Chavez’s 681% Returns Mean Socialism Buoys Goldman: Andes Credit
Since taking office in 1999, Hugo Chavez has spread his socialist revolution in Venezuela by seizing more than 1,000 companies. For bondholders that stuck by him, he’s also delivered returns that are double the emerging- market average.
The 681 percent advance, equal to 14.7 percent annually, has enriched investors from OppenheimerFunds Inc. to Goldman Sachs Asset Management LP that counted on Chavez’s willingness to siphon the country’s oil wealth to pay its creditors in the face of start-stop growth and falling reserves. While his policies drove away enough investors to keep Venezuela’s borrowing costs over 12 percent on average during his tenure, or 4 percentage points higher than those of developing nations, he’s never missed a bond payment.
“This is a really great high-income and high-total-return investment for your portfolio,” said Sara Zervos, an emerging- market debt manager at New York-based OppenheimerFunds, which oversees $176 billion in assets and has invested in Venezuelan notes for more than a decade. “Chavez hasn’t done a lot of good for his country, but he has the objective to service the bonds. Our interests are aligned.”
Now, as the 58-year-old leader battles cancer, the nation’s outsized returns may be nearing an end. While Venezuela’s benchmark bonds have climbed to a five-year high since Chavez said on Dec. 8 that he needed more surgery, they’re unlikely to replicate the gains they’ve posted in the past decade once the rally drives yields down closer in line with regional peers, according to Russell Dallen, the head trader at Caracas Capital Markets.
Chavez’s deteriorating health has triggered a 41 percent bond gain in the past year on speculation that a new regime will retreat from policies that curtailed oil production in the country that holds the world’s largest reserves.
Chavez missed the inauguration for his third six-year term on Jan. 10 as he recovered from surgery to treat an undisclosed type of cancer. Information Minister Ernesto Villegas told reporters on Jan. 27 that the president is healthy enough to make economic policy decisions.
A former paratrooper and an ally of former Cuban President Fidel Castro, Chavez has nationalized farms and energy companies, imposed price caps on products such as toothpaste and toilet paper and championed companies where workers participate in decision-making. He has devalued the bolivar four times since imposing currency controls in 2003, shut down more than 50 foreign-exchange brokerages in 2010 and threatened to jail people who trade in the black market.
The policies have led to shortages of everything from electricity to sugar and beef, fueled the world’s third-highest inflation rate and inflated Venezuelan bond yields. That’s rewarded investors willing to buy the debt at discounted prices.
Interest-rate payments on Venezuelan bonds exceeded price gains by 1.4 times since 1999, versus 0.3 for Brazilian bonds and 1.09 for Mexican securities, according to data compiled by Bank of America Corp.
Chavez has made good on debt payments as crude oil prices surged to $97 a barrel from $12 in 1998. The government will earn about $81 billion from oil exports this year, almost 10 times the amount of interest-rate payments and debt redemptions from the government and state-owned oil company Petroleos de Venezuela SA, known as PDVSA, according to Citigroup Inc.
At 22 percent of gross domestic product, Venezuela’s net government debt is lower than the median level of 36 percent among similar-rated countries, according to Standard & Poor’s.
“While the story has been deteriorating, Venezuela will continue to pay their debt,” Sam Finkelstein, an emerging- market bond manager at Goldman Sachs Asset Management in New York, said in a telephone interview on Jan. 25. “The situation will have to be much tighter, more fragile for a default to be likely.”
Finkelstein has been an investor in Venezuelan bonds over the past 15 years.
Venezuelan bonds accounted for about 6.7 percent of the holdings of Goldman Sachs’s $2.9 billion Growth & Emerging Markets Debt Fund (GSEMKDP), the third-biggest investment, according to data compiled by Bloomberg. The fund returned 12.8 percent over the past three years, outperforming 90 percent of its peers.
While calling debt the tool used by the U.S. “empire” to exploit Venezuela, Chavez honored his obligations even after a three-month nationwide strike in 2003 all but shut down the country’s oil industry and caused the economy to shrink 7.6 percent that year. He made an interest payment on a bond that is tied to oil prices in 2005 after a four-month delay prompted S&P to temporally downgrade Venezuela’s credit rating to selective default.
Chavez paid off the debt because non-payment would lead creditors to seize Venezuelan oil shipments, which supply half of the government’s revenue, according to Simon Nocera, a former economist at the International Monetary Fund. Bond investors can also freeze Venezuelan assets overseas, including refineries and gas stations of Citgo Petroleum Corp., a subsidiary of PDVSA, he said.
“Chavez makes noise, but he will never come out and say: ‘We are going to restructure our bonds,’” Nocera, now chief investment officer at Lumen Advisors LLC, said in a telephone interview from San Francisco on Jan. 23. “He knows if he does, he won’t sell the only product that allows him to survive. There’s no reason to be scared.”
The Finance Ministry declined to comment on the country’s bond performance in an e-mailed response to questions.
Investors have had to endure swings in the value of Venezuela’s bonds to reap their gains. Their yield relative to Treasuries touched an all-time low of 163 basis points, or 1.63 percentage points, in May 2006, before spiking to 1,887 in December 2008. Investors demand an extra yield of 722 basis points to hold Venezuelan bonds instead of Treasuries yesterday, versus 319 basis points for Sri Lanka and 307 for Zambia.
While the average yields on Venezuelan bonds have fallen to the lowest since January 2008, their current 9.04 percent level is still double the emerging-market average of 4.49 percent, according to JPMorgan Chase & Co. At 605 basis points yesterday, the country’s five-year credit-default swaps suggest a 35 percent chance that Venezuela will default by 2018, according to data compiled by Bloomberg.
“The spreads reflect the risk existing in the Venezuelan economy, and the perception of that risk is real,” Francisco Rodriguez-Caballero, an economist at Bank of America, said in a telephone interview on Jan. 23. “You are always happy when you win, but that doesn’t mean it’s a bet that you should feel comfortable making.”
Venezuela’s credit rating of B+ at S&P is four levels below investment grade and on a par with those of Zambia and Sri Lanka. Brazil, which was ranked the same as Venezuela 14 years ago, has been upgraded five steps to BBB.
Goldman Sachs’s Finkelstein said he still holds a “modest” overweight position in Venezuelan bonds as the economy is likely to improve after Chavez relinquishes power.
The extra yield investors demand to own Venezuela bonds instead of Treasuries will narrow to about 500 basis points should the opposition win presidential elections in the post- Chavez era, leaving them at levels similar to those of Ukraine, he said. Venezuelan bonds traded at a spread of 722 basis points over Treasuries at 10:29 a.m. in New York, according to JPMorgan’s EMBI Global index.
The constitution states that elections must be held within 30 days should Chavez step down or die. Vice President Nicolas Maduro, a Chavez ally, is running the government in his absence. Henrique Capriles Radonski, who lost to Chavez in October, leads the opposition party Primero Justicia.
“Investors are expecting a regime change,” Finkelstein said. “The new government will be more pragmatic and less idealist, and bondholders can benefit.”
Unlike Venezuela, other Latin American countries including Brazil, Panama and Peru rewarded bondholders with gains fueled by economic growth, slowing inflation and surging foreign reserves. Brazilian bonds returned 662 percent during the past 14 years.
The rally has squeezed most of the gains out of Brazilian bonds, leaving Venezuelan securities as a more attractive option, according to Oppenheimer’s Zervos.
“For Brazil, we just don’t think there’s a lot of upside,” Zervos said. “Chavez squandered a lot of money, but there’s still significant cushion and the ability to pay is still there. The spreads can definitely compress more.”