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‘Active versus passive’ versus the world’s worst regimes

‘Active versus passive’ versus the world’s worst regimes

Two venerable financial institutions have recently been dragged into the ongoing tragedy in Venezuela.

Goldman Sachs has been criticised after its asset-management arm bought Venezuelan bonds with a nominal value of $2.8 billion, while the country’s former minister of planning Ricardo Hausmann called on JP Morgan to exclude Venezuela from its widely tracked emerging-market bond index.

Goldman Sachs – which has certainly not been the only active manager to invest in Venezuelan debt in recent years – responded that it acted only in the secondary market and so is not directly financing the country’s government.

‘We recognise that the situation is complex and evolving and that Venezuela is in crisis,’ the group stated. ‘We agree that life there has to get better, and we made the investment in part because we believe it will.’

Hausmann, now director of the Center for International Development at Harvard University, has rejected such rationales.

‘Assume that you want to hold Venezuelan debt because you are hoping that President Nicolás Maduro will lose power and that a more sensible, democratically minded government, more in line with your moral compass, will emerge,’ he argued.

‘Even in that case, you will still want the gains from Venezuela’s future recovery to be used preferentially to service the old debt issued to finance the corruption and national destruction brought about by Maduro and his predecessor, Hugo Chávez. You will not be rooting for the recovery of livelihoods that Venezuelans deserve after having lived through this nightmare.’

Decent returns

Hausmann acknowledged that investors should not be prevented from buying emerging-market bonds, but made a proposal that is more likely to affect passive funds than active strategies.

‘The solution is to demand that JP Morgan immediately exclude Venezuela from the emerging-market bond indexes it calculates, thereby freeing fund managers from the need to compare their performance with hunger bonds,’ he urged.

‘Over time, JP Morgan should introduce a Decent Emerging Markets index, which would save you from moral anguish by ensuring that only countries adhering to minimal standards of respect for their citizens are included.’

Some active managers may be spared the Venezuela question by such a move if their mandate does not permit off-benchmark positions, but some will spy an opportunity to add alpha by accessing bonds their index cannot.

ETFs exit

Passive investors will have no such discretion, and will become forced sellers should Venezuela be purged from their index. The iShares JP Morgan USD Emerging Markets Bond ETF currently has a 2.4% weighting to the country, for example; the Vanguard Emerging Markets Government Bond ETF, which follows a Bloomberg Barclays index, has 2.5%.

Expunging Venezuela from these indices is unlikely to be the end of this story, though. What about Turkey, Russia, or the Philippines, to name only a few other unsavoury regimes that together comprise over 12% of the main emerging-market bond indices?

There are already plenty of ethical bond strategies on the active side, but the development of passive bond funds has so far focused much more on green bonds than general ethical screens.

Instead of requiring index providers to make more active decisions in selecting their constituents, the passive industry could do more to match its already wide range of ESG equity products with fixed-income equivalents.

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