Hedge funds are actively trading in Argentina's choppy markets ahead of its legal showdown with rebel sovereign bondholders later this month.
Investors and creditors are waiting to see if a U.S. court upholds a ruling on Feb. 27 that prevents Argentina from paying holders of bonds issued in debt swaps in 2005 and 2010 until it pays interest and principal due to so-called "holdout" creditors who had refused to swap.
Argentina has persistently refused to pay these holdouts who range from Argentine pensioners to NML Capital, an affiliate of activist fund Elliott, which last year detained the ARA Libertad, a three-masted Argentine naval ship, in Ghana, demanding it be paid some of what it is owed.
As the two camps square up again, hedge funds are taking advantage of the exit of other investors scared of a technical default by Argentina if the country is prevented from making further bond payments.
"Every couple of months there is something happening in Argentina -- YPF, Elliott, economic data. It makes for a very volatile market, which we love," said Francois Buclez, chief executive of hedge fund firm Cube Capital.
Last year, the left-leaning Argentine government seized energy company YPF from Spanish oil firm Repsol. And last week the International Monetary Fund reprimanded the country for inaccurate economic data.
Buclez bought June 2017 bonds issued under international law at around 80 cents on the dollar late last year, later selling most of them at around 86 cents.
He is looking for another chance to buy as he thinks negotiations between Argentina and NML could drag on for three to six months. The bonds now trade at around 78 cents.
"It's an interesting market to trade but not necessarily to buy and hold," he added. "Most investors have exited because of the binary nature of the market. We still have a little bit (of the bonds) as we like the yield of 15 percent."
Buclez also profited by betting the cost of debt default insurance would fall, after U.S. district Judge Thomas Griesa in November ordered the country to pay $1.33 billion into escrow for holdouts when it paid restructured bondholders.
The cost of insuring Argentine debt rocketed on the news to around $3 million to insure $10 million of debt against default, from less than $1 million. It fell back to just over $1.3 million when the 2nd U.S. Circuit Court of Appeals later delayed that decision so Argentina could appeal.
H2O Asset Management senior fund manager Loic Cadiou, who took part in the 2005 sovereign debt exchange but later sold out, has avoided international-law bonds because of the price.
But he said the legal uncertainty has created trades in local-law sovereign bonds and bonds issued by Argentine provinces, as neither are directly affected by the U.S. courts.
Two weeks ago, he bought into the dollar-denominated local-law 2015 bonds as "a tactical trade," citing their liquidity and selling by other investors.
"It's very difficult to know what will happen (in the U.S. judgment), unless you're a legal expert," said Cadiou. "The ruling has created a significant risk premium in all Argentine assets. ... (But) you probably don't want to have the external debt if you don't want to be exposed to the ruling directly."
The U.S. court decision effectively pitches hedge funds such as NML and Aurelius against funds such as Gramercy, a veteran of sovereign debt restructurings, Brevan Howard and MFS. However, some prefer to avoid the bonds altogether for now.
Julian Adams, chief executive at London-based Adelante Asset Management, is one of several fund managers to have sold positions in Argentine international-law bonds in January because of the legal risks.
"We re-looked at the dynamics of the court process. Most analyses that say it's worth holding Argentina are based on there being an injunction on the clearing system. It's a very tough call," he said.
Pharo Management, a $3 billion emerging markets firm, is among those mulling selling down its Argentine debt, two sources familiar with the fund said. Pharo declined to comment.
Some have sought protection from the U.S.courts by moving out of dollar-denominated debt and into euro-denominated debt, another investor said, believing legal protections are stronger.
The uncertainty highlights the big risks of investing in emerging market debt just when more and more traditional funds are moving in in their global hunt for yield.
"It's hard enough focusing on when countries will make (bond) payments, it's quite another thing focusing on when countries will make payments because there is a legal issue," said Michael Mabbutt, head of global credit at fund manager Liontrust, who has avoided the bonds.