A Vulture Fund Win-Win

I recently came across the following post from the Foreign Policy Passport blog about a recent transaction between Libera, along with the help of the World Bank, and a vulture fund. This is a great example of how a successful vulture fund transaction operates:

"Felix Salmon writes up a World Bank report on the returns a vulture fund made off of Liberia:
Liberia, with the aid of the World Bank, has been negotiating with vulture funds holding $1.2 billion of its debt. You know what vulture funds are, right? They’re evil hedge-fund types who buy up debt at pennies on the dollar, and then sue for repayment in full, with interest and penalties and everything.

Just look at the deal they drove in this case! Liberia, one of the poorest countries in the world, is going to have to pay them, er, nothing at all. The World Bank is kicking in $19 million, a few rich countries are matching that sum, and the vultures are walking away with a not-very-princely-at-all $38 million, or just 3 cents on the dollar. Which probably barely covers their legal fees, let alone the amount they paid for the debt in the first place.

Let's read that again: the World Bank and Liberian government negotiated a deal so that vulture funds holding $1.2 billion in debt ended up with a check for $38 million -- three percent!

It's distressing that Liberia got in such a bad fix. It needed to raise funds and banked on future growth to make the payments -- but a bloody civil war meant it couldn't. The original lenders decided to sell the loans off to vulture and hedge funds who drove a hard bargain. Which meant that at one point, Liberia owed seven times its national income to creditors.

So, the balance sheet -- in redux:

The vulture funds (name makes it hard to feel bad for them, doesn't it?) lost $1.26 billion on paper. (I doubt they paid the full $1.3 billion for the loans, the World Bank doesn't say.) For better or worse, it means they likely aren't lending anymore.

Liberia, struggling with a crushing debt burden, found forgiveness. This is a good thing -- if Liberia's government has put in place measures to ensure security, stability, and economic growth. Johnson Sirleaf's at least making an effort.

Liberia's rich friends (the United States included) stepped in with a bit of cash to help a very ailing economy. A good thing.

The World Bank negotiated what seems to be an amicable settlement. (Though the vulture funds might beg to differ.) A good thing for them.

Ultimately, though, Liberia isn't the story here. Emerging market and developing economies, like Liberia, will be among the hardest-hit in the Great Recession. Unlike OECD countries, they won't be able to issue debt or raise funds easily. They'll need the help of the international community -- and especially international organizations -- to ensure that their loans come with advisement and affordable repayment options.

The hero here's the World Bank. Suddenly, it and the IMF -- especially the IMF, perhaps -- have become the world's most important international organizations."

The author is correct in stressing that these types of transactions are what will be needed for many cash-poor countries, especially in times like these.

Sustainable Development Efforts By Emerging Market Funds

I wrote on Monday about DAI's white paper about vulture funds' interest in and ongoing efforts towards sustainable development in emerging markets. As a follow up to that I'd like to share the following, a recent entry on the website BankInvesmentConsultant.com of a similar sentiment:

Emerging Markets Warming Up to Sustainable Investing
By Money Management Executive
April 2, 2009

Fund managers in emerging markets are increasingly paying attention to environmental, social and corporate governance factors, according to research by Mercer.With $300 billion under management, sustainable investment management assets in emerging markets now represent 10% of all assets managed there. Fifty billion of that is in funds specifically labeled as sustainable investments, and the remaining $250 billion is in funds that practice sustainable investing.While managers in emerging markets often have a deeper understanding of social issues than their counterparts in developed nations, often they don’t know how to use their proxy voting power, noted Danyelle Guyatt, head of research in Mercer’s responsible investment unit.Mercer believes that if socially responsible investing is practiced in emerging markets, it can go a long way toward reducing poverty in those regions.

Worth a Look

In the interest of enriching the conversation about emerging market debt funds, I came across an extremely interesting white paper over the weekend from Debt Advisory International, a DC-based firm with experience and clients in Sub-Saharan Africa, Latin America, Eastern Europe and Asia. The paper, "Prospects For Reduction And Conversion Of U.S. Sovereign Claims On Developing Countries To Support Overseas Sustainable Development Activities," offers thoughtful insight into some of the issues associated with promoting sustainable development in emerging markets. From the Conclusion and Recommendations section:

"Despite these obstacles, potential exists for the use of debt conversion and other innovative financing techniques to support overseas development. While the issues examined in this report are quite complex, they do have an important impact on the budget and foreign policies of the U.S. and should therefore be carefully examined to maximize the benefits to all concerned parties ... In particular, the authors suggest that the following actions be undertaken:

• Thorough study by the U.S. Government of the costs and benefits of a comprehensive program to discount existing Ex-Im Bank and/or USAID claims on developing countries;
• Careful examination by the U.S. Government of the approaches of other creditor governments to converting and reducing their outstanding claims on developing countries;
• Harmonization of the policies of Ex-Im Bank, USAID, Treasury, and other U.S. agencies for valuing outstanding claims on developing countries."

Overall, the paper exemplifies the concerns DAI has about ensuring sustainable development in countries with emerging market funds. Learn more about DAI and read the full paper here.

More Food for Thought on Vulture Funds

I wrote last week about Salmon's post questioning the "silly war," as he puts it, on vulture funds. Reader comments and the views expressed as a result of the entry were thoughtful and added further color to this increasingly interesting issue.

One reader made a particularly thought-provoking analogy, comparing the public's discomfort about vulture funds to that of record or pharmaceutical companies. He says:

"The discomfort people feel toward vulture funds strikes me as rather a lot like (part of) the discomfort people feel toward record companies and pharmaceuticals. Each is playing the different games in the same way: they’re both playing for the tails of the distribution. Now these same people may have other good reasons to hate the recording and pharma industries, but claims that these groups “gouge” artists and patients (and debtors in the case of the vultures) on the basis that one particular “hit” has high margins/returns is a bit myopic."

I think this brings up an important point--perhaps because of the name they have assumed, or the couple of high-profile cases that have been splashed across the news, vulture funds are often only partially understood.

Thoughts?

Vulture Funds: What's the big idea?

I've shared the thoughts of now-Reuters-blogger Felix Salmon before on this blog--his post this week is worthy of mention once again. It's a clear explanation and defense of "vulture funds":

"The bill they’re talking about is this one, which is very similar to the Stop Vulture Funds Act being pushed by Maxine Waters in the US. Essentially it says that if you lend money to a country you have the right to get your money back — but if you then sell that loan to someone else after it has gone into default, the person you sold it to does not have the right to be repaid in full, and instead can only be awarded the amount they originally paid for the debt, plus a small set interest rate.

In other words, the single greatest innovation in the history of debt capital markets — the idea that obligations can be traded, rather than just being held to maturity or litigated upon default — is destroyed at a stroke.

What’s more, the problem these bills are trying to solve is absolutely minuscule. Not only are vulture funds settling their debts for three cents on the dollar, but they more generally have had a very hard time indeed successfully collecting on court judgments around the world. That’s why litigation is a last resort for vultures: anybody who thinks that they buy up this debt with the intention of litigating for repayment in full simply doesn’t understand the business model.
The good news, however, is that neither the UK nor the US bill has any chance of making it into law: the governments in both countries, for all that they’re nominally left-wing, would never support either piece of legislation. This is basically theatre on the part of lawmakers, not a serious and thought-through attempt to rewrite the international financial architecture. If it were, maybe the lawmakers in question might have asked developing countries what they thought of this legislation. And they might well have been surprised at the answer, which is that countries want no part of any act which might hinder their access to capital or their equal-player status on the world stage.

Anti-vulture-fund legislation like this is paternalism of the worst kind: it might be well intentioned, but at heart it’s a bunch of ill-informed northerners telling impoverished southerners what’s good for them. If and when vulture funds ever become a real problem — which I doubt will ever happen — then I fully expect to see the afflicted countries coming up with their own suggested solutions. In the meantime, let’s not exacerbate the plight of those countries by cutting off whatever access to international capital that they currently enjoy."

Salmon knows his stuff and articulates the operational elements of vulture funds in language that we can all stand behind. More to come...

Some Positive Economic News (for once)

According to a Wall Street Journal article by Kejal Vyas from last week, the times, they are a'changin... and not in a bad way. Vyas writes: "With risk premiums on emerging market assets edging lower and with some investors coming back in the past several weeks, the mood at the Emerging Markets Trade Association's spring forum was mostly upbeat.
Emerging-market asset managers from some large Wall Street firms agreed Thursday that the worst may be behind us."

This is certainly encouraging news for those of us invested in the emerging market fund arena, and it gets even better: "Panelists also said they don't see the U.S. leading out of the global economic decline. They spoke highly of developing markets and their chances of outperforming developed economies namely because of aggressive interest rate cuts by central bankers, which have allowed them to stimulate growth."

For those of you who have been considering or even on the fence about getting involved with an EMF, now might be just the time to dip your toe... Stay tuned--my next few posts will recommend some companies worthy of your consideration as you invest in an EMF.

Come on in, the water's fine.