“Stop investing in hate,” Ilanis Hernandez, a Puerto Rican resident living in Connecticut, recently told The Intercept in reference to Yale University’s investments in Puerto Rican bonds. Forget the medical relief the university provided the island territory, and even ignore that Princeton and Harvard University is, likewise, exposed to Puerto Rican debt. Is what is hatefully supporting the economy to certain degrees? What if bond investors just stopped investing in areas like Puerto Rico where repayment was uncertain? And where are the lines drawn in the future over investments? An activist leading the charge against Yale University had some answers for Valuewalk but left many more questions.
Pension fund managers have a fiduciary and moral obligation to deliver the best returns possible for their client portfolio. But to what extent does that moral obligation extend?
Distressed debt has always been a nuanced investment with certain types of hedge fund sharks knowing how to game the system. After Argentine bonds defaulted, for instance, “vulture hedge funds” purchased the investment at a steep discount. The government had previously negotiated a settlement regarding payment on the bonds, but the hedge fund managers pressed their case for more – and ultimately won.
In a large economy like Argentina, the social impacts were not as widely felt as in smaller, more impoverished regions, where the government was forced to cut or eliminate services to the needy.
With over a third of Puerto Rico’s residents, nearly 900,000 people, living without power almost five months after Hurricane Maria, tensions are run high. The poverty rate is at 46% and almost 80% of the island’s crops, worth an estimated $780 million, have been wiped out. The prospects of bond repayment in the near term are bleak. Should institutional investors even bother entering this cauldron?
At Harvard University, hedge fund manager Seth Klarman’s Baupost Group, who covertly invested nearly $1 billion in Puerto Rico’s COFINA debt, has been a target. A Hedge Clippers report claims that investors such as Baupost are receiving money that should be going to humanitarian causes.
But what would happen if institutional investors just stopped buying Puerto Rican bonds? Activists refuse to consider the possibility. “I don’t think they are going to stop buying Puerto Rican bonds,” Julio Lopez, Connecticut state director at Make The Road, told Valuewalk.
He says that institutional investors have a moral obligation over that of gaining a return on their investment, something that an investment board might disagree with. “The bondholders lent money to Puerto Rico when it was decimated knowing full well they wouldn’t repay.”
Direct endowment and pension fund bondholders, meanwhile, have never publicly claimed to have invested knowing that the bonds would default, a seemingly dicey investment thesis to get past an investment board.
Lopez says that “neoliberal practices” that force austerity on a government and privatization of government services such as public utilities and schools is not the answer. Bondholders, meanwhile, have complained that Puerto Rico has not cut government worker wages, benefits, and reduced political corruption to create a shared sacrifice environment.
Lopez mainly has an issue with activist bondholders who are unwilling to negotiate and who he claims have taken advantage of those in distress. If an investor knew the government couldn’t pay on the bonds when they lent the money, they shouldn't be entitled to the same rights as other bond holders, is the logic.
Where does politically correct investing end? How can institutional investors be on guard for the next significant investment that turns into a hot potato? If an institution invests in bonds that help the regional economy and does nothing more than expect the return on investment they are promised, should they be subject to political pressure for making such a decision?
“The moral obligation has to be with people who are dying,” Lopez said. “The moral imperative is life.”
If it does come down to forgiving the debt, Lopez says that small bondholders, those who face life-threatening choices if they don’t receive a payout, should be made whole. “We don't need to be paying bondholders that would only stand to lose one more Ferrari,” he said. When it comes to saying bond investors are engaged in “hate” through their financial investments, Lopez thinks that hate is practiced in the bondholder's unwillingness to negotiate. “We believe there has to be a way for the well-being of Puerto Rico to be considered relative to bondholders being a little less rich.”
It is unclear if significant bondholders would invest in bonds where the payout priority was given to smaller investors. The notion that when funding the allocator must accept the fact they might not receive payment in full but don’t receive additional compensation for the risk is one that is likely to find difficulty getting through an investment committee meeting.