ARGT: Positive Change Is Afoot For Argentina

Argentina has dominated global headlines this year for all the wrong reasons; its triple-digit inflation has only accelerated in Q1 and looks unlikely to moderate anytime soon. With the current government reluctant to use the currency as a release valve (i.e., via a one-off mass devaluation event), expect more ad-hoc measures to stop the spiral, from one-way capital controls to growth-restrictive multilateral assistance in the meantime. But there is light at the end of the tunnel - for the first time in a while, the upcoming general election will likely see Argentina elect a non-Peronist, market-friendly administration. At present, Javier Milei, the far-right candidate running on a 'dollarization' platform, is leading the polls, though centrist candidate Horacio Larreta's proposal for a free-floating currency is also gaining momentum. Either way, the road ahead won't be easy, and it will take time and a lot of political will to stabilize the macro.

Assuming no tail risk outcomes (e.g., a return to Peronist economic principles), beaten-down equities such as the banks, which have seen their relative P/B valuation discount widen significantly relative to their LatAm peers, have the largest re-rating potential. Beyond the deep value names, Argentine franchises with good through-cycle earnings growth trajectories should also re-rate, particularly those with diversified income streams outside of the country. Finally, an eventual lifting of capital restrictions will pave the way for a re-inclusion in major equity indices globally, though this catalyst may take some time to play out. All in all, expect a bumpy road ahead for the Global X MSCI Argentina ETF (NYSEARCA:ARGT); while some of the positives are likely priced in following the YTD rally, investors willing to weather the pre- and post-election turbulence should still be well-rewarded.

Fund Overview - Low-Cost, Concentrated Exposure to Argentine Champions

The US-listed Global X MSCI Argentina ETF seeks to track, before expenses, the total return (i.e., yield and price performance) of the MSCI All Argentina 25/50 Index, comprising a select group of at least 25 constituents (subject to concentration constraints) of the Argentina equity universe. The ETF held ~$50m of net assets at the time of writing and charged a 0.6% expense ratio, making it a cost-effective option for US investors looking to access Argentine equities. A summary of key facts about the ETF is listed in the graphic below:

The fund is spread across 26 holdings, with Consumer Discretionary making up the largest sector contribution at 29.8%, followed by Consumer Staples at 15.8% and Materials at 13.9%. Three other sectors contribute over 10% of the fund, namely Financials (12.3%), Energy (11.3%), and Utilities (10.1%). On a cumulative basis, the top five sectors accounted for ~83% of the total portfolio, making ARGT one of the more top-heavy single-country ETFs. While the fund's equity beta stands at 1.12 vs. the S&P 500 (SPY) and 1.23 vs. the MSCI EAFE (EFA), a proxy for developed markets ex-North America, ARGT is less cyclical than most global emerging market exposures, with a beta of 0.96 to the MSCI Emerging Markets (EEM).

The single-stock allocation of ARGT reflects its consumer-focused sector allocation, with the fund's largest holding being online marketplace MercadoLibre (MELI), at 23.3% of net assets. Other key holdings include state-owned energy company YPF SA (YPF) at 6.6% and independent energy company Pampa Energía S.A. (PAM) at 5.8% of the portfolio. Other sector allocations exceeding the 5% threshold include financial services company Grupo Financiero Galicia (GGAL) at 5.5% and fast food restaurant chain operator Arcos Dorados Holdings (ARCO) at 5.1%. In total, the five largest holdings contribute ~46% of the overall portfolio, making ARGT a relatively concentrated ETF from a single-stock perspective. The fund's portfolio is priced reasonably at 11.4x earnings and 1.7x book (much lower after adjusting for MELI), screening reasonably relative to the underlying ~15% return on equity.

Fund Performance - Impressive Capital Growth Despite the Macro Turbulence

On a YTD basis, the ETF has appreciated by 22.6% and has compounded at an annualized +3.4% rate in market price and NAV terms since its inception in 2011. Unsurprisingly, given the macro volatility in Argentina and its financial troubles over the last decade, equity performance has mirrored the turbulence. The one and three-year performance stand at 13.7% and 35.4%, respectively, as equities rebounded strongly post-COVID. Zooming out, the five-year annualized return shrinks to +3.2%, though on a ten-year basis, the ETF has still compounded at an impressive +9.3% pace. The low tracking error is a bonus - the fund has generally tracked the index performance closely after accounting for expenses.

The distribution runs on a semi-annual basis and comes entirely from ARGT's recurring income stream. Given the fund's outsized concentration in high-growth consumer names (discretionary and staples), the trailing yield is decent at 1.4%. Last year was a good year for payouts, though, so the fund's distribution could normalize lower as the energy/commodities tailwinds (note YPF SA and Pampa Energia were the biggest portfolio outperformers over the last year) ease over time.

A Massive Election Catalyst on the Horizon

The near-term macro backdrop couldn't be worse for Argentina - inflation at >100% YoY and a pending recession (worsened by the drought) are fueling political instability. But with elections due in October and current polls indicating a more market-friendly government will be voted into power, there is light at the end of the tunnel. Thus far, the dollarization platform by far-right opposition candidate Javier Milei appears to be gaining the most traction, followed by centrist candidate Horacio Larreta's free-floating exchange rate proposal. And with the political shift toward a market/business-friendly platform also contrasting with other LatAm countries, where recent elections have favored populist platforms, the post-election operating backdrop could improve significantly for Argentine corporates. Successful reforms would pave the way for an eventual lifting of capital controls, as well as an equity index re-inclusion, presenting a massive upside for equity valuations.

Yet, the relative outperformance over the past year, led by sectors such as energy and utilities (key holdings for ARGT), means some of the positives have been priced in. Thus, investors willing to take the plunge at these levels should probably be prepared for volatility heading into the election months. Still, valuations screen very reasonably at ~11x fwd P/E (even lower after adjusting out MELI, which trades at >80x fwd P/E) relative to earnings growth estimates (+50% for 2022 and +14% for 2023), so investors could still come out ahead.

Positive Change is Afoot for Argentina

Argentine equities have outperformed this year despite the constant negative macro headlines, particularly around its accelerating inflation levels (poised to end the year in the triple-digits). Despite the existing administration's best efforts, for instance, via tighter import restrictions, the stickiness of the country's inflationary pressures means this will remain an issue throughout the year. Expect more ad-hoc measures to protect currency stability and insulate the FX reserve war chest in the meantime, albeit to the detriment of overall economic activity. Yet, the upcoming election in October presents a major positive catalyst for the mid to long-term as the country looks to transition away from Peronist-era economics for the first time in decades. Whether this ultimately results in a stabilized macro scenario is unclear, but with market-friendly opposition candidates emerging as the frontrunners, the recent re-rating across Argentine equities seems justified.

From a valuation perspective, there remains ample upside potential from here - major Argentine banks, for instance, trade at steep discounts to their book value and relative to their LatAm counterparts. Post-election, the successful implementation of business-friendly reforms will be key to unlocking the next leg of the upside and re-focusing investor attention on Argentine corporates' strong underlying earnings growth potential. Also worth monitoring will be the new administration's approach to macro issues such as FX devaluation and structural inflationary pressures; success here will pave the way for an eventual lifting of capital controls and, by extension, an index re-inclusion catalyst. While some of the positives have likely been priced into ARGT based on the YTD rally, valuations still trade below their underlying earnings growth potential; thus, the risk/reward remains attractive for investors willing to ride out the volatility.