It may strike some as insensitive to discuss possible bond market winners against the backdrop of war in Ukraine. But money has to flow somewhere, and the talk among some emerging market bond watchers since the Russian invasion has been of the potential emergence of Latin America as a rather unlikely safe haven from the turmoil.
The shockwaves generated by Russian missile and ground attacks in Ukraine on February 24 did not immediately rattle spreads in Latin America. Indeed, certain credits that had been underperforming, such as Colombia, began to catch up with the benchmark thanks to the rally in oil prices.
Colombia is not the only LatAm country that could benefit from higher oil prices. Mexico, Ecuador and Brazil could also turn it to their advantage. Higher grain prices, on the other hand, could come in handy for Argentina.
LatAm sovereigns are also somewhat insulated from the crisis due to their relatively low exposure to trade with Russia. Those few countries in the region that do have close political and trade ties — Venezuela and Nicaragua — are largely irrelevant to the day-to-day concerns of fixed income portfolio managers. Nor do any major LatAm corporations have significant exposure to Russian exports or investments.
What’s more, it is likely that US growth, a key variable determining Latin America’s economic fortunes, will be less badly affected by the conflict than European growth. Sheer geographical distance from Ukraine is no bad thing, either.
And as Russia is dropped from fixed income indices, and with few obvious alternative destinations for the allocation of cash, Latin America is, unsurprisingly, holding up relatively well, which in turn supports the narrative that is gaining traction with both buy-side and sell-side analysts that LatAm can play the role of EM safe haven.
Oversimplification
However, this narrative is both premature and an oversimplification.
Sure, Latin American debt is unlikely to suffer in the same way as bonds from the countries directly involved in the conflict, those adjacent to it, or those with direct links to the Russian economy.
But for much of the investing world, emerging markets are treated as a single flock, tarred with the same brush. The overriding thesis of EM investing, that things might not work quite like they do in developed markets, but investors are compensated with higher returns, applies universally.
Until investors stop getting paid, that is.
Bond buyers with holdings in Russia are taking a major financial hit right now, and international asset managers that have invested there and in Ukraine are engaged in very difficult conversations with their clients. In the vast majority of cases, those are the same asset managers that look at LatAm bonds.
And this is not the only EM crisis that investors have lived through recently. There have been large sovereign defaults in Latin America and Africa, while last year’s Chinese real estate crisis is still a fresh, painful memory. With each disaster, it seems like an easier decision for end investors to remove themselves from the scene completely by cutting exposure to emerging markets, full stop.
Outflows and redemptions could very quickly outweigh any possible reallocations from Russia as it is removed from indices. In fact, the difficulties in trading Russian debt right now bring those very reallocations into question — portfolio managers may instead have to sell liquid Latin American bonds to raise the cash to give back to investors.
What’s more, Latin America's shock buffers are threadbare in the wake of the Covid-19 pandemic. Debt ratios are higher across the board and the economic recovery is in most places precarious.
The global macroeconomic impact of Russia’s invasion cannot possibly be understood yet, but in times of uncertainty, investors rarely reach for riskier regions — especially LatAm, which has been unreliable territory for bond investors for some years.
And the war is hardly likely to be an economic boon if inflation continues to rise, provoking further rate hikes in the US and Latin America itself. Though there may be some benefits for net oil exporters, these will remain peripheral for bondholders unless the windfall is well spent — which seems unlikely, given political risks are rife across the region. And for oil importers, particularly Central American sovereigns, higher energy prices are painful.
Inflation would also bite the LatAm voter, an important consideration when one remembers that unpredictable politics have been a key driver of the region’s underperformance in recent years. Mixed diplomatic signals on the Ukraine conflict from Brazil and Mexico may be of little immediate consequence, but are in keeping with governments that are increasingly hard for bond investors to read. This conflict in Europe will not calm Latin America’s enduring political polarisation.
For all of these reasons, there will be opportunities for investors with the expertise to pick among the various Latin American sovereigns and corporations. But a safe haven implies shelter from storms, and Latin America does not match this description.
The region has plenty of turbulence of its own, including — let's not forget — plenty of longstanding internal conflicts. The region is not, on the whole, in a fundamentally strong position, and it would be naïve to think that devastation on the other side of the planet could make up for this.