C&B Notes

Re-Weightings Obscure Fundamentals

J.P. Morgan’s decision to change the weighting of Colombian debt in a key bond index has prompted investors to pour capital into assets to remain closely coupled to the updated benchmark.  Of course, these rising prices have nothing to do with improving fundamentals, meaning buyers are being promised lower future yields with greater underlying risk.  Our mandate is flexible and broad to specifically avoid feeling forced to make these ‘me-too’ investments based on relative index weightings.  Instead, we want to remain opportunistic and only feel compelled to invest when the discount between prices and value are attractive.

The value of the peso has soared since March, when foreign investors began piling into Colombia’s bond market.  They were taking their cues from  J.P. Morgan Chase & Co., which boosted Colombia’s weighting in a bond index followed by funds that manage some $200 billion.  To many investors, the bank’s decision was akin to an order to go out and buy Colombian bonds.  Other investors and speculators also bought the peso and Colombian stocks, anticipating that they would benefit from the reweighting as well.

The peso, which had been sliding for months, saw its biggest one-day percentage gain in almost two years on March 19, the day J.P. Morgan announced its plans.  then, the currency has risen 7.3%, trading at 1,882 to the dollar early Wednesday.  MSCI Inc.’s emerging-market currency index was up 3% over the same period.

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J.P. Morgan announced on March 19 that Colombia’s peso-denominated bonds would make up 8% of its GBI-EM Global Diversified index, up from 3.2%.  The change, which J.P. Morgan says is one of the largest in the past five years, came after Colombia “improved transparency and accessibility for international investors,” J.P. Morgan said in a news release.  Last year, Colombia’s government reduced the tax that foreigners had to pay to hold the country’s peso bonds… Since the reweighting, however, the country’s stocks and bonds have seen $5.6 billion in inflows, according to  Deutsche Bank.  Analysts predict an additional $2 billion to $4 billion in inflows over the coming months. The share of foreigners holding Colombia’s peso-denominated bonds has jumped to 12.5% from about 6.5% before the reweighting.