The Venezuela debt dilemmas
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To hold or not to hold? That is the dilemma facing holders of debt issued by the Venezuelan government and its sovereign and quasi-sovereign entities. The issue has been labelled a “moral quandary” by The Wall Street Journal, put Goldman Sachs in the headlines and prompted a Harvard professor to call on index providers to exclude Venezuela from benchmarks used widely by investors.
Defined very narrowly, the question is whether to hold a bond that trades at a very high yield, has been the best performer this year in emerging markets, but whose default risk is considerable given that Venezuela is increasingly a failing state that already faces runaway inflation, growing poverty, hunger and socio-political unrest.
At one level, this is no more than the calculus facing emerging market and high-yield bond investors when considering opportunities offered by low-rated issuers. In such cases, there are three types of strategies for holders of the debt, and they need not be mutually exclusive: The first is motivated by the view that the marketplace has priced in an excessive sovereign default risk. This consideration is often embraced by those who believe that, being an oil producer that needs to maintain critical international linkages, Venezuela will go to huge lengths to make its debt service payments on the global bonds it has issued.
The second has to do with confidence in trading abilities—that is, the belief that the holders will be able to capture the high yields and exit their investment before default becomes even more likely.
The third is driven by the desire to hold the bonds through a default, comforted both by the implicit and explicit securitization and confident that a good post-default deal will be struck.
But these considerations fail to capture the broader issues, whose basic elements speak to what rightly motivates socially responsible investments. As an illustration, consider some of the recent press coverage of Venezuelan bonds.
In noting the “moral quandary” facing holders of the bonds debt, particularly Venezuelan citizens, The Wall Street Journal wrote, “many of the Venezuelan investors profit from their country’s bonds” but “are also acutely aware” that the country “is gripped by an economic crisis so deep that some of its citizens, including children, are starving.”
In commenting on Goldman Sachs’ purchase, Bloomberg Markets noted that the campaign by the Venezuelan “Hunger Bonds movement” has “suddenly gained a surge of momentum.”
Advocating for Venezuela’s exclusion from the EM index, a Harvard professor, Ricardo Hausmann, argued that, because Venezuela accounts for 5% of the index and 20% of its yield, “investing in the EMBI + (Emerging Market Bond Index Plus) means that you will rejoice when Wall Street analysts inform you that the country is literally starving its people in order to avoid restructuring your bonds.”
The argument here is no longer about credit quality and sustainability. Instead, non-commercial considerations are added to commercial ones in judging the appropriateness of an investment. And in the extreme, such concerns could compel investors to avoid a certain investment, even though they believe it will be remunerative and viable; and they could push index providers to exclude a set of bonds, even when they qualify on widely accepted commercial criteria.
When such a decision is left to individual portfolio managers, the results tend to be a mix of good, bad and ugly, potentially opening the door to controversies and even legal threats—a phenomenon that has played out to different degrees when it comes to environmental issues, including investments in coal, tobacco, and arms manufacturers. A better approach is to urgently improve the governance over this issue through transparent decisions by the boards of mutual funds, foundations and endowments, pension and retirement plans, other institutional investors, and index providers. It is at that level that the trade-off between financial and non-commercial factors should be struck, rather than by portfolio managers.
While a greater effort on this is already overdue, we are unlikely to see sufficient progress any time soon. In the meantime, there are three simple things that portfolio managers investing in emerging markets may wish to consider:
First, be open and upfront with your clients in the periodic updates about how you are combining financial and non-commercial considerations.
Second, place greater pressures on industry groups, advisory bodies and index providers to move toward a common view and collective approach.
Third, should you still feel compelled to increase your Venezuelan holdings after all that— and you would need really strong reasoning to do so—avoid to the maximum extent possible buying bonds where the resulting dollar proceeds could be used to pursue socially repressive behaviour in that country.
Over the longer-term, most socially responsible investing is likely to translate into profitable ones, too. But in the short-term, deviations do occur. Venezuela is a case in point. And the resulting dilemmas, as important as they are, should not be left to portfolio managers alone who then find themselves torn between a narrow definition of fiduciary responsibility and legitimately consequential broader issues. It is high time to make governance structures more responsive, assertive and transparent on these issues. Bloomberg
Mohamed A. El-erian is a Bloomberg View columnist.