Photographer: Meridith Kohut/Bloomberg

Hedge Fund Plows Half Its Money Into Venezuela Bond and Wins Big

Updated on
  • Knossos reaped 12% return when Venezuela paid bonds Feb. 26
  • Venezuela has the highest default probability in the world

When Carmelo Haddad and Francisco Ghersi invested half their hedge fund’s money into a soon-to-mature Venezuela bond in mid-January, only two outcomes were possible: the trade could go horribly wrong or it could pay off fabulously.

Haddad, left, and Ghershi

Photographer: Wilfredo Riera/Bloomberg

After all, the odds that Venezuela would make the Feb. 26 payment were far from good. Racked by political turmoil, the economy was on the brink of collapse as slumping oil prices deprived the government of much-needed income. At the time, traders put the chance Venezuela would default in the next 12 months at 80 percent -- by far the highest probability in the world.

Venezuela went on to make the $1.5 billion payment, handing the founders of Knossos Asset Management a return of 12 percent in just 45 days -- or an excess of 150 percent on an annualized basis.

“Every time a bond dies, people have their own war story,” said Haddad, who together with fellow Caracas native Ghersi oversees the fund’s $40 million in assets. “We had our ups and downs. It was painful with the rumors, but we were comfortable with the trade or we wouldn’t have bet that much on it.”

The pair has been reaping outsize windfalls on Venezuela bonds from a windowless den in a Caracas shopping mall since 2011, when they raised $1.5 million with the help of friends and family to found Knossos. The fund, which invests all its money in Venezuela assets, returned 29 percent last year, when junk-rated developing nation debt gained just 6.7 percent.

Since its inception, it has outperformed the average gain in emerging markets every year except one. Last week, Knossos hired Daniel Urdaneta, a Banco Caribe Curacao trader, as its fifth full-time employee, signaling the hedge fund’s aim to broaden its investor base in North America and Europe.

Haddad, 40, and Ghersi, 48, say their vast network of local contacts helps them make more informed investing decisions than overseas fund managers, who are often deterred by the volatility in Venezuela’s bond market.

“We understand the news much better and how to think local,” said Ghersi, who worked in the treasury at bank BanCaribe in Caracas before co-founding Knossos. “We also know how they think on Wall Street and how they act before the news.”

Haddad, who graduated with an economics degree from Indiana University in 1997, worked as a currency trader at BBO Financial Services before helping start the fund. Given the small size of Venezuela’s local finance community, Haddad and Ghersi say they became acquainted before starting Knossos. They also belonged to the same gym. Ghersi has completed an Ironman triathlon in Austria, while Haddad has run the New York City Marathon.

Haddad and Ghersi are now buying bonds sold by Venezuela’s state-owned oil company that mature in October. The notes have already gained 10 percent to 76.50 cents on the dollar since Venezuela repaid its sovereign bonds at the end of February. Knossos has invested more than 10 percent of its assets in the securities from Petroleos de Venezuela, the crude producer known as PDVSA.

To Lucas Toro, a fixed-income strategist at Helm Securities, Knossos’s investments are way too risky given Venezuela’s precarious state.

“If the fund makes it through October, it’s the trade of the year,” he said from Bogota.

Toro estimates the probability that PDVSA will make the payment in October is about 35 percent.

It’s easy to see why Toro is so pessimistic. In January, the central bank said the South American economy shrank 7.1 percent in the third quarter from a year earlier while its inflation rate soared to 141.5 percent. Venezuela depends on oil, which has tumbled 63 percent in the past two years, for almost all of its export revenue. Meanwhile, President Nicolas Maduro, the late Hugo Chavez’s handpicked successor, is facing increasing opposition from Congress, making the passage of desperately needed economic reforms unlikely.

For Venezuelans, all that has meant a surge in violent crime and ever-worsening shortages of everything from milk to medicine.

But Haddad and Ghersi are well aware of how dicey things are in their country.

“We suffer day to day the consequences of the economic problems,” Haddad said. “Last week, we didn’t have electricity a couple of times. We had to climb up and down nine flights of stairs. They’re beginning to ration electricity. There’s insecurity. Nobody that lives here can go out at night and feel safe.”

Still, they’re betting they can make enough sense of this chaos to profit from it. Ghersi points out that the fund’s logo is an an adaptation of the famous Bull-Leaping Fresco that once adorned the ancient Palace of Knossos in Crete, Greece.

“We represent the rider of the bull, trying to dominate and control it,” he said.