Investors piling into EM debt tracker exposed to Venezuela

Investors piling into a Legal & General tracker fund are earning yields highly exposed to Venezuelan debt highlighting the risks of passive products when investing in emerging market bonds.

According to FE data, the £812.5m L&G Emerging Markets Government Bond hard currency index has 3.3 per cent in the emerging market country, which has seen violent clashes over the summer as its starving population revolts against Hugo Chavez’s successor Nicolas Maduro.

The oil-rich nation’s sovereign debt has been labelled “hunger bonds” as the government focuses on repaying foreign creditors as its population goes hungry. Three quarters of the population lost an average 9kg in 2016, according to a study by Venezuelan universities and NGOs.

Venezuela’s GDP is expected to contract 5.5 per cent and inflation is set to end the year at 600 per cent, according to Fitch.

The hard currency version of the fund, which tracks the JPMorgan Emerging Market Debt Plus, is the second most popular fund in the Global Emerging Markets Bond sector for the last year after the local currency alternative, attracting £328m.

Despite Venezuela accounting for a small part of the index it delivers up to a fifth of the yield.

LGIM head of emerging market debt Uday Patnaik says a “proactive approach is taken to monitor events and engage with the benchmark provider to fully understand the impact on the funds”.

“In the event of a debt restructure or default occurrence this would not automatically lead to Venezuela being removed from the benchmark.”

Patnaik says Argentina and Ukraine have been through default or restructure scenarios in recent years were not removed from the benchmark.

Venezuela is also included in other mainstream indices, such as Morningstar Emerging Markets Sovereign Bond, Markit iBoxx USD EM Sovereign, Bloomberg Barclays EM USD Sovereign, Citi Emerging Markets US Dollar Government Bond and BAML USD EM.

JPMorgan has offered an emerging market debt index that excludes Venezuela since 2004. It also offers an index for sovereigns that are B-rated or higher.

It declined to comment on its indices’ exposure to the Latin American country.

Venezuela’s sovereign rating pushed further into junk status as a result of US sanctions issued in July with Fitch downgrading it to CC.

Fitch warned in its sovereign ratings downgrade that sanctions will likely “deepen the political and policy uncertainties, aggravate the economic crisis, heighten political polarisation and increase social unrest”.

Active alternatives

Adviser Centre investment director Peter Toogood says most active managers got out of Venezuela over the summer “because it just looks like a complete mess”.

He adds it is “very unnerving to think of a passive strategy” in emerging market debt, but investors have “ridden the global liquidity wave”.

“The flip side is that when the default cycle turns it can hurt,” Toogood says.

The Adviser Centre recommends the Absolute Insight Emerging Market Debt fund, managed by Colm McDonagh, and the First State Global Emerging Markets Bond fund, which is benchmarked to the JPM EMBI Global Diversified index and managed by Helene Williamson.

The investment research agency also added the £495.2m M&G Emerging Markets Bond fund, managed by Claudia Calich, to its recommended list last week.

The M&G fund has been the most popular active fund in the sector for the 12-month period, behind the hard and local currency versions of the L&G index funds.