July 6 (Reuters) - Foreign hedge funds have been lapping up Argentinian equities at cheap valuations in anticipation of a change in political regime and given sky-high inflation, pushing the country's benchmark stock index to a record high.
Argentina's S&P MerVal index has more than doubled in the first six months of this year in dollar terms and hit its highest level since early 2018 late last month. It also touched an all-time high in local peso terms in late June.
Ratings of the ruling Peronist alliance have been hit by a mounting cost-of-living crisis in Argentina, and with other front-runners for October's general election belonging to a conservative opposition and the far-right, hopes have grown that the next president could be more market friendly.
"The current state of the economy is very poor. A hope of change means that the outlook can be better than the current scenario and hence some people will try to invest ahead of that change," said Pablo Riveroll, head of Latam equities for Schroders, which has had exposure to Argentinian equities for the past twelve months.
Centre-left President Alberto Fernandez is not running for re-election and the ruling coalition has picked centrist economy minister Sergio Massa as its nominee, spiking the candidacy of a close ally to populist Vice President Cristina Fernandez de Kirchner.
The Global X MSCI Argentina ETF saw inflows of $5.5 million in the past week to June 28, the highest in over four months, while assets under management have more than doubled to nearly $65 million from the same period last year, according to Refinitiv Lipper data.
Investors, though, caution the rally in the benchmark stock index is unlikely to last over the long term, with the new government facing the daunting task of steering Argentina out of the country's worst economic crisis in decades.
South America's second-largest economy is currently battling annual inflation that is over 100% and dwindling foreign currency reserves, that have compelled the government to enforce strict capital controls to support a rapidly depreciating currency.
"The situation is a perfect storm, almost. If inflation is going up, if the currency is getting devalued, if you can't take your currency out of the country because of FX controls, you put it in local equities," said Ashish Chugh, portfolio manager of global emerging market equities at Loomis Sayles, which is invested in Argentinian stocks.
Equities are also getting a boost from certain companies' ability to pass through price increases to consumers.
Argentina, which has a history of debt default, is trying to revamp its $44 billion loan program with the International Monetary Fund after a historic drought hammered exports of key commodities such as corn and soy and wiped out the country's foreign exchange reserves.
Investors believe the top priority of the new government should be to tackle inflation and loosen capital controls supporting the official exchange rate.
"Long-only (investors) aren't involved, because there's no clarity on how Argentina will get to the other side smoothly and who will take it there," said Chugh.
(Reporting by Amruta Khandekar and Siddarth S in Bengaluru; Editing by Shounak Dasgupta)
