Hungary: It doesn’t pay to be passive says SIG’s Gillham

Anthony Gillham, portfolio manager at Skandia Investment Group says Hungary is the latest member of the EU to hit the headlines for all the wrong reasons, and that this could have a negative impact for investors holding passive emerging market debt funds.

Having been rescued from the brink by the IMF in 2008, Hungarian PM Viktor Orban and his government have locked horns with the IMF and EU over changes to the Hungarian constitution and composition of the central bank. Events culminated in Thursday’s T-Bill auction where investors demanded elevated yields of around 10%.

Hungary’s fiscal and short term liquidity position appears reasonably robust. Hungary currently runs a primary surplus, in contrast to many in the EU, and following a number of one off measures taken last year can draw upon reasonable levels of liquidity if it continues to be shut out by capital markets. However, at around 80% debt:GDP, 1 year yields of 10% risk derailing longer term debt dynamics.

Much has been written in the past weeks about these rather surprising moves by the Hungarian government. Given the fiscal picture, market action is not wholly routed in economics and is instead wrapped up in politics. Emerging market debt managers are used to dealing with such issues and are able to draw upon many examples in the recent past such as Argentina in 2001 and more recently Ecuador in 2008.

Both countries were constituents of emerging market debt benchmarks at the time of their default. Indeed, unlike equity indices where representation grows with the size of the company, issuer representation in fixed income benchmarks actually grows with indebtedness, leaving them open to fundamental criticism. Hungary’s approximate 80% debt:GDP has earned it almost a 6% weight in the widely followed JP Morgan GBI-EM Global Diversified local currency index.

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