Fixed Income

EMD Relative weekly notes

Week Ending November 3, 2017

11/15/2017

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

Venezuela finally announced late this week that it would seek to restructure its debt. Given that a restructuring will likely be impossible with US sanctions, which preclude investors from buying new debt from Venezuela, we (and the market) anticipate this will result in a near-term default. Bonds that mature in the next year or so are down in price by some 50% as of this writing.

We earlier in this space called the Venezuela case an interesting exercise in behavioral finance and in our opinion it remains so. The largest holder of the country's debt today is quoted as saying that the big price drop "might be a big opportunity". Another investor appeared on Bloomberg TV to declare that "Venezuela is the best profit-making opportunity in EM".

Of course, there might occur an odd set of circumstances by which both of these investors could be correct. But it would have to be, by definition, unusual. That is because no country has ever defaulted while under US sanctions that would essentially legally preclude the participation of an overwhelming percentage of investors. Nor has any country in our recollection ever announced a payment while simultaneously saying that further payments would occur only under a refinancing or restructuring regime.

This all occurs in a country where reliable economic data is nearly non-existent, but where we know hyperinflation has taken hold and the IMF estimates GDP has fallen by 12% in two years. Total debt levels can only be guessed at because bilateral liabilities to Russia and China and their repayment schedules can only be guess-timated. Arrears to suppliers are similarly only approximated, and a series of potential international court judgements against the country are pending. Oil production is steadily declining, and anecdotal data regarding oil shipments being held up awaiting payment have spoken to steadily increasing stress.

So on what basis can an investment decision be made? Nothing more than a hope that somehow the country will pay as they have done in the past, it appears, and a gamble that interest payments--far above that of the rest of the asset class given the high probability of default--would continue.

Now that that specious investment case has been stretched to its limit if not finally snapped, we suggest observers and EMD participants and potential investors treat the strange story of Venezuela not as a cautionary tale on the asset class but as a textbook case for analyzing how risk is processed by investment managers entrusted with capital. We believe the latter will prove to be a far more fruitful way to think.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.