Bridge over ocean
3 February 2017 Multimedia

Searching for Yield in Latin American Debt Markets

  1. Juan Camilo Guzmán
  2. Alexis Roach
  3. Edgardo Sternberg

This panel discusses how they navigate the fixed income markets in Latin America. Comprised of Juan Camilo Guzmán of Santander Asset Management in Chile, Alexis Roach, Vice President at Payden & Rygel in Los Angeles, and Edgardo Sternberg, Vice President at Loomis, Sayles & Company, this panel covers fundamental trends in the macroeconomy and its impact on Latin American debt markets. They explore regional themes and differences by country, evaluate risks in sovereign debt, and discuss managing risk in Latin American debt portfolios.

MARIA DEL PILAR AMADOR, CFA: Welcome again to our investment conference. We're beginning our afternoon sessions, and we're going to discuss a little bit searching yield in Latin American markets. I would like to introduce my panel. I will begin with my far right, Juan Camilo Guzman. He's head of fixed income at Santander Asset Management in Chile. Prior to that, he worked as a trader at Fogafin, as Portfolio Manager at AFP Old Mutual and AFP Porvenir, and as CIO of Alianza Fiduciaria. Mr. Guzman received his BA in economics from Universidad de los Andes and his master's degree in risk management from Universidad Francisco de Vitoria. Welcome, Juan Camilo.

Our second panelist is Alexis Roach. She's Vice President and Emerging Markets Strategist at Payden & Rygel, where she focuses on sovereign risk in Latin America and the Caribbean. Before, she worked as Senior Macroeconomic Analyst of the Federal Reserve of New York, covering Latin American sovereigns and commodities. She received a BA in international relations from the University of Pennsylvania and has studied abroad at Torcuato Di Tela University in Argentina. Mrs. Roche earned an MA degree with a concentration in Latin American studies from the School of Advanced International Studies at Johns Hopkins University. Welcome.

Our third panelist is Edgardo Sternberg. He's Vice President of Loomis, Sayles & Company and Co-Portfolio Manager of the Loomis, Sayles emerging markets opportunity funds. Before joining Loomis, Sayles, he was a senior analyst and portfolio manager at Evergreen Investments. Mr. Sternberg received his engineering degree from Facultad de Ingenieria, en el Universidad de Buenos Aires and earned his MBA at Sloan School of Management at MIT. Welcome to you all.

I would like to start inviting you to talk us a little bit about your role in your firm and how do you approach investing in emerging markets? And if you want to highlight or concentrate in a specific risk or opportunity, I will welcome that. And I would like to begin with you, Juan Camilo.

JUAN CAMILO GUZMAN: Thank you. I have an especial opportunity in my life. I was local in two markets, Colombia and Chile, and I manage portfolios in Colombia and Chile from an institution. So I have the experience to understand how it works, the detailed market, and understand how to play these markets. And I think that is very interesting, and I'll try to give you some idea of how these markets work.

Chile and Colombia have very interesting markets. And they are the third and the fourth markets in Latin America debt markets. So everyone speaks about Mexico; everyone speaks about Brazil. But Colombia and Chile, they are not in the news, usually. Maybe Colombia a little bit more, but Chile's totally off. And I think that they have great opportunities in order to serve for you. And, please, next slide. Chile and Colombia have very big players, very big for the size of the countries. They have financial pension funds. Chile is $182 billion in AUMs. Colombia is $72 billion in AUM, and more than 40% of their AUMs is in fixed income, in local fixed income. And this is very important because the person who invests in these markets have earned a great [INAUDIBLE].

The pension funds are interested in measured volatility in the correct price of their assets. They are interested in the current regulation, and that is more important what has happened with the credit in these countries. They are locals, the companies that issue in these countries are locals, and they know very well. So they work as a [? saver ?] in these markets. Also, it's important that Chile have a market. It's $140 billion; Colombia is $73 billion, and have a market with [? variety ?] that helps the people to hedge if they want to use these local markets in different currencies.

Two panels ago say, OK these markets have strong regulation and-- how to say-- and a positive financial market. I say positive in order to say they suffered, 20 years ago, different problems, and they are solved. They are very solvent; they are very prudent. And, for example, I want to give you one number. If you say, OK, what is the price to loan with a guarantee for the loans in these markets? It's very big. It's around 50% in the mortgage market. Very important is-- and it's very different for the rest of the world. This, the fixed income in these two markets is negotiated by the stock exchange and have one market, one screen, that you see all of the paper that are negotiated in the day. You can see at every moment what the price is, what is the description, and how different-- and information is very clear. Everyone can see this information through time.

And also, these countries have very strong entities that if you want to make clearance, a settlement, and administration it is covered. But the countries have different things. Chile is a safer country. What it means, safer country? It's double A, and it means that have better numbers than the majority of the emerging markets countries. Colombia is just an emerging market. Debt to GDP, Chile's 17%, but Chile has a national fund, and the net debt of Chile is around 2.

So Chile is a very safer country. If you want to invest in a safer country, and you can't-- and you want to have always risk returns, from Chile is a very interesting country. Have a very large market in the time deposits, and a great part of the outstanding-- of the issues in Chile are inflation linked. That is very interesting if you're a foreigner and you want to invest in Chile, you have a procedure that covers what inflation is in Chile, but have an opportunity, or maybe sorry, I don't know, that less than 5% of international investors are-- the total players in the market, and the negotiation, just 5% is foreigners. And Chile is a long history market. I have frequently issuers from different ratings.

Colombia is totally different. It's a sovereign debt market, principle, has a market maker's system that is provided to the government for the banks, and they make very liquid the sovereign bonds. For example, I once said if you want to pick up a position in Colombia for 100 million euros, will affect the market in one day, maybe two. And this is interesting. This is interesting. And if you want to search for yield, this is a country that you have to look. Colombia also is very important in securities lending, so if you want to put short procedures or long procedures, in Colombia, you can get with these positions. And what is different in Colombia, 25% of the transactions is for foreigners. So international players are important in this country. And this is very, very, very important because the volatility increase the market with this [? information. ?]

Next slide, please. I can give you some examples what it means. You have three bonds. The first one is Colombia 2024; it's local bond in pesos, in Colombian pesos. And it's just 1,000 days. This bond returned 6.3 total return from the 14th to 17th. OK, if you see the white line, it's volatile, it's interesting, but you have nice return. The second one is 2024 from Chile, in pesos Chilean. 6.92 in the 1,000 days. But if you see, the line is less volatile. So you have on a market that is not in your scope but has the best return from these three bonds, the same duration, in local currencies. And, in return, you have the [INAUDIBLE] that you know how it works.

But if you make down the numbers on a napkin, and you say, OK, if I start a forward rate in May of 2004, this is rate, it's 2.68. I make this number is 4.24. So this means that Chile, if you evaluate in US dollars, is the best return of these three bonds. Better than treasury, better than Colombia, and it was the better of three. If your objective is best search for yield in US dollars, Chili is an option. It was an option. I don't know if in the future, it will be. But you have to evaluate these kind of markets; you have to evaluate these kind of bonds.

Colombia, the forward rate is comp USD is 3.22. It's 6.92 less 3.72 is 2.588. It's OK. Led by the Treasury, not efficient, but a lot of players play this game. But Chile's lost in the market. And it's very interesting to see what can you do with local markets in countries like Chile. I'll just give you an idea, searching for gain is more than high yield, it's more than corporate; it's play local markets. And local markets need special abilities. What are these abilities, and it's very important to understand. You have to have foot in this country. You have to understand what is happening, how the players are thinking, are happening in these countries and in these markets with these players.

And just, I give you two links. It's-- the stock exchange of these countries are very open to explain to people how to get into the markets. And the stock exchange from Colombia and Chile have a lot of information available if the local investors want to do this in these countries. So my invitation is to understand how could you get into these countries.

ALEXIS ROACH: Hi my name is Alexis Roach. I work for an asset management firm in Los Angeles named Payden & Rygel. We are largely fixed income. We're about $100 billion or just over. And I am on the emerging markets team, and I head up the Latin American research side of things. So I'm going to start describing how we look at things, talk a little bit about growth, as you see in the chart there, and then talk about some investables themes.

So our process, we like to say, is top down, bottoms up. And we start with the top down, which is country selection. So the basis of our theory is that we do well in country selection, so we focus there. And then we look at asset allocation, so are we going to be in sovereign, dollar pay, which is what I specialize in. We're going to be in local or are we going to be in corporates, and some variant of that, which is quasis. And then we look at and we do security selection. So what I look at from the top down point of view is I always start with growth.

And I thought I was very original this year by noting that Latin America actually has the largest change in growth from last year. It turns out I wasn't all that original, because a bunch of sell-side reports came out saying that at the beginning of the year. But if we're going to get into the nitty gritty, you had a recession last year, probably about a contraction of 0.7% on a regional level, and this year, we're going to have growth of maybe 1.2%. So the delta, which is what we look at as part of our fundamental analysis, is what counts. And Latin America, the change in growth is actually pretty large when you look at it versus other regions.

Now that's-- there's a big caveat here, and this is something that people forget to mention, growth in Latin America is still low. At 1.2%, that's way below what most of the academics are thinking potential growth is for Latin America, which is somewhere on the order of two and 1/2 percent. But the trend is your friend when you're looking for investment stories, and the trend in terms of growth has been positive. So if we go to the next slide, I did some completely subjective groupings for the benefit of the case that I'm going to make, and that is I divided the countries into the interventionists group, the ones that are more pragmatic, and you're going to have to excuse me because some countries go from interventionist to pragmatic overnight, as we have seen in the last year-- Argentina would be the example-- and then the Central American countries.

And the reason that I've sliced and diced the data, there's no rule or reason for it, it is just to make a few points. And the first would be the political point. And that's where you have these pragmatic countries. And Argentina, which was interventionist, is probably going into the pragmatic country bucket next. But the idea here is these countries were hit in the last year, two years by very-- a number of idiosyncratic factors but because of a lot of political events, have actually turned around quite nicely. So we're looking at Brazil, for example, where we don't expect growth to be huge, but we expect that it's actually going to turn from recession to growth, which is actually pretty important considering that Brazil had one of the worst economic recessions of modern history.

So here, the big takeaway is that politics matter. So we've looked at Peru; we've looked at Brazil; we've looked at Argentina. All have political transitions within the last year that we've thought to be relatively positive in different degrees. We think that the honeymoons of these administrations is probably going to start to wane, but we think that they have enough political capital to move forward.

And then the second case I would make is that Central America and the Caribbean is a unique subregion within Latin America. And here, the big takeaway is that differentiation matters. So while some of the countries in Latin America, especially the oil exporters, the Brazil, the Ecuador, and even to some degree, Colombia, sorry for the Colombians on the panel, were suffering from a very negative oil shock. You saw Central America and the Caribbean benefit quite a lot. So one of the trades that we liked going into 2015 was move from a country like Colombia into a country like Panama that was less exposed to oil. So understanding what the macro climate means for individual countries and making sure not to paint the region with one brush I think is a key part of our process.


EDGARDO STERNBERG: Hi, my name is Eddie Sternberg and I work for Loomis, Sayles, an asset manager in Boston from early last century. And I don't have slides, so I'll just quickly tell you how we approach things. Loomis, Sayles is medium size, $250 billion in assets under management, mostly in fixed income, all over the world, and in emerging markets is about $18 billion. Long player in emerging markets but not as a dedicated player. Only it's been in the last 11 years that we've become a dedicated player.

We, a lot like Alexis, don't mingle our different strategies, so we're players in local currency as a separate strategy, in sovereigns, and in corporates, are all distinct strategies. So for all of them, we have the same approach, a fundamental analysis, value-oriented approach. And in each one of those, we do mix top down to the bottom up in different degrees. So for a local strategy and sovereign strategy, the top down is significant. There's less to select from, and in the security side, you can select different parts of the curve, but not necessarily go to one company or another because you have this government paper or quasi-government paper.

In the corporate strategies, what we do focus on is a lot on the bottom up, also, because at the end of the day, we are sort of bankers, and we have to make sure that we are paid at the end, especially because the liquidity in the corporate market is much, much lower than in other markets. Which, by the way, has been a benefit in the last few years because-- that's the one chart I could've put up-- it shows that corporates behave with much less volatility than sovereigns do, unless they default, right, which happened a lot in 2015. I'll stop there so that we can continue.

MARIA DEL PILAR AMADOR: Thank you very much. Well, we definitely have some high convictions, ideas here. But I would like to start with some more general trends. And, Alexis, you spoke a little bit about growth. So I wanted to ask you, do you think the growth advantage in emerging markets is set to remain? And are you optimistic in which countries of Latin America in terms of growth?

ALEXIS ROACH: Well, I think in emerging markets more generally, what we've seen is-- or we saw in the last panel, the growth differential, from all the forecasting that we can do from the IMF, which is what I use as kind of the baseline, the emerging, or the differential between emerging markets and developed markets is set to remain high and widen in favor of emerging markets going forward. Now I think that's an important thing to keep in mind.

But at the end of the day, Latin America, you have to get your countries correct. And it's not just about the actual growth level but about the change in growth. So where we're most constructive is probably a country like Argentina, where this year, growth will probably be north of 3%, coming from a recession last year of 2% and change. Brazil, we're actually optimistic as well, and it's the same reason that we were talking about. You have-- you're going from a recession of negative 3% to, let's say, it's positive 0.6 percent, the delta is still pretty enticing. So at the end of the day, it's individual country selection, and we do look at the broader trend of where emerging market growth is going because it affects our region very importantly.

MARIA DEL PILAR AMADOR: Thank you. And you mentioned liquidity. Have Latin American markets changed over time? I mean in terms of the type of bonds available, the size of their liquidity, the type of investors, how has this changed over time?

EDGARDO STERNBERG: It has changed a lot. It all depends on where you start. Some people start in the early '90s, and at that time, or slightly before that, you had just secondary loans that big money center banks had made in the '80s, and then every country defaulted on, so they were transacted on a secondary basis. Then it became a much more interesting and active market with the launching of the Brady bonds to replace those defaulted loans. And that got a lot of investors, international investors, involved more so than your local or your traders that you had before. That then became a much larger market, and that was the EMBI at that time, just the EMBI and it was treasury bonds. And then we got the EMBI global. It included many more countries. I think we are at 65 countries right now-- 67, you're right, 67 countries. That was not the case before. Oh, by the way, most of those loans were to Latin America.

And so everyone knows Latin America. So everyone feels sort of comfortable with Latin America. But In the meantime, what we had in the '90s was, in the late '90s, was the development of local markets. And that again put many more instruments available to investors. And then you had the development of what Juan Camilo was talking about, which is the local players, the local pension funds, Chile being the oldest one, and that is a very good thing, by the way. Because what you have is always a local liquidity provider, since we were talking about liquidity. So if you're investing in the local markets, or even in local companies, even a dollar bond sale in some of these countries, there's going to always be some appetite from the players there. Their pension funds always grow because they get more money, and the local players know their companies, so they'll be buying those companies. Some of them, at least.

And lastly, what we had in the last few years was the yield advantage that everyone loved in emerging markets. And so everyone and their mothers and cousins got involved in emerging markets. And in 2013, that was a disaster. And that's when we proved that liquidity is a problem. And that killed, in a way, the developing corporate market. The good thing about that is that only the dedicated players-- not only, but mostly the dedicated players-- stayed in those markets, and that gives you that low volatility that you have now. They know their companies better; they don't invest just because there's a higher yield.

MARIA DEL PILAR AMADOR: Thank you. Alexis, how much do you think that the US Federal Reserve policy drives markets here in Latin America?

ALEXIS ROACH: Well, there's two ways to consider it. First is from the side of the road, which is what I do, and that's, we work in a spread product, so we have US dollar debt, and it trades at a spread to treasury. So in the most recent, I guess most recent event, which was the election of Donald Trump, you saw treasury sell off. And that is very important in terms of how you're positioned for your portfolio. So Latin American debt, if you were in the long end, you definitely got smoked during this period. And you have to look at your sell versus kind of on an absolute basis and versus a benchmark. But, yes, treasuries do matter. Our personal, or our company's view is that we're a little bit more cautious on where treasuries are going to go from here. The sweet spot, we think, is probably the five-year paper, some of the higher-yielding instruments, so those are lower-rated countries where we like the story.

The second part is obviously the local markets, and that's a bit of a different game. But you're looking at interest rate differentials, and there's questions about portfolio flows and are portfolio flows going to reverse, and is that going to be a question mark for countries like Mexico that rely heavily on portfolio flows or even a country like Colombia. Our bias is to say that these countries are strong enough, and history would tell us a country like Peru, which saw foreign ownership go down and weathered the storm quite well, they can handle it. But it's something that people do watch. And somebody like me, who looks at macroeconomic variables a lot will look at the reserve coverage metrics. I will look at how much of a current account deficit is funded by FDI versus portfolio flow. So it's the basic macroeconomic ratios that you're going to focus on, but it does affect both sides of the investment process that we look at.

MARIA DEL PILAR AMADOR: Taking that into account, Juan, do you feel like foreign investors are chasing deals in Latin America?

JUAN CAMILO GUZMAN: Yes, but there's so few big investors that they are not coming for all of the portfolio that wants yield, going to Latin America, going specifically to Colombia. Maybe someone is in Mexico and Brazil, but Colombia and Chile, so far, if they want to achieve these yields, they need a strong back office in order to understand accountability, the legal derivations, the taxes, that is very important. So it's a complex process, but it's an opportunity that is available in those countries.

MARIA DEL PILAR AMADOR: Eddie, what do you think about this?

EDGARDO STERNBERG: To the question of whether investors are just for the yield in Latin America, I think it goes a little bit beyond that. Of course there is the yield, and that is always an advantage. Especially in a rising rate environment, you have a little bit of a cushion with the spread side, which was what Alexis was talking about. But also, they are also looking at the fundamentals and whatever was mentioned in the equity panel that there is a rising growth differential in Latin America. The fundamentals in many countries are improving coming out of recession. And something very important. If you look at a benchmark that goes beyond just Latin America and you look at the global benchmarks, you'll always see almost consistently that everyone's always overweight Latin America. And--

ALEXIS ROACH: It's a great region.

EDGARDO STERNBERG: It's not only a great region, it pays more yield. So that answers a little bit that side of the question. But it's a region that everyone knows the most. A little bit related to the part we were talking about before, it's the first region that came to the market in general on the sovereign side. And it's also the one that's in the same time zone for those in the United States. In a way, the language is very similar. And they're more used to these markets when you go a little bit down the ladder and you go into the corporate sector. So it's a little bit of both, but certainly, there's a little bit more than just yield.

MARIA DEL PILAR AMADOR: Than just yield. If we speak a little about local central banks, what are your views about the effectiveness of central bank monetary policies nowadays? I don't know if, Alexis, you want to start with that?

ALEXIS ROACH: OK. Well, I'm of the view that central banks have actually been quite cautious in the current environment. You look at a country like Brazil that was only recently over 14% on its overnight-- or its sell-it, which is its policy rate. You look at Colombia, which got to 775. I think that these countries were clearly in contractionary territory in terms of the policy effect of that. And I think that all else equal, that gives them space to be more aggressive now. So if you looked at a place like Brazil, where they-- where the new central bank governor was coming in, in an environment where there were questions about credibility, they've been easy on the throttle in terms of easing.

If you talk to economists down there, if you look at the numbers, they could probably go below 10%. That's not where they are right now. So they have space. And Colombia, you could probably get closer to 6%. So I think that the central banks have been pretty active in managing what inflation expectations they have to manage, because at the end of the day, that's one of the important channels through which you influence inflation. And I think they've been generally ahead of the curve. Now there is one caveat to that. And the caveat to that is if policy in the United States provokes more volatility. As one of my previous panelists said, this is not an 11 VICs administration. If it turns out that this is a 20 VICs administration, then the calculations are going to change. So we're all operating under the base theory that things kind of continue along the same basis that we've seen in the last six months, and inflation continues to roll over, giving the central banks the policy scope to continue doing what they're doing cautiously but in a more confident manner. If that changes, they're going to have to re-evaluate.

JUAN CAMILO GUZMAN: I am a little bit worried about that because if your dollar will be strongest, it will be affecting inflation of these countries. And the central banks don't have the ability to manage after an inflation shock, to manage an expansionary monetary policy. So I am not sure what will be the path for the central banks in Latin America. I think that it would be a little volatile.

MARIA DEL PILAR AMADOR: What do you think of that, Eddie?

EDGARDO STERNBERG: Well, the central banks, which are pretty recent, good central banks in Latin America, have done, in my mind, a pretty good job in the last few years, which were difficult years, in trying to reduce volatility in some of these countries and manage flows. Peru comes to mind. Not the greatest way to do it, but they built reserves, and then they little by little sold off those reserves when it impacted their currency markets in a low-growth environment, where they could not really cut rates all that much. They did. Likewise in Colombia, but Mexico was outstanding. If you look at Mexico and the pass-through to inflation in the last few years with the depreciation of the peso, what is it, going from 15 to almost 21 and change. And that's pretty decent.

Helped by other things that they were doing in the deregulation market-- deregulation by the administration did, but still. I take a relatively positive view on central banks. Of course there's countries like Argentina, where their central bank was nonexistent, and in Venezuela and some other places. But in general, I agree it will be a hard job going forward if yields in the United States go high, very high very fast, and the dollar strengthens a lot. But it's a much higher VICs administration. It's an administration managed by tweets, and so it all depends on what the next tweet is. We'll see.

MARIA DEL PILAR AMADOR: And mentioning currencies, do you hedge your currency risk in your portfolios?

EDGARDO STERNBERG: That was interesting in the morning panel. It was always my view, and they confirmed it, that equity managers couldn't care less about currency. They never hedge. For us, because if an equity goes up a lot and the currency goes down and they're still better off. And in fixed income markets, whatever you can go up is very limited. At the end of the day, you'll always pay par on your bonds. And so if the yield is not very high, you lose it all in the currency. So we-- and it's very hard to hedge currencies when they're very high yielding, also, so do we? Yes, from time to time, we do. We don't always hedge it, so we don't protect ourselves from the currency. But we do take views on what the currency is.

They're always mostly wrong because it's very hard to predict a currency market, except from 2003 to 2010, let's call it, with the exception of 2008, when commodities were going up, the dollar was going down, and everything else was going up. So that was easy. But you do it by overweighting and underweighting countries to some point of view. And one of the things we mentioned before, sorry I extend myself, is talking about instruments. Latin America has seen tremendous inflation in the '80s and '90s. And so they created all these inflation-linked bonds, which come very handy when you want to protect yourself a little bit on the currency side, because if inflation, I'm sorry, if the currency depreciates, inflation tends to go up, and your inflation-linked bonds give you at least a little bit of protection in that case.

MARIA DEL PILAR AMADOR: It's the same for you as he mentioned?

JUAN CAMILO GUZMAN: Yes. So we have local portfolios. We previously invest in local market, so we hedge all our investment outside in CLP or COP.

MARIA DEL PILAR AMADOR: OK. So coming back also to the topics that we discussed in the previous panel, besides currency risk, how important is political risk in your analysis? How do you incorporate it? And I will start again with you.

EDGARDO STERNBERG: Well, it is very important. We have to look at politics. We have to look at the election calendar, especially in the case of Latin America, because they tend to be bunched together for some reason. It's not only Venezuela, I'm sorry, Brazil and Mexico every 12 years, but many other countries have elections coming up, and then there is midterm elections. So all of that matters, but the external politics matter, too. So we do have to-- and that's part of a fundamental view for a country, part of the top down view. A change in politics is also important. We saw it with Argentina and Brazil. That's very significant. I worry a little bit about what may be coming for Mexico, especially in the current context with its neighbor. And that may bring a totally different view for us in Mexico, which for us, has been, despite what everyone has been telling us an overweight, because we find value in Mexico. The problem is we always keep finding value because it keeps getting cheaper and cheaper. But that's OK. And it doesn't hurt the bottom line.

MARIA DEL PILAR AMADOR: Thank you. I want to go a little bit into some specific countries. And there is a question that is popping up. Do you think that Venezuela is going to default?

ALEXIS ROACH: Oh, my goodness. OK, so I am going to take that question, and I am going to dovetail exactly on what my colleague Eddie was just saying. And for political risk purposes, what we try to do is we have a scorecard process that looks at a bunch of different macro factors, and then we have something called ESG, which is environmental, social, and governance. And for some countries, that's weighed 10%. There's not going to be any change in Peru for another few years. You just had a new administration. For other countries, like Venezuela, that is probably 50%, if not more. And so the issue with Venezuela is there's a bit of Kremlinology that goes on. You don't really have much insight into the black box.

You can only-- the best you can do is try to figure out how much cash is going in and how much cash is going out and determine if the economic crisis is going to feed into a social crisis. Whether Venezuela defaults or not I think is probably beside the point for the near term. What happens in terms of how they manage to kind of continue servicing their debt and keeping social stability is what you watch. I think eventually, there will be some kind of restructuring. I don't know if you'll call it a default or not, but it's clearly a country that's very much in flux, and you don't have a lot of insight into what the next play is going to be.

EDGARDO STERNBERG: What's interesting about that question is we always ask whether it will default, and we're always referring to the Venezuela PDVSA bonds that are denominated in dollars and that most investors have. But the country is in default everywhere else. It's defaulted to the suppliers. It's defaulted to the people. It's-- I don't know. It doesn't pay for anything, and it doesn't have much of anything. But I was so sure that it would default in 2016, that back in 2015, I said it's certainly going to default in 2016. I find it harder now to say those things, especially because I've been saying it for quite a while. But in 2015, I was convinced that that would be happening. The interesting part is that many people find that you can invest in Venezuela, because the yields are so high that by collecting one or two coupon payments, if you bought cheap enough, you made your investment. And no one cares so much about whether it will default or not. I follow Alexis's rule, and we do follow that, and we cannot really feel comfortable with Venezuela, whether it defaults or not.

ALEXIS ROACH: There's one thing that I would probably add onto what your point was. It's that in Venezuela, the returns last year were about 50%. So if you manage against an index, like we do, and you were completely out of Venezuela, that's a huge hit to performance. So there's also a consideration on what position do you want to take. You might think that Venezuela is at the border of a pretty serious social crisis. There's obviously humanitarian issues. There's definitely economic issues, hyperinflation, huge recession. But being out of Venezuela can be just as painful as being in. So you have to understand that the country can, if it continues to pay, the yields are quite juicy, so you have to make your decision based on what your upside and your downside is versus your investment universe. And that's not a small decision to make.

MARIA DEL PILAR AMADOR: Definitely. So if we go to Brazil, Brazil is expected to be the outperformer this year. Some investors have Brazil as their high conviction [? on that. ?] Then, do you agree with this view, Eddie? How is your outlook for Brazil looking?

EDGARDO STERNBERG: Our outlook is positive. I was, in preparing, looking a lot about what our sovereign analyst for Brazil is saying, and she's Brazilian, by the way, and normally, she would always say some bad things about Brazil. But she's been saying good things since the change in government last year, and she continues to say that, despite the big returns that Brazil has provided, that despite the currency appreciation, despite many things, especially because we haven't seen the growth, which is expected to start showing up this year. I don't want to change the country, but I have more expectations for Argentina, which is my home country.


EDGARDO STERNBERG: Just because the potential in Argentina is pretty high. And it's been under-invested, I mean in fixed investments, for years, and a lot could be coming in there. But those are the two favorite countries.

MARIA DEL PILAR AMADOR: And how does your outlook on inflation will affect your view on Argentina's market?

EDGARDO STERNBERG: Outlook on Argentine inflation or on world inflation?

MARIA DEL PILAR AMADOR: Yes, Argentine inflation.

EDGARDO STERNBERG: My outlook for Argentine inflation is that it will continue to come down, whether at the same pace that the government hopes or at the higher pace that the market expects. But I think the trend is still going down, and eventually, I think they may be able to bring it down to a single digit, as they foresee, in a couple of years.

MARIA DEL PILAR AMADOR: So let's just stay for a while on Argentina. Analysts expect some corporates to be selling in the market. Some amount around 7 billion international bonds that will be on top of what they're expecting the government to roll over. Do you think the market is ready to digest all these offers?

EDGARDO STERNBERG: Yeah, there's a ton of bond issuance out of Argentina. There was none for many, many years, but that's not the point; there has to be money to buy. One of the big things for Argentina I think is the tax amnesty that they passed and has worked out quite successfully. It's not over yet, but more than 100 billion were declared of undeclared assets, which is a pretty sizable amount for the country. And Argentines have a very big advantage of buying anything that comes from Argentina, whether it's a sovereign or a corporate. They don't get taxed on those. And Argentina has hefty taxes, both income taxes and asset taxes. So if you have to pay 1 and 1/4 percent on all your assets, and you declare them now, and the government incents you to do that from Argentine assets, there you have 100 billion that are looking for Argentine assets. Maybe not all of it, but quite a sum.

ALEXIS ROACH: I think I can dovetail off of the Argentina one pretty easily. I think that the side of it that is interesting is that you have a new administration in place that understands the market quite well. And part of it is this tax amnesty and money looking for a home. But also, they have been good on the liability management front. I think you saw the Trump administration-- or you saw the election of Donald Trump-- and Argentina was hit hard in terms of spreads. The spreads widened out after elections pretty significantly, because Argentina's one of those countries where they do need to go to the markets this year.

And we saw two things happen. First, the Argentines announced that they had a $6 billion line of credit with international banks, so that would reduce how much they were coming to international markets. And then, as if it was planned, one would say, they came to market the day before inauguration. So the markets had firmed, and the sovereign came with $7 billion. So they've done pretty well in terms of reducing those financing needs that the market was very scared they weren't going to be able to meet for 2017. So you have to give it to them. They are, on the technical side, doing a pretty deft job of figuring out how to work the system to their advantage.

JUAN CAMILO GUZMAN: About Brazil and Argentina, it's a lot of expectations, but the numbers is not in the same way. So if the market give you some time, but this time it's few, it will be problems if they don't have the number that everyone expects.

MARIA DEL PILAR AMADOR: So on the other side, we have some investors that are bearish on Mexico. Are you finding opportunities here in the Mexican market? Eddie, I'll leave that one for you.

EDGARDO STERNBERG: We invest a lot in corporates. And as it was mentioned in the panel-- in the equity panel, there's a lot of Mexican corporates that have a lot of assets overseas and produce a lot in the United States, so there's always-- we don't invest in automotive because there's not much except maybe, here and there, a parts company. But in general, many of the Mexican corporates. ACEMIX as a case in point has assets in the United States, produces in the United States, produces in Europe. Others, like [INAUDIBLE] and other similar companies, produce in the United States, have a captive market in the United States. So there are opportunities. And we do not, I would say we're not overly overweight in Mexico, but we're not very underweight on the corporate side.

On the sovereign side, it's a little bit different. But again, today, Mexico, we always talk about spreads, and Mexican spreads are higher than Colombian spreads and are about the same as Brazilian spreads. A lot of people left Mexico to go and invest in Brazil. It gets to a point where if we don't see the growth or the numbers that the market is expecting, that may reverse, especially if it sells off a little bit more. It's always a matter of valuation. It's not always just unidirectional. And again, we have in play elections, and we'll have to see what the Mexicans want for their government.

MARIA DEL PILAR AMADOR: And if we come back to the NAFTA discussion that we were having before, how do you think it's going to affect the debt markets, or which sectors are going to be most affected? If NAFTA is-- yes.

EDGARDO STERNBERG: I don't know what they're planning on NAFTA, but obviously, the automotive sector will be greatly affected. But then again, there's a reason why they're in Mexico. It's not only because labor is lower than in the United States and you can sell into the United States, but also, labor is quite skilled in Mexico. Mexico has done great things in terms of investing in education for those sectors. And I don't know that you have that in the United States at the same cost, also, as in Mexico. So it's hard to know, but that's the one that would be mostly affected. In terms of food, maybe some companies, but all the others with their assets overseas or a mix of assets may not see that as much. And consumption will be affected. Now the other side of the coin is what happens to all the people who send remittances from mostly the United States into Mexico. That helps a lot with consumption here. And if those are BART taxed or people report it, then that's a problem. But I have a pretty hard time seeing any of that happen.

MARIA DEL PILAR AMADOR: Thank you. Before we go with the audience questions, some analysts are forecasting a huge peak in capital flows, volatility, as the US increases rates. And we have some countries, like Mexico and Colombia, where foreign holders are a very representative group. Do you think that those-- how do you think those foreign investors are going to react whenever the rates are going to increase in the US?

EDGARDO STERNBERG: These investors go into Colombia fast and leave fast. And this is the story for the last ten years. And always have bid at the end, at some point, and always have offer. I think that the volatility will be increased in the next 12 months, but it's not a big issue. It's just an opportunity to understand when to enter and when to leave.

MARIA DEL PILAR AMADOR: Do you have something to add, Alexis, or to comment on that?

ALEXIS ROACH: I think that the experience, as I mentioned earlier, with Peru was instructional. You had foreign holders that were 60% of the market, and they've gone down to the 40s. And yet the Peruvians, they had a reserve cushion. They used it. They introduced a $1 swap program. But at the end of the day, it wasn't "easy," but they were able to do a transition that was, I would say, reasonable. So my expectation is that most of these countries are able to transition if there are portfolio outflows. The one that I am concerned about more is Mexico, not because they don't have the desire and the means to adjust, but there is a huge political economy cost of letting the peso go too much further. So you see that the peso can go 15% or maybe even 25% in a year, but at some point, the central bank starts to wonder, OK, is there going to be portfolio dollars [INAUDIBLE] within Mexico. And so how fast can you let the peso go? What is the signaling effect of going to the IMF and tapping on that flexible credit line? There are things that in economic terms are not the biggest of deals, but as a central banker, you have to keep in mind in terms of policy response.

MARIA DEL PILAR AMADOR: Thank you. So I'd like to start asking you some of the questions that the audience has sent to us. To the whole panel, has the nature of the issuance in Latin American debt changed since the financial crisis?

EDGARDO STERNBERG: In what sense? If we are thinking at the country level, and we are thinking in dollars, it hasn't changed much. It's always been for financial needs. Of course, what we've seen, I think, is some countries understanding that they cannot come to the markets, especially because-- not so much as a result of that, but as a result of deteriorating fundamentals. In terms of companies, I would say pretty much the same thing. I don't know, maybe Alexis would see something different.

ALEXIS ROACH: Well, I would actually take the question from a different angle, and I would say that what you're saying, and this has been a gradual thing over the last several years, but you're seeing that countries are trying to develop their local debt markets. And that's what we've seen with your presentation. And countries feel more comfortable having local denominated currency, which, if you have currency volatility, you saw the depreciations in the currencies in 2014 in the region, it makes sense. So if you're looking at debt outstanding, local governments, I just used JP Morgan's data, thank you very much to them, but local government's debt was about 6.4 billion in 2016, whereas external sovereign debt was 865. So this is the universe of [INAUDIBLE] debt, but I think it's representative of what a lot of Latin American countries want to do. They want to have a bigger local market and less dependence on the external side. And when the countries do come on the external side, that means that there's more demand for it. So I think that that's kind of-- that's the prevailing trend that we're seeing across the board.

JUAN CAMILO GUZMAN: In the local markets, the issuers are the same. It's high-quality corporates, and they leave after the crises, some before the crisis. So it's the same. It's not--

MARIA DEL PILAR AMADOR: So not much difference. Speaking about rating agencies, do you think they're doing a good job? How much do you rely on them? And are you expecting to see any move, upgrade or downgrade, for any country in the region this year?

ALEXIS ROACH: I'll let you do that.

JUAN CAMILO GUZMAN: Yeah, that's a tough one.

EDGARDO STERNBERG: We do rate our countries. We've rated corporates since the 1930s and actually started one of the rating-- one of the first asset managers to be rating companies. Of course, it's proprietary and it's just for ourselves. And we've done the same thing with countries. However, we do look at what the rating agencies do, and it is very important to us because it is very important to the markets. Because if you are going to fall from an investment grade rating to a below investment grade rating, there's many investors, which are part of emerging markets or are not part of emerging markets, which we call crossover investors, who have emerging market countries in their benchmark. And they have to be investment grade.

So if you fall off investment grade, you care about that a lot. That happened with Petrobras when it fell from investment grade and disappeared from those benchmarks. And the same thing happened with Brazil, and the same thing happened in other parts of the world, with Russia and, more recently, Turkey. So that figure was always on the verge. I know it's not in Latin America, all these countries, but was always on the verge, and it did impact asset prices, bond prices, a lot because people could have been expecting. So after years and years of rising or improving ratings, we're seeing now, what is it called, the king, or there's a better word for that, ratings. And so we do follow them. They may be faster or slower; they may be looking at different things than we are looking at, and therefore, you can never say they're doing a good or a bad job.

JUAN CAMILO GUZMAN: That's political enough.

ALEXIS ROACH: I think I'll echo the political sentiment that you can never say good or bad. I think that I can talk about how we look at it, though. In terms of rating agencies, you get a snapshot. So if you're looking at a country like a Brazil, a Peru, a Colombia, one of the countries that's a larger economy in the region, that is followed by a lot of people, you get a snapshot of where they think the credit rating stance at this moment. What our process is, is to not necessarily just look at the snapshot, but to look at the change. So they're a starting point, but they're not the ending point for our analysis. So in that sense, they're useful, but it's not what drives the investment thesis necessarily.

The second point with the rating agencies is they do have, for some of the smaller countries that are not on IMF programs, per se, they do have access that is harder to get for an analyst such as myself. So they can be very useful if you don't know that much about what would be-- an El Salvador, and you're starting from scratch, that's a good place to start. They do go there every year. They do talk to the relevant officials. So you can get some nuanced details that are harder to get in markets that are not covered as well. But once again, it's a starting point. From there, you have to build up your own research.

MARIA DEL PILLAR AMADOR: Thank you. On the corporate side, I think that's a [INAUDIBLE] for you, how much of the local markets or companies have US-denominated debt? If you could probably give a couple of examples in some countries.

EDGARDO STERNBERG: So the question is how many of the local companies in Latin America have debt?

MARIA DEL PILLAR AMADOR: US-denominated debt.

EDGARDO STERNBERG: US-denominated debt. Well, it's a good question. I don't know the number answer, but I can give this type of answer. It used to be, before everything that Juan Camilo was telling us, that the only way for a company to have long-term debt was going to external markets or external banks and get dollar-denominated debt that could be longer than five years. That is not the case anymore. But still many, let's say, less well-perceived companies or better-rated companies in those countries, but there's still people, locals that are still looking for investment-grade companies more so than anything else do come to the market. So it's interesting that it's not necessarily the better or the more of the stronger companies that look for dollar debt, but the weaker, below investment-grade companies. Especially if they have long-term projects in mind.

So, I don't know-- that doesn't give you a number but gives you an idea of who in a market would be looking for external debt even though it may go against the nature of their business or-- comes to my mind always, a milk company in Argentina. Every time they came to the market, and to begin with, they're selling domestically, they're selling milk that's produced domestically. And by the way, milk is-- it's as something imported, the government will always put a maximum price on it. And so if the currency goes much weaker or they cannot increase prices, they will have always a very hard time in debt. So they should not, but they do.

JUAN CAMILO GUZMAN: In my experience in Colombia and Chile, less than 20% of the issuers put bonds in US dollars. So it's just few companies have their agreements and their logic to put bonds in the US market. The local markets you see enough for [INAUDIBLE] part of commerce.

EDGARDO STERNBERG: You have very strong pension funds and very strong banks, and that does it.

JUAN CAMILO GUZMAN: You don't need to extend the regulation. You don't need an analyst.

MARIA DEL PILLAR AMADOR: How much can you deviate from your benchmark? Any off-index countries you are positive about that are worth investing in?

ALEXIS ROACH: We get to-- we can deviate from our benchmark. And it depends on the account. We have a lot of external accounts that have various-- or a lot of institutional accounts that have very specific guidelines. We also do have a full toolkit mutual fund that is managed against the global diversified, the JPM Index. And we can use corporates, we can use local, and we obviously do dollar pay. So we have a lot of latitude. I don't know about off-benchmark countries, per se. The benchmark does have a lot of countries. Sixty-five is not a small number, and what's it called-- so I don't know if we're very novel in terms of inventing new countries. But I think that we are active in looking at total return opportunities. And that's, when we look at asset allocation, what we're comparing is the total return for a sovereign in dollars, the total return for local in dollars, and the total return for corporate So we have a corporate analyst team that works closely with us, which I'm on the sovereign team, and we come up with kind of the mix that we think is appropriate. And, yeah, we can, if we think a certain-- if we think corporates are going to do well, we can up our allocation significantly, depending on the account we're managing.

JUAN CAMILO GUZMAN: But a switch over to-- that you go out of the benchmark? How usual is?


JUAN CAMILO GUZMAN: How you-- how frequently you go out of the benchmark.

ALEXIS ROACH: It depends on the environment. So we can--

JUAN CAMILO GUZMAN: In the last five years.

ALEXIS ROACH: For the time being, we do have local; we do have corporate. It's a question of-- so for our full toolkit mandate, we can go up to 20%, 30%. But at the moment, it's on the lower side. So it's pretty much it's depending on how we're seeing the market. So there is flexibility, but that also is account dependent. So if we have an account that is only investment-grade, dollar pay, you're obviously not going to be buying local for that account, or if you do, your regulatory people will go after you.

EDGARDO STERNBERG: We-- I personally love going outside the benchmark. Many times because it gives you the opportunities that Alexis was mentioning, but other times because it gives you a protection from very volatile markets. That is the case, for example, in local currency markets where you can select some countries, the benchmark is very small in the sense that it, overall, it has 15 countries and only five, or four or five in Latin America. And so looking for opportunities in the Dominican Republic, for example, in local currency is a great opportunity. Looking for the same thing in Costa Rica many years ago, or even going into Argentina sometime last year, was a great opportunity, because you saw that total return that Alexis was mentioning. And you didn't know, but you expected the volatility not to be high because it was more flow-driven and more expectations-driven than anything else, and totally unrelated to the rest of the world, which is great. It's a great place to protect yourself. India is a great place these days. Not in Latin America, again, but it doesn't matter what tweet goes out, it doesn't affect India.

ALEXIS ROACH: I would agree, and the local accounts, the off-benchmark plays can be much more juicy, and they can present opportunities that are a bit out of the mainstream. Costa Rica two years ago, last year, was one of those examples that it was a sleepy credit but there were some good returns to be had.

MARIA DEL PILLAR AMADOR: Right, thank you. Where do you see the EMBI spread going in 2017 and '18?

EDGARDO STERNBERG: I will take that one. We do an exercise. Every three months, we have to tell the rest of our firm where we think spreads are going. And of course, it's theoretically a very scientific exercise--

ALEXIS ROACH: With a Maypole?

EDGARDO STERNBERG: We use models and everything. But at the end of the day, we also look at what the high-yield teams look at and what their expectations are, and we adjust them. And we haven't been that wrong in terms of relative performance to other markets. But if you look at the EMBI global right now, I think it's at 320 as of yesterday, the spread. And that's pretty much where we think it's going to end the year. If treasuries go up and if we don't go up like crazy because yields go up a lot and the dollar goes up a lot, then we could see still that that cushion is strong enough or high enough to provide you some protection and people will not rush, totally rush out of the market. Then again, it's hard to predict. So we have no view of how this year will develop. And our horizon returns, which are always managed to about 12 months, all we've been able to say these days is there's a lot of uncertainty, so we'll come up with something that is only for two or three months' worth of time.

ALEXIS ROACH: The way we approach it is we do best, worst, and base case scenario. Base case scenario, I think that we're expecting a little bit of tightening, but pretty much where things are. And then we rely very much on the country differentiation theme that I've been talking about, that some countries, they will perform better than others. And we look at the best, worst, base for those countries as well. So I think that's about as scientific as you can get unless you have a model that you would like to share.

EDGARDO STERNBERG: We do have a model. I don't know that it works, but--

ALEXIS ROACH: We've looked at models, too, but I don't know, at the end of the day, it's--

JUAN CAMILO GUZMAN: Searching for yield is the language. So if the spread's going high, I think that it's a lot of buyers who want to buy these spreads. So I think that this level is just, and it will be all the time, but it's an opportunity to increase.

MARIA DEL PILLAR AMADOR: Well, this has been a very interesting conference and presentation. Thank you for sharing your views, your experiences, and please give an applause and a thank to our panelists.

SPEAKER 1: Copyright 2017, CFA Institute. All rights reserved. This program is designed to give accurate and authoritative information in regards to the subject matter covered. It is distributed with the understanding that CFA Institute is not engaged in rendering legal, accounting, tax, investment, or other expert advice. If legal advice or other expert assistance is required, the services of a competent professional should be sought.

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