The notion that investors are “reaching for yield” when investing in risky sovereign bonds has become too much of a cliché for Macquarie’s Victor Shvets. The problem is that concept provides easy cover, a limp excuse for bond investors making obviously flawed decisions, as was the case during the Petrobras 100-year bond offering. Those same set of circumstances appear to again be taking hold across the emerging market landscape, and institutional investors are falling into the same trap.
While trusted research reports were touting the Petrobras 100-year bond deal, certain investors, most notably Bridgewater Associates, took the opposing point of view. To the world’s largest hedge fund, it was obvious the emperor had no clothes. Despite all the usual suspect consensus analysts gushing over the prospect of 100-year Bond offering with exposure to a scandal-tainted enterprise amid a government with a history of instability, there were mathematical reasons to question the offering.
Nonetheless, “yield-starved” investors piled in – and the result was a tragedy.
The same situation appears to be playing out in far-flung regions of the world such as the Ivory Coast. Investors were lining up outside the door and around the corner to get a chance to purchase bonds yielding 6.25%. The June 2017 sovereign bond offering attracted US$10 billion in bids for US$1.9 billion in issuance for 16- and 5-year exposure to an unstable government.
When evaluating the Ivory Coast investment prospects, the question is: Where in the modeling did it account for default? How much loss potential was factored in when evaluating the potential for a 6.25% annualized return?
Factoring in bond default and restructuring would appear as an obvious consideration by looking at the nation’s history since it gained independence from France in 1960. Shvets categorized the nation as a “state wrecked by coups and civil wars” but more importantly it has been “a serial defaulter.”
It doesn’t take a history major to figure out past bond investments have statistically involved a meaningful degree of default risk. In 2011 it simply stopped bond payments that were issued due to a restructuring of 2010 bonds, which themselves were part of a restructuring of loans made in the 1970s and 1980s.
But it’s not just the Ivory Coast.
Investors are loading up on Iraqi and Greek five-year bonds at 6.75% and 4.63% respectively, making them a relative deal compared to 16-year Senegal bonds paying 6.25% and “serial defaulter” Argentina’s 100-year bond offering that yields 7.92%. While Argentina’s government is currently “pro-market,” that could easily change over the next 100 years – if not the next ten years. But if you don’t want to commit capital for 100-years to a traditionally unstable government, perhaps the slightly higher yield in Ukraine’s ten-year bonds at 7.3% might do – so long as investors ignore its location in the middle of a war zone.
Shvets is flabbergasted. “How can one rationalize such investor behaviour?”
The excuse of investors “reaching for yield” no longer does justice to such investments, he says, pointing to the only logical thesis being central banks being unable to normalize interest rates – or this is just a bubble that will burst like all others.
Pensions and other institutional investors are in a tough predicament. With yields in the developed world knuckle dragging at or near negative on a real, inflation-adjusted basis, there are not many “safe” yield chooses – and the situation might not correct itself. Over the long term Shvets muses that “there is no alternative” to the “unorthodox monetary policies” he sees playing out into “perpetuity.”
But is there "no alternative" to an Ivory Coast bond offering?