Caracas Chronicles

A couple  ofweeks ago Emiliana came up with a hilarious mental picture while casually talking paja on our Whatsapp group. ‘Tenedores de Bonos’ (bondholders in Spanish) can be read literally as Bond Forks. Ever since, we haven’t been able to picture the holders of Venny debt as more than giant pieces of cutlery, grappling at our national treasures.

After the giggling died down, we were left with the uneasy realization that we didn’t have a very clear picture of who exactly these bondholders are.

So here’s our attempt at categorizing the market of Venezuela and PDVSA bonds by their main tenedores. They go from the multibillion giants of the financial industry, such as PIMCO and Blackrock, through the small-time doñitas who bought some Petrobonos last decade with their Bolivar savings. Every group has different reasons to choose Venny as their investment alternative, and hence different ways to cope with the fact that a credit event in the foreseeable future isn’t at all out of the question.

Now look, trying to ID which groups hold how much in terms of bonds is an exercise in Voodoo Finance. Except for most of Real Money, there are no reporting requirements —and so, no publicly available holding figures— for how much each of the other groups holds. Custodians such as Euroclear and Clearstream might know the real picture, but they’re contractually barred from disclosing client information. Please do not take these numbers as more than a rough estimate of the relative importance of each group, based on market activity seen by each of these investor classes throughout the last two years.

It’s my guess, basically: you should feel free to fight with me about it in comments.

I. Institutional investors: “Real Money”

Real Money is the name given by Wall Street to large-scale investors such as pension funds, mutual funds, investment trusts and ETFs. They are the behemoths of the the industry: globally-oriented, passive managers of the world’s savings. This is where big Teachers Unions put their pension plans, where big institutional players go in for the long run.

Their money is indeed real in a key sense: these funds are easily the biggest market-movers, especially on long-term price movements; this is mainly because their positions are so big, they sometimes take several weeks to get in or out of a trade. Under the legal framework used by most of these companies to operate (based in the US, Japan and European countries), they are bound by law to publicly and periodically disclose their holdings.

Their idea of investing on Venezuela is straightforward: as long as market-standard indexes such as the JP Morgan EMBI (Emerging Markets Bond Index) have Venezuela in its weightings, passive investors will ‘track’ the index, and position accordingly.

What happens to them if VENZ defaults? Besides a muted effect on the Fund’s value (VENZ represents about 3% of the EMBI in its current weightings), and subsequent forced selling on those entities that are forbidden from holding defaulted debt, not much. This is mainly because the bulk of the damage was done in 2014, when bond prices cratered alongside the -60% crash in crude oil prices.

Market share: 20-25%

Biggest names: Allianz (PIMCO), Blackrock, T. Rowe Price, Franklin Templeton, Vanguard, Fidelity, sovereign wealth funds.

II. Hedge Funds

Make no mistake: this is not the Teacher’s Federation of Quebec pension fund we are talking about. Think about 3-billion-dollar-a-year kingpins gambling with their (also billionaire) friends’ money. These managers are categorized in the literature as large-scale ‘active investors’, which are allowed by their mandates to hold long, short or leveraged positions in VENZ bonds. These aren’t vanilla investors that only care about clipping the coupons: these guys aim to make money when the bonds go up, down, sideways, backwards.. As they are slightly smaller than RM, they don’t move markets as much. Another thing they got in favor: Hedge Fund holdings are usually private, thus being able to hold ‘stealth’ relatively large positions.

Their thesis on Venezuela was the reason they started to get really interested (as in, vultures circling over a dying animal) in 2015: bond prices are so low, and yields are so high, that they argue buying on the ‘holdout’ issues – those without the legal provisions that allow for a negotiated restructuring – and holding while waiting for the end-game, is a killer trade. So far, time has proved them right.

What happens to them if VENZ defaults? They are mindful of the event’s likelihood of happening; that’s why they buy the paper with no collective action clauses and a weak pari passu clause (VENZ 18/27 and long-end PDVSA), and would likely become holdouts in the event of a default, seeking full repayment from the Oil Company and/or the Sovereign through all legal means at hand. These guys don’t play carritos: market gossip says some of these funds have already prepared their line-up of sovereign default lawyers. Los propios buitres.

Market share: 15-20%

Biggest names: Elliott, Ashmore, Emso, Gramercy, Stone Harbor, Autonomy, Marathon, Brevan Howard.

III. Swiss-based “Private Banks” (PBs)

Does talking about Venezuela and Swiss Private Banks in the same sentence ring a bell to you? PBs act as broker-dealers for their base of high net worth individual investors and ‘wealth management’ accounts. They are brutally efficient as brokers: through unparalleled technology and market access, and a rigorous system of checking at least three market price quotes before executing a trade, they embody swiss-level quality in trade execution. Their flows come from fast and well-informed money, some of that belonging to venezuelan individuals.

Investments seen through PBs are pure Momentum plays: these types tend to pile in on short-end bonds on the good days, and are the heaviest sellers on the not-so-good ones. ‘The Swiss’ are always seen as being the first to buy on the beginning of a rally and sell at first signs of a market top with statistics-defying accuracy. Relative to the total size of the market, these are relatively small accounts at the individual level. But as a whole, PBs represent a big, market-moving player in the Venny market.

What happens to them if VENZ defaults? This is tricky question. By virtue of their origins, many of PB clients will not have a problem, as they will likely sell before the announcements of such an event. Nevertheless, it cannot be ruled out that these investors would remain filled with bonds in the last days, purely out of greed and the psychological impairment affecting all traders: total reluctance to take losses.

Market share: Unknown. My best guess is 10%.

Biggest names: Credit Suisse, BSI, Julius Baer, EFG, Credit Agricole.

IV. Dealers – “The Street”

The link above goes to EMTA, the guild of Emerging Markets bond traders. If you’re Street, you’re part of it!

Besides acting as ‘market-makers’, buying and selling bonds based on their clients’ orders (and sometimes because of it), the bond trading desks of several NY-based investment banks are allowed to hold positions in VENZ/PDVSA, either long or short. Street traders are ‘short-term price insensitive’; this means that they aren’t afraid to move prices up or down in huge magnitudes, if that allows them to balance supply and demand and do their business: buying at the low ‘bid’ price and selling at the high ‘ask’ price.

Their ‘strategy’, if we could talk about any, consists on positioning ahead of expected market flow: buying when they think the market is going to have excess demand, or selling short when they expect a “heavy” market (one with downtrending prices). Nevertheless, their role as “liquidity providers”, as their allowance to take positions in the securities on which they make markets is also called, has come down a lot in the past years, ostensibly due to new financial industry regulation that has made risk-taking very expensive and troublesome for these institutions.

What happens to them if VENZ defaults? These new regulations force banks to, among other things, set aside capital provisions for losses in their Trading operations, so a meltdown limited to a single credit shouldn’t be traumatic for the banks. If there’s a rogue trader callously gambling with Venny debt for one these institutions, we will find out post-mortem.

Market share: about 5%.

Biggest players: Citi, BofA Merrill Lynch, Deutsche, Barclays, Jefferies, Goldman, Morgan Stanley.

V. “The Government”, the market’s only hope

We in Venezuela got our own version of the yankee Plunge Protection Team: a group composed of public sector financial institutions, pension funds and treasuries of public companies/ministries, that have one key mission: Spending all money available to buy moaaar bonds!!! These are HUGE market movers, especially when they are buyers (the rest of the market finds out quickly and buys bonds ahead of them). To be honest, public sector traders are as stealth as a bull in a china shop.

The public sector way of trading is the least complicated and the riskiest. These governmental entities go all-in on the next-to-mature bonds and hold them to maturity; if PDVSA of the Republic do pay, they make a serious buck; if they not, que Dios nos agarre confesados…

What happens to them if VENZ defaults? Massive losses able to wipe all equity will ensue for all of the involved government entities. These institutions don’t have any diversification criteria and no real understanding of the risk embedded in being invested in their own debt; that’s why the coñazo could be epic (of course, besides the fact that THE COUNTRY WOULD BE IN FREAKING DEFAULT).

Market share: 20% (mostly in short-term bonds).

Biggest players: BCV, Banco de Venezuela, Banco del Tesoro.

VI. “The rest”

There’s a last group: a mishmash of retail accounts, corporate treasuries, private sector Venezuelan banks, family offices, and individual/corporate investors from all around the world (North America, Europe and Middle East), but especially in Latin America. A big chunk of this component is made up of Venezuelan individuals that bought bonds on the ‘bolívar-dólar’ primary auctions and have held their positions ever since.

A common theme with retail clients, especially domestic ones, is the preference for high-coupon bonds. Los dos paticos are their top picks: PDVSA and VENZ bonds due 2022 have identical 12,75% coupons and are trading around 50 cents; that means two-digit rates of return are all but guaranteed when buying these bonds, goes their investment rationale. Consistent with their uber-optimism with regards to Venny credit, they keep their positions for as much as possible, and re-invest coupon payments into more bonds, thus steadily increasing their stream of income. In total return terms (that is, adding interest payments to changes in bond price) this group as a whole is close to making up for the steep losses suffered during 2014.

What happens to them if VENZ defaults? That’s a very good question. Some of these investors haven’t fully understood the very big likelihood of a credit event coming to Venezuela, nor which would be the most likely recovery rate they’re going to reap from their defaulted bonds when that happens. But they have to understand this is the counterpart to the sky-high interest rates they keep collecting from Venezuela all along, and that nobody is guaranteeing their investments in CCC-rated paper.

Market share: The remaining from other classes (around 25%).