt default in December 2001. Over the course of the next nine years, Argentina was able to restructure 93% of that NY law debt, effectively convincing holders of those bonds to exchange them for restructured paper of lesser value. The remaining 7% continues to hold out, demanding full payment.
This 7% has since won a Manhattan Federal District Court ruling stating that Argentina could not make payments to the exchange bondholders until it paid back the holdouts. Any financial institution that wants to continue to do business in the U.S. is not likely to assist Argentina in defying this order.
Our Exposure to Local Law Bonds
Oppenheimer International Bond Fund has 0.1% exposure to Argentina as of June 30, 2014. More specifically, we own local law bonds, not the NY law bonds that are currently the center of attention. We believe that regardless of the outcome, Argentina will continue to make payments on local law bonds. Additionally, it is important to remember that what happens to a credit after a default is just as important as the default itself. Though they are likely to see volatility in coming days, we expect that local law bonds will continue to show far more resilience than their NY law equivalents.
Effect on the Portfolio & Our Outlook
Of course, this is a very complex situation with an uncertain outcome. But at 0.1% of the Fund, any impact will likely be minimal. My view is that over the medium term, Argentina will continue to move towards a solution that will bring it back to more normalized relations with international capital markets. Needless to say, Argentina has a number of challenges it will have to overcome in order to do so. Despite this, it is our belief that Argentina, the exchange bondholders and the holdouts will come to agreement on NY law debt by the first quarter of next year, though not likely without a healthy dose of political and legal drama. Therefore, I will be closely monitoring the situation for opportunities to potentially add to our very low exposure.
Fixed income investing entails credit and interest rate risks. Interest rate risk is the risk that rising interest rates or an expectation of rising interest rates in the near future, will cause the values of the Fund’s investments to decline. Risks associated with rising interest rates are heightened given that rates in the U.S. are at or near historic lows. When interest rates rise, bond prices generally fall, and the Fund’s share prices can fall. Below-investment-grade (“high yield” or “junk”) bonds are more at risk of default and are subject to liquidity risk. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes and geopolitical risks. Emerging and developing market investments may be especially volatile. Due to the recent global economic crisis that caused financial difficulties for many European Union countries, Eurozone investments may be subject to volatility and liquidity issues. Derivative instruments, whose values depend on the performance of an underlying security, asset, interest rate, index or currency, entail potentially higher volatility and risk of loss compared to traditional stock or bond investments. Currency derivative investments may be particularly volatile and involve significant risks. Small and mid-sized company stock is typically more volatile than that of larger, more established businesses, as these stocks tend to be more sensitive to changes in earnings expectations. It may take a substantial period of time to realize a gain on an investment in a small or mid-sized company, if any gain is realized at all. The Fund is classified as a “non-diversified” fund and may invest a greater portion of its assets in the securities of a single issuer.