Gecko Capital’s Maunakea Emerging Markets Debt Recovery Fund has delivered an impressive 74% return over the past year, and its managers are particularly bullish on the future of two South American economies. The fund’s manager, Jean-Jacques Durand, said the fund’s goal is to achieve double-digit returns annually in U.S. dollars, with the current yield of about 10% being a “conservative” estimate. It generates these returns by investing in bonds where borrowers often face difficult financial situations that may require restructuring or bailouts – known in the industry as “exceptional circumstances.” Where are the funds invested? Mauna Kea’s two largest positions are in Venezuela and Argentina, which Duran considers one of the “most compelling and attractive” trades he has ever made. Venezuela presented what he called the “case of the century” when bonds issued by its state oil company PDVSA were trading between 13 and 18 cents on the dollar until last October due to the threat of U.S. sanctions. Instead, the U.S. government partially lifted sanctions after the Venezuelan government began negotiations with the opposition. “This was the first increase in prices, and within a few days prices almost doubled,” said Duran, who previously managed an emerging-market bond portfolio at Edmond de Rothschild. The investor believes Venezuela’s long-term potential, combined with the potential for sanctions easing and the country’s geopolitical importance, make it an “attractive asymmetric” investment. However, he stressed the need for patience in these situations, as investment thesis timelines can be lengthy. The fund manager said the election, expected to be held on July 28, will be a critical time for investment in the country. “Whoever wins, will we end up with a legitimate government and further lifting of sanctions by the EU or the US, or will we have a regime that closes in on itself and is clearly becoming more and more undemocratic? That is the question,” he added . ‘Very Simple’ Factors Duran’s approach to calculating the upside potential of these markets is simple. Duran said that in a situation like Venezuela, the payback (or recovery value) depends on the country’s long-term ability and willingness to pay. For example, Venezuela relies on foreign capital to develop oil and gas fields. Duran said the country had previously negotiated with bond investors in “good faith.” “Typically, it’s very simple,” he explains. “If they want their oil operations and the economy as a whole to function properly, they cannot afford to be shut out of the market for years.” This contrasts with the situation in Argentina, which has a history of defaults that have resulted in severe losses for bondholders. Duran said Argentina is less dependent on capital from foreign investors because much of its economy is driven by private businesses, which can operate even if the country is excluded from capital markets. “They have been serial defaulters. When they get the chance, they default,” Duran said of Argentina. “They will try to get as much return as possible from bondholders and pay back as little as possible.” However, the fund manager is optimistic that Argentina will reverse its economic woes. He points to the country’s first-quarter government surplus as the germ of his thesis. Duran said he was eyeing the next trade in Bolivia, a once market darling that has run into major problems recently as its bonds began trading at discounts. The country’s government has had to deal with a worsening dollar shortage that has left supermarket shelves empty and workers without pay. Earlier this year, Fitch downgraded the country’s rating to CCC, or junk, meaning a default was “a real possibility” amid a worsening currency crisis. Bond prices fell sharply as investors questioned the government’s ability to pay interest. “We don’t have it in the fund yet. That could be the next spot,” he added.
