A few months ago, I wrote that Venezuela was a terrible place to invest.
But since then, an index that reflects the price of U.S. dollar-denominated Venezuelan sovereign bonds – the only way portfolio investors can put money into the country – is up nearly 13 percent. By comparison, a general emerging markets bond index is up just 2 percent.
So have things gotten better in Venezuela over the past few months? Does this increase in Venezuelan sovereign debt reflect an improved ability to repay its obligations?
No… just the opposite.
A few weeks ago, the New York Times called it a country “on the brink of collapse”. Inflation this year may be as high as 2,200 percent. The IMF says Venezuela’s economy will shrink by 7.4 percent – which will bring the total decline to 30 percent since 2013.
Goldman Sachs steps in
But a few days ago, Venezuela was in the news – and not for the riots, food shortages or protests that have pushed the country towards failed-state status.
“Goldman Buys $2.8 Billion Worth of Venezuelan Bonds, and an Uproar Begins,” blazed a headline in Tuesday’s New York Times. The story read:
[Venezuela] is in near revolt and has barely enough ready cash to feed its people, much less pay the billions of dollars in debt that the government owes to its foreign lenders.
Yet bonds issued by Venezuela’s national oil company, Petróleos de Venezuela, or Pdvsa, have attracted some of the world’s most sophisticated investors.
… Goldman Sachs’ decision to snap up $2.8 billion worth of Pdvsa bonds maturing in 2022, at a 70 percent discount to the market price, has struck a nerve.
(To clarify: Goldman Sachs didn’t really buy the bonds at a 70 percent discount to the market price. It bought the bonds at market price – which is a 70 percent discount to the par value of the bond. You can learn more about how bonds work by reading our piece about the basics of bonds.)
So why would one of the world’s most respected – and occasionally disparaged – investment banks buy bonds issued by the government of a failed state that’s been on the edge of implosion for years? From the New York Times again:
… the transaction highlights the extent to which investors are willing to take on increasing levels of political and economic risk as they seek high-yielding investments when interest rates still hover near zero.
… Driving the bet, analysts say, is a view that emerging market economies, regardless of their political and economic challenges, are no longer willing to face the wrath of bond investors by defaulting on their debts.
… As investors see it, if you can buy a Pdvsa bond at 30 cents on the dollar, which also provides a double-digit yield, even if this government — or another for that matter — has to default, the gains made on the investment would be enough to overcome any loss.
It’s different for bonds
Two months ago, I wrote that investing in Venezuela was taking contrarian investment – that is, investing in out-of-favour markets – to an extreme.
… the real problem is this: What if all the contrarians are lining up together? Then there’s no one else to sell to. And eventually, reality takes over. I don’t know if this will happen in Venezuela tomorrow, or next month, or next year. Or perhaps the situation will actually improve, and these investors will be vindicated.
The thing is, investing in bonds is a totally different game from investing in stocks. The value of a company – its share price – is infinitely debatable. You can look at the P/E ratio, you can analyse the sector and the industry, you can look at cash flows… and on any given day, investors (the market) “vote” on the value of a company in the form of a market price.
It’s different with bonds, though. A bond is – simply put – a promise to pay money back. There are different ways to calculate the chances that a borrower will pay back bondholders.
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In Venezuela’s case, the country is the borrower. And it’s running out of U.S. dollars that it needs to repay the bond (as shown in the graph below). Soon it won’t have much money to pay bondholders – so it will need to borrow again. So the value of the bond will probably drop.
(Note: we’re talking about the bonds of Venezuela’s national oil company, and not the government itself. But in this case, the two are pretty much the same.)
Recovery analysis – and a price for everything
But that’s not necessarily a reason not to buy…
In early April, a very smart friend and former colleague who runs her own hedge fund read my piece and told me that I was missing the point. She wrote:
Whether and when [a change in government] occurs is a debate, of course. But when looking at what is the cheapest sovereign credit on earth one cannot conclude that you lose money in the trade without a proper recovery analysis and understanding of the political economy.
That’s another way of saying that there’s a price for everything. And if the bond of a corrupt, edge-of-disaster failed state is cheap enough – taking into account the chances that Venezuela could default (and, if it did, how much bondholders would recover) – then it could still be a good investment.
And Goldman Sachs and other investors are, says the New York Times, “betting that the government will use its dwindling supply of dollars to pay bondholders instead of importing food and medicine for its people.” That’s because the Venezuelan government knows that it will need to borrow again – and that will be impossible if it doesn’t pay bondholders now.
Goldman Sachs isn’t getting in early to the game, as shown in the graph below. Venezuela’s bonds have been on a tear, as more investors have calculated that the country will – at all costs – repay its bondholders.
But… as conditions grow more dire and as international reserves continue to fall, will it still pay?
Goldman Sachs clearly thinks it will. Maybe it’s neither crazy nor stupid. In any case, I think that – for individual investors – there are a lot of investment destinations that are a lot more safe and a lot more compelling. (Early next week we’ll be telling you about a few… closer to home.)