Wall Street investors find themselves on the sidelines when it comes to the best performing bonds in emerging markets this year. Despite the significant 151% increase in Argentine government bonds since Javier Milei won last year's presidential election, foreign holdings have actually decreased. Data compiled by Bloomberg and INDEC shows that the foreign share of holdings is down, and for the first time in four years, there are more local than overseas investments. Even with Milei's "shock therapy" economics aimed at slashing deficits and inflation, foreign investors have remained cautious.

Investor Hesitancy and the Impact

Compared to former President Mauricio Macri's first year in office, where a pro-business agenda led to a surge of hot money, the current situation is much more tepid. Milei's decision to maintain capital and currency controls inherited from the previous administration has effectively shut out foreign money. Investor optimism in Buenos Aires has not translated into bullishness among asset managers on Wall Street, including bond giant Pacific Investment Management Co. Pramol Dhawan, who leads Pimco's emerging markets portfolio management team globally, acknowledges the pain of being underweight these bonds but views it as a trade.There is a clear fear of missing out on the trade, but Dhawan also emphasizes the need to look for better risk-return profiles elsewhere while remaining underweight on Argentina risks with high degrees of clarity. The share of foreign holders of Argentina's 2035 bond fell to 71% in the second quarter, down from 81% a year earlier. Barclays Plc strategists even recommended swapping Argentine bonds maturing in 2030 for similarly dated Ecuadorian bonds.

The Role of Currency Controls

Argentina's currency controls play a significant role in this trend. With a tightly managed exchange rate that is on average 20% stronger than the market rate and capital curbs prohibiting international investors from withdrawing their money, foreign investors are hesitant to enter the market. Marcelo Garcia, director for the Americas at Horizon Engage, describes Argentina as a "closed pen for local investors" with the longer administration of exchange controls giving local investors an advantage.At least for now, Milei is sticking to this framework as he needs to hold onto political support leading up to the 2025 congressional election and access foreign funding. Over time, he will need to find a way to lift these controls.

Hesitancy in Mergers and Acquisitions

The hesitancy among foreign investors is also evident in the realm of mergers and acquisitions. International companies like HSBC Holdings Plc, Exxon Mobil Corp., and Xerox Holdings Corp. have sold their assets to local investors this year. The share of foreign investors in M&A transactions has fallen to 49% in the first half of 2024, the lowest level since 2020. PwC Argentina reports that caution around the "transition of the economy" has resulted in only 37 M&A deals in the first six months of the year, totaling about $1.12 billion, well below the average of 50 deals during comparable periods.Garcia explains that foreign investors see that they will not have the possibility to take their profits home, which makes it difficult to obtain final investment decisions from their headquarters.

The Importance of Removing Controls

Looking at the past, it is clear that the removal of capital and currency controls will be crucial for international investors. More than $10 billion entered Argentina between 2016 and 2018 before a selloff by offshore investors caused a financial crisis. Alberto Ades, a director at investment advisory firm NWI Management LP, notes that foreign investors are starting to be encouraged and value the government's program, but it is a gradual process. Argentina has a complicated history for foreign investors, and they need to see consistent progress in lifting controls.