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The difference between Paraguay and Uruguay: Active Management in the coming global monetary policy shock

The Emerging View

03 July 2014

Introduction The approaching shock caused by global monetary policy normalisation will strongly accentuate the differences between Emerging Markets (EM) countries. Knowing the differences between EM countries will therefore become critical to performance. This poses a challenge to a market that all too often glosses over the differences between EM credits. The tendency to lump EM countries together is wrong today, but it will be positively detrimental to performance going forward. Paraguay and Uruguay illustrate the importance of paying close attention to credit fundamentals perfectly. They are two relatively small countries with roughly similar-sounding names in the southern tip of South America; many investors probably casually group them together. Yet, Paraguay and Uruguay are very different countries and so has been their performance. Paraguay 2023 bonds today trade 43bps wide of Uruguay 2024s, but this spread was as high as 171bps just a year ago. Uruguay was last upgraded by the ratings agencies (to BBB-) in July 2011, but Paraguay has been upgraded no fewer than four times since then.1 Paraguay and Uruguay, it turns out, may be similar in size and location, but they are very different in terms of their credit dynamics and performance. The normalisation of global monetary policy will amplify further the already significant differences between EM countries. The resulting credit differentiation will strongly favour active over passive management, both to enhance returns and to reduce risk.

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