- Why analysis of ESGP factors can bring valuable insights when investing in EMD.
- Why bond investors have found themselves under the microscope in the Venezuelan crisis.
- What our ESGP analysis tells us about Venezuela's direction of travel.
A country's creditworthiness is fundamentally dependent on its competitiveness and ability to sustain economic growth over the long term. To assess this, investors traditionally look at a range of macroeconomic variables. However, the ability to sustain economic growth also depends on socioeconomic factors, such as education, healthcare and levels of inequality. As such, we believe that analysis of environmental, social, governance and political (ESGP) factors can allow for a more holistic assessment of sovereign creditworthiness.
This is especially true in emerging markets, where the degree of political stability or the entrenchment of the rule of law can vary significantly from one country to another. This can have important implications for sustainable economic growth, competitiveness and the ability to repay debt.
Nowhere is this currently more true than in Venezuela, a country fast-becoming the poster child for societal breakdown. Critical food and medicine shortages, near-daily street protests, widespread corruption and rampant inflation all point to a country in a state of almost permanent crisis. More than 60 deaths have resulted from clashes between protestors and security forces this year, a sobering reminder of the human cost that can occur when a country's social, economic and political structures come under severe stress.
Recently, bond investors have found themselves dragged into this febrile atmosphere. With more than $4 billion of outstanding bonds to redeem in 2017 alone, Venezuela comprises a large part of JP Morgan's emerging market debt (EMD) indices. However, the country’s opposition party has been vocal in its condemnation of foreign investors, whom they accuse of financing an authoritarian regime that has been cutting imports of necessities in order to safeguard bond payments. The perception of a population going hungry (the average Venezuelan adult reportedly lost more than eight kilos in 2016 due to food shortages) to protect investor interests has even led to certain lenders being publicly criticised for the nature of their dealings with the government. It has also encouraged discussion around the merits of applying sustainable and responsible investment criteria to bond portfolios; an underdeveloped approach relative to its use in equity portfolios.
Having held no exposure to Venezuelan assets for some time, our EMD team recently revisited its ESGP assessment of the country using our in-house proprietary framework. By scoring countries on 18 indicators across the four ESGP pillars we aim to identify long-term factors and tendencies that might not be fully priced into sovereign bond spreads. Our research showed that Venezuela continues to score poorly on most fronts, with bottom-quartile positions across many of the political, governance and social categories. Indeed, it received the lowest score among 84 countries for both 'Corruption Perception’ and ‘Ease of Doing Business'.
Importantly, Venezuela's overall score (21 out of 100) was lower than in 2016, indicating a negative direction of travel, which is a central determinant of our decision whether to hold a country's bonds or not
This ESGP analysis chimes with our negative fundamental view of Venezuela and is a key driver of our increasing scepticism that it can sustain debt repayments. It is unlikely that a country exhibiting such levels of institutional weakness is in a position to implement a set of policies that would materially improve its creditworthiness. For now, while yields on Venezuelan bonds in excess of 20% might appear optically attractive, our analysis leads us to maintain a zero exposure across our portfolios.