Bullish Chavez Bond Trade Has TCW’s Foley Beating Emerging Peers
In June 2010, when Venezuela’s economy was mired in recession, inflation was accelerating and President Hugo Chavez was shutting currency trading, Penny Foley scooped up bonds of state-run Petroleos de Venezuela SA as they sank below 60 cents on the dollar.
While other bondholders sold, Foley, who oversees TCW Group Inc.’s Emerging Markets Income Fund (TGEIX), realized these actions would do little to hurt the oil exporter’s ability to repay debt, especially as global crude prices climbed. The bonds due in 2014 have returned 73 percent, more than double the average gain in JPMorgan Chase & Co.’s benchmark emerging-market debt index.
The investment helped the fund managed by Foley and David Robbins return 16.3 percent annually over the past three years, beating 96 percent of peers, according to data compiled by Bloomberg. Investing in the company known as PDVSA, Mexico’s peso debt and high-yielding bonds of Chinese developers helped the fund increase assets to $4.1 billion from about $150 million in 2009, making it the fourth-fastest growing emerging-market debt mutual fund in the U.S, Bloomberg data show.
“The best trades are those where the perception of the risk is greater than reality,” Foley, 66, said in a May 2 interview in her office in midtown Manhattan.
Foley, who began her investment career 45 years ago, and Robbins, 51, started managing the fund at Los Angeles-based TCW in December 2009 after more than 40 of its fixed-income professionals left to join former investment chief Jeffrey Gundlach at DoubleLine Capital LP.
The managers, who had previously run TCW’s Worldwide Opportunities Fund, added more local-currency debt to take advantage of the higher yields and potential currency appreciation. They increased domestic bond holdings to as high as 25 percent of the fund’s assets last year, before paring them back to 9 percent in May. The fund held no local debt at the end of 2009.
They have also bought more higher-yielding securities, including PDVSA bonds for the first time since at least 2006, according to Robbins. Venezuela is rated B+ at Standard & Poor’s, four steps below investment grade.
While Chavez, a former paratrooper who led a failed coup in 1992 before winning election six years later, drove away foreign investment by taking over oil and cement industries and imposing capital controls, he has honored debt payments. Yields on the PDVSA bonds due in 2014 have dropped to 11.7 percent from 20.3 percent at the end of June 2010.
The managers had used a similar strategy at Worldwide Opportunities, which TCW says has returned an average 17.4 percent annually since Foley started the fund in 1987 to invest in emerging-market stocks and bonds.
When Argentine President Cristina Fernandez de Kirchner announced the nationalization of pension funds in October 2008, the country’s benchmark dollar bonds maturing in 2015 tumbled to 18 cents on speculation the move signaled the government was running out of cash amid the global financial crisis.
Foley and Robbins reasoned these moves would give the government access to enough financing to remain out of capital markets for at least two years. In January 2009, they bought the benchmark dollar bonds at 31 cents for Worldwide Opportunities. In May 2010, the managers cashed out at an average of 76 cents.
“We are more comfortable buying sovereigns and credits that we think are in the early stage of a recovery,” said Robbins.
The strategy increased volatility at the fixed-income fund. The so-called standard deviation of return, a measure of price swings, was 7.7 percent annually over the past two years, compared with 5.9 percent for JPMorgan’s EMBI Global Diversified Index. The fund’s adjusted return as measured by the Sharpe Ratio trailed the index the past two years, a reversal of its performance between 2008 and 2009, according to data compiled by Bloomberg.
Miriam Sjoblom, an analyst with Morningstar Inc. in Chicago, said she wants to see if Foley and Robbins can keep delivering superior returns as markets shift before considering a change on their fund’s rating from neutral.
The fund returned 1.9 percent last year, trailing the 7.4 percent gain in JPMorgan’s EMBI Global Diversified Index, as the deepening European debt crisis caused a selloff in emerging- market currencies and higher-yielding assets.
The Mexican peso and the bonds of Chinese home developer Evergrande Real Estate Group Inc. have since recovered, helping the fund gain 12.6 percent this year and beat 95 percent of its competitors. The three-year return of 16.3 percent is 2.9 percentage points higher than the JPMorgan index.
“We tend to underperform in significant risk-off periods,” said Foley. “If you stay the course, however, the total return approach tends to outperform.”
A marathon runner, Foley splits her time between offices in Los Angeles and New York. When in California, she starts her day at 4:30 a.m.
Away from the markets, she serves as board chairwoman of Trickle Up, a group that provides business training and seed capital grants to poor people in countries from India to Guatemala. She’s also a board member of Kids In Sports in Los Angeles, which provides after-school sports programs. In 2008, she posted a personal record at the New York City Marathon, completing the race in 4 hours, 25 minutes.
“Penny is the most enthusiastic 66-year-old that I know, whether it’s professionally or athletically,” said Benjamin Segal, who manages $9 billion assets at Neuberger Berman Group LLC in New York and is a board member of Trickle Up.
Growing up in Hazleton, Pennsylvania, Foley studied economics at Hollins College, now Hollins University, in Roanoke, Virginia. She started her career in 1967 as an associate at Lehman Brothers, working on U.S. bond and stock offerings and mergers and acquisitions.
In 1974, she landed a job at a newly established investment banking operation for Latin America at Citibank, now part of Citigroup Inc. She was responsible for arranging syndicated loans, euro bonds and project financing in the so-called “lesser developed countries” or LDCs.
“As a woman in business in the early ’70s, you had to take some risks,” said Foley. “Opportunities were not immense.”
Foley left Citibank in 1985 for Drexel Burnham Lambert, the New York-based investment bank that pioneered junk bonds, to start the LDC debt trading business. Foley and her colleagues raised $170 million to set up the DBL Americas Development Association LP in 1987 to invest in developing-nation assets.
Two years later, the U.S. Treasury Secretary Nicholas Brady announced a plan to allow banks to convert their bad loans to developing countries into tradable debt instruments. The so- called Brady bonds helped transform the defaulted loans into more liquid securities. Debt trading volume increased from $734 billion in 1992, to $6.5 trillion in 2011, according to EMTA, a New-York based association for emerging debt market.
When Drexel collapsed in 1990, Robert Day, chairman and founder of TCW Group who was an investor in the DBL Americas, bought the fund and named it TCW Worldwide Opportunities Fund. Foley stayed on.
Over the past two decades, Foley rode through the Mexican peso devaluation in 1994, Asian financial crisis in 1997 and the Argentine default in 2001. She lost money on Russian bonds after the country defaulted in 1998, while profiting from distressed company debt in Argentina following the country’s 2001 crisis, she said.
Robbins joined Foley at TCW in 2000 after leading emerging- market debt trading at Morgan Stanley and Lehman Brothers for a combined 17 years. The two are assisted by Javier Segovia, who leads a group of three credit-research analysts for the bond fund.
For now, the fund is trimming risk exposure, favoring lower-volatility dollar-denominated assets, as the European debt crisis cuts into global economic growth, according to Foley. Its cash position increased to 10 percent of its total assets at the end of May, from 3 percent in September, while holdings of local-currency bond reduced by half to 9 percent, according to TCW.
It has cut the holdings of Venezuelan and Argentine dollar bonds as inflation of more than 20 percent makes the countries more vulnerable amid the slowdown, Foley said.
The fund still has more Venezuelan dollar bonds than the benchmark model would suggest. These securities yield an average 12 percent, compared with less than 1.5 percent on 10-year Treasuries, according to JPMorgan.
PDVSA’s bonds accounted for 4.6 percent of the fund’s assets as its top holding as of May, according to Foley. It also owns Indonesian, Russian and Croatian government debt as well as bonds of Itau Unibanco Holding SA, Latin America’s largest lender by market value, and VTB Capital, a Russian investment bank.
“If you know the credits, if you know the fundamentals, once the risk-off trade stops, you will see a tremendous rally,” said Robbins. “Our view is that if you wait, you miss the bulk of the rally.”
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