The evidence has been clear for nearly a year. Venezuela isn’t just experiencing isolated food shortages. The whole country is starving. Media reports from last year showed that there were malnourished infants showing up in hospitals, and 90% of people said they didn’t have enough to eat. ENCOVI, a study carried out by an independent consortium of Universities, showed 3 in 4 Venezuelans are losing weight, and not a little bit. Earlier this month, the government health ministry released data showing a huge increase in infant and maternal deaths, leading Maduro to sack the health minister. The humanitarian consequences of the regime’s actions cannot be ignored by anyone who is paying attention.

Is there any moral justification for handling debt from a country facing this much hardship?

Actually, it depends. It depends on how you get involved. When a bond is first issued, the entity buying it is putting money directly in the government’s pocket. But most bond trading isn’t like that: mostly, the bond market consists of people buying and selling existing debt. That’s the so-called secondary market: debt shifting hands between third parties. When that happens, no new money is being extended to Maduro & Co.; it’s just a transfer of risk among private market players. Think of it as a game of hot potato on which millions of dollars worth of bonds change hands day-in, day-out, but the government doesn’t see a dime from any of those transactions.

Does all of this mean that you, as an investor, are morally exposed only on primary market transactions? I think so (and so do most investors), save for an important exception. Remember what Daniel Urdaneta cheekily calls the Bachaquero of Wall Street trade: buying up bonds close to maturity (the ‘short end’), effectively putting yourself first-in-line to collect debts from the government. Your “investment” consists on buying today in the secondary market (at a discount) a claim to receive money from PDVSA tomorrow. If this is the game you’re playing, you’re directly betting on the government’s policy of willingness to pay at all costs. You’re gambling that the government will privilege your payment over the next shipment of antibiotics. How comfortable are you with that?

As the regime has strangled imports and found innovative ways to find enough dollars to kick the can down the road, short-end bondholders have benefited greatly, despite the country’s wretched condition. Over the past year, Venezuela and PDVSA debt has returned 52%, and short-end bonds have returned 70% or even more. Over that time, Venny debt has been responsible for about 15% of the total performance of the most important benchmark Emerging Markets (EM) debt index, which has returned about 9%. This return was made possible in large part by the government’s resilient willingness to pay regardless of the human consequences.

No EM mutual fund manager can afford to simply ignore Venezuela (or any other authoritarian government out there, for that matter); its huge size, astronomical yields, and high volatility make it a key component of the performance by which managers are evaluated. Had a manager decided to step aside from Venny debt last summer when the acute food shortages became chronic, they would have missed a big portion of those gains, leading to a career-threatening underperformance relative to the benchmark.

Just to stay level with the benchmark, you’re forced to cash in on some of Maduro’s most damaging decisions. Venezuela’s rulers have conspired to hoard as much hard currency as possible by pawning assets, constricting imports, liquidating reserves and then using the dollars to pay the tab on the country’s $150 billion debt pile, with the fringe benefit of enriching themselves along the way. Billions of dollars needed for food imports have been redirected to debt service, including roughly $17 billion in 2016 alone. It is Marxist rent-seeking on an unprecedented scale with grave and well documented humanitarian consequences.

It is a way for the government to keep the generals happy. They are recycling dollars to the generals via these bonds.

So how do foreign investors in Venezuela and PdVSA sleep at night? Does the government’s clear intention to sustain the regime by putting debt service ahead of food and medicine imports impact their investment decisions? I asked a group of emerging market bond strategists, traders and portfolio managers if and how Maduro’s path has changed their approach to Venezuela. All are anonymous to allow them to speak more freely.

When asked how the food crisis would impact his decisions, a manager at a large hedge fund said, “It is a very dangerous game… Inside information is the key to playing the regime’s longevity. The decisions are made with a political framework we are not familiar with… So we are not involved… We might buy bonds opportunistically and hold them over the weekend, but never in ‘size’ and neither for the long haul.” This is the consensus opinion among investors that aren’t required to have a view due to their mandate to follow a benchmark.

Probably the most succinct statement on trading the country’s debt came from a trader at a Latam bank. “The thing about this regime is that you don’t know. You don’t know how long it will last, you don’t know who is in charge, you don’t know if the bonds will be worth 40, 20 or zero in a restructuring. You don’t even know how much money is still in the country or how much gold is in the vaults. What we do know is that the military is getting rich. Very rich.”

A US-based trader agreed that the drivers of prices are not foreign investors, but buyers from within the regime. “There aren’t any real money investors looking for a good yield. Locals trade quite actively… It is a way for the government to keep the generals happy. They are recycling dollars to the generals via these bonds… it is a good way for them to buy at 80 cents on the dollar get paid at 100, and bring the dollars back from offshore through the parallel market. It is one of the biggest money laundering schemes out there.”

A manager at a Latin family office offered a more measured outlook. For him, the moral question doesn’t apply because he thinks holding short-end Venny bonds in the current context is a bad investment to begin with. If the government keeps on stubbornly paying its debts until inevitably running out of cash, he believes that the humanitarian situation would get worse in the midst of a hard default, one on which there is no pre-negotiated restructuring of sovereign and PdVSA debt.

This return was made possible in large part by the government’s resilient willingness to pay regardless of the human consequences.

“If Venezuela defaults, people will starve in the streets,” he tells me. “The ‘starvation index’ will go up because what remains of the financial system will seize up, oil could be embargoed, and production could fall further. Things are going to get worse before they get better.” Not that these concerns are driving his decision-making: he just doesn’t think it’s a good investment, period.

The most stark comment on the morality of debt prioritization came from a trader at a US fund. He made clear that mutual fund managers can’t afford moral considerations: “They would be breaching their fiduciary duty to consider the moral issues […] and money walks —assets have been walking out of active funds and into index funds, and these bonds are represented in the index. They can’t afford not to own them.”

Another US-based trader agreed with the power of the benchmark. “Everyone who owns bonds there is an index follower. The moral/ethical argument against holding the bonds doesn’t exist because there are no discretionary investors left that are seeking a good yield. People own it only because they have to own it, and if they don’t it is a huge problem.”

This view was echoed by a Wall Street strategist. “From a cashflow perspective they have the capacity to continue to pay through the end of the year, and I suspect that (holders of the debt) are going to start bailing when it is too late. Anyone that has anything to do with an index gets burned by being underweight, so they inevitably come back. To completely step out of the position, you would have to compensate somehow. And there isn’t enough risk-adjusted yield to compensate elsewhere.”

Billions of dollars needed for food imports have been redirected to debt service, including roughly $17 billion in 2016 alone.

This strategist also laid out the “worst-case scenario”. “It’s tricky from a social perspective…because of the way they have painted themselves into a corner, it could be a Cuba or Zimbabwe-style default, where they stop paying and nothing happens for years.” Indeed, it is complicated to make the moral decision to avoid the debt because of the regime’s human rights abuses when it is far from clear what will happen in the short-term, say nothing of what happens after the country inevitably runs out of money.

You can call it Wall Street cynicism or moral ambivalence. Maybe you want to play the Gordon Gekko card and say it is an amoral lust for a bigger bonus.  But at the end of the day foreign investors see enough ambiguity about the social and economic reaction function of default (as well as to the extent that their actions really help the government to stay in power) to allow them to sleep at night, and most importantly, many are simply shadowing an index that mandates they own the bonds.

What’s the solution? Perhaps there are clients that wouldn’t want to be involved in owning Venezuela for political or philosophical reasons, especially public pension funds. But despite increased media attention over the past couple months, the US government has failed to use its economic influence with banks, public pension funds and asset managers to put more pressure on Maduro. The markets have callously gone ‘business-as-usual’ on Venezuela despite the precipitous collapse of the democratic institutions and, even though it may not be in the best interest of market efficiency (and it would certainly be a huuuge argument for the government to cling onto their conspiranoid claims of the American Empire’s ‘financial blockade’ against Venezuela), the question on whether the regulating bodies should step in and put some order in the ruckus is more pertinent than ever.

One way US government could turn up the heat in this area is sanctions, and this might be changing. Last week the US Treasury Department imposed sanctions on eight members of the Supreme Court as punishment for the annulment of the National Assembly. The sanctions on these individuals freeze US assets, prevent them from travelling to the US, and prevent US citizens from doing business with them. There is precedent for wider sanctions similar to what the US imposed after Russia invaded Crimea. Those sanctions caused a serious upheaval in Russian financial markets as asset managers sought to assure they were in compliance with the law (or to put it more delicately, they ran scared-shitless towards the exits like a stampede). The Russians had the resources to ride that out, but the Chavistas may not be so lucky.

Without a catalyst from the banks, index providers or US government, most EM investors are going to keep owning Venezuelan debt until the end, because their jobs depend on it. And it’s hard to get a fund manager to sell a bond when his paycheck depends on not selling it.

29 COMMENTS

  1. EXCELLENT article. I am not very sanguine as to morality issues playing into investment decisions, even in the primary market, unless your prospectus obligates you to do so. True, indexing current popularity is a big factor (how many fund managers were caught flat-footed with the Trump election, including Soros?). Financial capital management is about numbers, not moral right-and-wrong, generally (how many managers have missed out on the excellent returns of Phillip Morris?). However one sees it, as a fund manager, it’s about risk-reward, and at least keeping up with your peers, if you want to keep your job. And, yes, the U. S. should give Venezuelan debt the Russia/Crimea treatment, not to mention put sanctions on Venezuelan oil entering/being refined in the U. S. (and, that’s all part of the big risk, isn’t it?). By the way, we do have a Venny bond discretionary trader/holder on this Board–Venny Trader.

  2. The posting of import data prompts the following observation. From World Bank data, (Goods imports (BoP, current US$) and Food imports (% of merchandise imports)), we find that food imports accounted for 15.6% and 18.4% of Venezuela’s merchandise imports for 2012 and 2013, the final years before the 2014 crash in the price of oil. Doing the math, we find that Venezuela imported $10.3 and $10.5 billion of food in 2012 and 2013 respectively.

    The $64 questions are: how much food has Venezuela imported since them, and how do food imports compare with foreign exchange ripped off by the enchufados via the favored exchange rate scam?

    Regarding the GOv’s not sending out unfavorable data, consider the number of countries not reporting their food import data:
    Countries not reporting data on Food imports (% of merchandise imports)
    2012 63
    2013 65
    2014 67
    2015 85

    Most countries which posted food import data in 2012 and 2014 also posted data for 2014 and 2015. [The World Bank gets its data from governments or from the UN- which also gets data from governments..Venezuela was conscientious about supplying food import data when the oil price was high. Not so since the fall in the price of oil.

    The issue of food imports is germane, given that the GOV so far has been paying off bondholders- some of whom are foreign and some of whom are enchufados- while most Venezuelans have lost a lot of weight on the Maduro diet. Too bad Nicolas hasn’t followed the Maduro diet he has enforced on the country.

    http://data.worldbank.org/indicator/TM.VAL.FOOD.ZS.UN?locations=VE

  3. I don’t see anyone judging people holding US treasuries or dollars for that matter, and we can agree that the US govt has done quite a lot of unjustified and reckless damage out there (especially in Irak, Syria and Lybia) and had also been a business partner of one of the most barbarous regime in modern times (Saudi Barbaria). So let’s cut the crap about morality.

    But the biggest flaw in the argument about morality is not the fact that holding such bonds may be moral or not, but that paying bonds is immoral because it entails diverting money that could be used to pay for imports and subsidies. This is brain amputated populism at its best. It’s not just me saying it (go read it in Prodavinci for example), those dollars FIRST need to be produced before being used to pay subsidised food and medicine, which if you haven’t read the memo, don’t produce money. Corporate finance 101. Subsidising food and medicine is not a business and it’s not sustainable, which partially explains where the country is now.

    Moreover, showing that imports chart is very very misleading without putting some context around it. What is the right level of imports? Are you really going to say that imports between 2006-2014 were an ok amount of imports knowing all the CADIVI racket that was going on with people over-invoicing, siphoning money away and actually not bringing anything in to the country? And not only Chavistas by the way, also people from “decent” families and students from private universities. Instead of pointing fingers at bondholders, you should look for all those billions of dollars that all of those people, including bolichicos, took away. The country received more than $1tn. of revenues from oil income yet bond holders are to blame because they are holding $100bn. debt? Well that makes total sense.

    The bottom of this is that the topic is now being used as a political weapon. The opposition has been too incompetent to take the government down and therefore they prefer to sink the entire ship with them (and all the Venezuelans) on board than working towards a viable solution. As we have seen in articles written by other authors in this website and local analysts, it is not true that the government needs to ask for approval to enter into the new debt, so why does Borges keeps repeating the same thing over and over again? For political reasons. And it is reckless. Instead of having a conciliatory tone, he prefers to go to war over debts and concessions with China, Russia and bond holders (not very clever if you ask me). Why? Wouldn’t it be much simpler to get to power, advocate for macroeconomic and microeconomic reforms, wait for yields to decrease, auction more equity in the 50+ Faja projects, and then do a friendly restructuring (which might not even be needed at that point because may be able to rollover debt if the curve normalises)? Of course it would be, but that its not politically good for the opposition because they can’t find a way to take power without first bringing the ship down. And let’s not even get into the consequences of an actual default happening, as the person working in the family office highlighted. There is no upside to defaulting: CITGO will be gone, oil might be seized, etc. etc. How does that solve any of the problems? It doesn’t, it makes them worse. Why? Because again, the problem is not debt. Why does the opposition keep repeating time after time that the Govt doesn’t want to import food? Does anyone really think that the opposition would be in a much difference place should they take office tomorrow? Give me a break…But sure go ahead and push for default, it will only get worse.

    • Instead of pointing fingers at bondholders, you should look for all those billions of dollars that all of those people, including bolichicos, took away.
      What proportion of those bonds are held by bolichicos/ehchufados?

      • Impossible to tell Boludo Tejano…What I do know for a fact is that plenty of bond holders at the issuance of many of those bonds were regular Venezuelans (venezolanos de a pie), hence why the minimum amounts of many of those bonds are so low ($100 each as opposed to $100k). Many of them might have sold them but I know of plenty who haven’t, precisely because it has been one of the only mechanisms to preserve value and save in a stronger currency.

        Now if bolichicos, military, etc bought also bought bonds with ill-acquired money, the issue is not that the bonds exists, but that they stole money in the first place! Plus, if the government were to default, they would probably be the first ones to know beforehand (they would probably be tipped-off from the inside no?) so what is the point then? Only the country will lose in such a scenario. Who will recover all the assets lost in that case? The idiots from the opposition who don’t seem to know anything about finance either?

      • Wrong.

        1) CITGO is not gone as long as they keep current

        2) That is debatable. There have been various cases in the past where oil was seized from tankers (a HF seeking to attach assets of defaulted Congo for instance). Anything that is owned by PDVSA or that in court can proved to be ultimately owned by PDVSA may be seized.You can’t run an oil company like PDVSA with a default on its back. Question for you: why is it that Mexico defaulted, but not its oil company? Why is it that Brazil defaulted, but not its oil company? Recently we saw how the Russians attached a vessel in the Caribbean carrying Venezuelan oil, so what happened to the selling oil in the Venezuelan port thesis?

        • If any oil company fails to pay its commercial creditors these can take action to seize assets belonging to the creditor if they are available , for example if a tanker has been time chartered the vessels fuels are assummed to belong to the hirer and thus be seized by creditors of the latter , not the cargo mind you but the fuel tanks , but thats only if you have a time charter not when you have a voyage charter……which isnt all that common these days ….

        • 1) Even if they keep up, not much left there.
          2) The oil in the tanker must not have been sold yet. If it had, the owner would have raised hell.

      • Your are right in that oil cannot be seized where ownership over the crude has passed to a purchaser of venezuelan crude within Venezuela territory , which is a standard provision in all Venezuelan sale of oil agreements (and also in US law) , what can be seized is the ‘collectible’ on the price of that oil even where it is to be paid outside Venezuela ……of course payment can be routed thru jurisdictions where US courts decisions are not enforceable or require a judicial process to become enforceable.., its a complicated subject but Pdvsa would not be toothtless in a fight to protect its export income from seizure !! Pdvsa (unlike Congo) would take good care to hire some of the best US law firms to represent it in any future litigation ……!!

        • Thanks for your valuable insights Bill. Indeed, the collectible can be seized. But the way they have acted so far tells me that they are not willing to go down the fighting path though. Things can always change, of course…

      • Please…Let’s not get into the origin of the conflict in Syria. It’s the entire approach of the US (and its allies) towards the region for the past 20+ years that has been reckless. Iraq, Libya, Syria, they are all inextricably linked. Al-Qaeda, ISIS and Saudi Arabia…It’s all connected. If you can’t see that, especially in the current environment, then you are blind. But that is not the matter we are debating here.

  4. Wouldn’t be more interesting, more profitable and morally correct to come up with a Venezuelan Operation Freedom Bond?
    These bonds would finance an armed militia group and the resistance to finally kick Maduro and his cronies out and in jail.
    It would paid high dividends secured with oil reserves.
    I think many Venezuelans would back up such initiative.
    A group in Miami could start it or the National Assembly to give it more legitimacy.
    Bonds have been used before to finance wars, so why not?

    • Toro Volt, this has occurred in the past. A very notorious case took place during the US civil war, when the south issued bonds backed by the cotton production. It is a fascinating story. Long story short, the holders of those bonds lost some of their money because the South lost the war and the North never recognised their outstanding bonds (extremely short summary of what really happened).

      But your proposition is highly unrealistic.

  5. Without going any deeper into the morality question, the repetition of the idea that bond traders are forced to trade in Venezuelan bonds to keep their jobs sounds a lot like, “I was just following orders.”

    • They aren’t forced, it’s a game called risk-reward, where morality doesn’t play a part; if Venezuelan existing bonds drop in price 50% from here, because of lack of demand, people in Venezuela will still lack the same amount of food/medicines/etc. It’s the Castro-Communist Venezuelan Govt. that is continuing to service the bonds (interest/amortization of capital), in order not to have its oil tankers/shipments seized by defaulted creditors, which would cause for them a Govt.-tumbling even greater lack of food/medicines/etc., not to mention insufficient gravy for the corrupt Venezuelan military hierarchy, that is the problem. What’s happening in Venezuela is a SA unprecedented human tragedy disgrace: the countless deaths by hunger/lack of medicines-health care/disease epidemics (min. 240 THOUSAND estimated malaria cases this year); and; especially, the slaughter of 60 (so far)/illegal injuring- jailing-torture of many hundreds/and illegal detaining of thousands of innocent young marchers, not to mention the firing of tear gas into civilian buildings. All those responsible–and, there are many–must be made to pay!

      • Indeed. And I don’t think wishing for an even greater lack of food/medicines/etc. is the way to go. It is more of the same destructive “paro petrolero” mindset that doesn’t get you anywhere. If and when the opposition takes power, they just need to have a relatively coherent plan and yields will decrease and the market will open up. At that point in time, having paid down debts would put them at a more advantageous position than not having done so. It is the nation’s credibility, which transcends any government. Becoming a nation of defaulters will only harm any government in the future.

        With reward to risk/reward, I conclude with an aphorism:

        “Distributive justice isn’t taking from a risk taker who earned honorably, it is
        keeping his probability of losing it very high”

        • Fuck you and this shit.

          Defaulting is precisely you and the rest of you fucking vultures LOSING your money in the bet you made that Maduro will pay you even if it means starving and killing Venezuela. The “credibility” of paying when people starve only works to insulate you from that risk.

          You and your lot didnt take any risk “honorably”. You are just part of the whole machinery of arbitrage in Venezuela AND in Wall Street. Meanwhile, people honestly working all their lives are seeing everything, from their money to their health to their democracy to their lifes disappear.

          You are a disgrace.

        • I believe the Regime will only release its tentacles if maximum pressure is applied: escalating street protests/effective general strike/U. S. economic sanctions (and, if necessary, military intervention). If economic sanctions cause a default, the increased short-term pain for the Ven. population until the Govt. falls will be far less than the much greater.longer-term pain if the Govt. stays on. This isn’t about the Oppo “winning”, or not. It’s about democracy winning in a showcase country on the South American continent. Make no mistake about it–the U. S., and Venezuela’s SA neighbors, cannot/will not allow the installation of a Castro-Communist dictatorship on continental SA soil!

  6. “most importantly, many are simply shadowing an index that mandates they own the bonds”

    Yes, and how could it be any different? I doubt that most of those people know what’s going on in Venezuela, one of the most depressing aspects of American society, in my opinion, is their lack of curiosity/understanding about the rest of the world, be it on a political level or culturally speaking.

    They have such a developed and rich society, yet just around 3% of them travel abroad every year. Their most watched TV news channels don’t talk much about the rest of the world either, but show an “around the world in 60 seconds” segment.

    How can you feel morally guilty about something that you don’t even know it is happening?

    • As someone that has been sparsely in touch with foreign portfolio managers involved with Venny bonds, I can assure you they understand quite well what’s going on in here (sometimes, perhaps even better than some locals).

      Bottom line, the issue is that most managers are bound to the benchmark, which at current weights implies a guideline of 4-5% of their money invested in Vennies. If you’re underweight and Maduro keeps on paying (2016 scenario), this will show up negatively in your performance. It’s a tough choice between fulfilling your investment mandate and being morally solvent, in my view…

  7. Would you believe Venezuela isn’t the only FUBAR nation in the world? I am a passive USA investor with about 20% of my portfolio in foreign and EM funds. I would like to do the morally correct thing with my money.

    Please, will someone more world-wise than me rank the countries, starting with the LFU (least fucked up) to the MFU (most fucked up), and then draw a line through the list somewhere, to indicate which countries it is morally correct to invest in and which ones it is not? Or should I hold them all to a US, Canadian, European standard, and deprive all emerging markets of my share of investment?

  8. What happens if fund managers who continue to be index weight going into a restructuring because bond indices continue to have these bonds? Is there a downside in being index weight if your base case is a near term default/bond restructuring in Venny/Pdvsa bonds?

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