NEW YORK/LONDON: As Venezuela's economy teeters on the edge of collapse and some people go hungry, a growing number of foreign investors are reaping outsized returns betting on the oil-rich nation's depressed debt.
Venezuela's bonds have sunk so low amid a deep crisis that even if it defaults on its debt, bondholders reckon there will still be rewards when the South American country eventually recovers, helped by its huge reserves of crude.
Venezuelan dollar bonds on average have returned an impressive 14.1 percent so far this year, according to Datastream figures. That means investors have reaped around $3.5 billion in returns from the bonds already in 2016, according to a calculation by London-based brokerage Exotix Partners.
The figure is nearly three times the $1.2 billion Venezuela plans to spend on imports of pharmaceuticals this year as dire shortages of medicines from anti-itch skin cream to chemotherapy drugs hit home.
The crisis has forced Venezuela to sharply curtail such imports, adding to hardship for millions of people already struggling with triple-digit inflation, power cuts and food shortages.
But with the world's largest proven oil reserves of nearly 300 billion barrels and an almost doubling of oil prices off this year's troughs, the OPEC nation is expected to keep servicing debt at least through 2016.
And the precedent of Argentina being forced to pay up to dissatisfied creditors years after a 2002 debt default will protect against excessive losses if Venezuela also restructures its debt, investors reckon.
John Baur, a portfolio manager for Eaton Vance's Global macro Absolute Return Fund, added further to his holdings of Venezuelan bonds earlier this year after a sizeable cutback in 2015.
"The view has been that the bonds are trading below recovery value. The situation is the country is disastrous, they're very likely to default at some point, but with the world's largest oil reserves, you're likely to see a recovery that's well above the current bond prices," Baur said.
Derivatives markets assign a 95 percent probability of default over the next five years, according to credit default swaps (CDS) monitored by data provider Markit.
Bonds from the government and state oil firm PDVSA still only trade around 40 cents in the dollar on average. But Venezuelan yields above US Treasuries - a measure of the country's risk premium - have contracted a third since February to about 2,800 basis points on JPMorgan's EMBIG index.
All eight investors canvassed for this article believe recovery rates post-restructuring will be higher than the bonds' current market value.
"This is one of those situations where the bond prices have simply sold off so much that even in a very bad outcome we still think you're going to make money," said Jan Dehn, head of research at emerging markets asset manager Ashmore, which has also raised Venezuela exposure.
President Nicolas Maduro insists Venezuela will honour all debts, repaying $1.5 billion in February. Government leaders routinely point out that the ruling Socialist Party has never missed a bond payment. They say the huge discounts on bonds are unfair and unwarranted given the country's payment record.
Maduro faces a huge challenge ahead from protests and food riots, and blames the crisis on the fall in global oil prices and an "economic war" by his foes, whom he also accuses of seeking a coup.
Critics say the economic chaos is the consequence of failed socialist policies for the last 17 years under Maduro and his predecessor the late President Hugo Chavez, especially price and currency controls.
Security forces fired tear gas at protesters chanting "We want food!" near the presidential palace in Caracas last week and a woman died on Monday after being shot when looters raided state food warehouses in a town near the Colombian border.
Venezuela has fallen hard from the 1980s when it enjoyed AA-credit ratings in debt markets.
The government and PDVSA combined now have $61 billion in outstanding bonds, according to brokerage Exotix.
While no sovereign bond matures until 2018, PDVSA must repay around $8 billion in 2016-2017. However, a significant chunk of this is believed to be in the company's hands after a series of quiet buybacks.
PDVSA did not respond to a request for comment but has repeatedly assured investors it will meet all bond commitments.
Indeed, Caracas has made provisions to repay short-term debt, having liquidated $3.6 billion of gold since September, analysts at consultancy Eurasia note.
It is also slashing imports to preserve hard currency - imports shrank 42 percent in the first two months of 2016 after falling 21 percent last year, Eurasia added.
CDS reflect expectations that short-dated debt will be honoured, with one-year contracts implying a 61 percent default probability, down from 78 percent in February, Markit says.
In the meantime, the sovereign 2022 dollar bond pays a 12.75 percent semi-annual coupon, while Venezuela's most-traded 2027 issue pays 9.25 percent .
Coupon returns on Venezuelan debt are almost 10 percent year-to-date versus an average 2.5 percent on the EMBIG index.
"The bonds are still paying coupons which is a miracle per se. So one enjoys (a) surprisingly large current yield for now whilst waiting for this to unravel," said Jason Maratos, principal at London-based hedge fund Onslow Capital Management Ltd, which holds Venezuelan bonds.
Longer-term, default looks likely. Yet creditors' hand may be strengthened by Venezuela's oil reserves and Argentina's tough experience at the hands of hedge funds.
Almost $40 billion of Venezuelan bonds are estimated by debt experts to lack collective action clauses (CACs), a mechanism that makes a restructuring binding on all creditors and makes it harder for funds to "hold out" for better terms.
Without CACs, Venezuela will want to avoid an Argentina-style battle with hedge funds who could attempt to seize oil shipments or overseas refineries.
"We think that not having a CAC adds value," Baur of Eaton Vance said.
Investors also say any future Venezuelan government can ill-afford to impose punitive terms on foreign creditors as it will need investment into its degraded oilfields.
Even impoverished Ukraine inflicted a mere 20 percent writedown on bondholders during its 2015 restructuring in order to keep markets' goodwill.
"You may not get 80 cents a la Ukraine but the majority will be happy with 50 cents, with that you can make a significant return and that's the end game," said Marco Ruijer, a portfolio manager at NN Investment Partners.