The controversy over Goldman Sachs Asset Management's purchase of Venezuelan government bonds (really Petroleos de Venezuela SA bonds) from Venezuela's government (really from a small broker acting on behalf of Venezuela's central bank) has gone on longer than Goldman probably expected, given that Goldman apparently didn't think about it at all:
- Internally, the purchase didn’t receive heightened scrutiny. The two co-heads of the unit, GSAM, were informed only after the trade had been completed, the people said. The trade didn’t reach Goldman’s firmwide standards committee, which often vets deals that carry potential blowback, they added.
- An ensuing uproar over that trade, which critics say extends a financial lifeline to Venezuela’s embattled government, caught top executives at Goldman off guard.
Goldman Sachs Group Inc.'s "compliance and legal staff are reviewing the purchase" to see "how the process can be improved," but you can see how they missed this. It's controversial for Goldman to buy controversial stuff; but GSAM isn't quite Goldman. It manages money on behalf of customers; it bought the bonds with their money, not shareholder money. Its decisions aren't, in some sense, made on behalf of Goldman Sachs; they're made on behalf of GSAM's customers. Of course those decisions are made by Goldman employees in Goldman offices, not by the customers, but still, there is some deniability there. (Disclosure: I used to work at Goldman.) There is deniability for the customers too: Sure they own and benefit from the Venezuelan bonds, but they didn't decide to buy them; Goldman did. Somehow Venezuelan bonds are owned without anyone fully taking the responsibility of owning them.
Elsewhere in deniability, Ricardo Hausmann wrote last month about the moral taint of buying Venezuela's "Hunger Bonds." His argument is not quite that people shouldn't buy Venezuelan bonds. That would be too radical: Emerging-market bond funds almost have to invest in Venezuelan bonds. "The returns of the JP Morgan Emerging Market Bond Index (EMBI+) are heavily influenced by what happens in Venezuela," because Venezuela's bonds make up a lot of the yield and the price volatility of the index. Emerging-markets managers can't just walk away from Venezuela; they "currently spend a disproportionate share of their time 'getting the Venezuelan call right,' because their bonuses are based on their over-performance relative to the index – of which Venezuela is the main driver." And investors can't just walk away from emerging-markets bond funds:
- Clearly, this would punish other countries that are innocent bystanders in the Venezuelan mess. There must be a better way.
- There is. The solution is to demand that JPMorgan immediately exclude Venezuela from the emerging market bond indexes it calculates, thereby freeing fund managers from the need to compare their performance with hunger bonds. Over time, JPMorgan should introduce a Decent Emerging Markets index, which would save you from moral anguish by ensuring that only countries adhering to minimal standards of respect for their citizens are included.
The assumption here is that investment managers, and individual investors, cannot be expected to make moral decisions about investing for themselves, not when an index lurks in the background. (Others disagree; here is a story about Venezuelan investors who wrestle with the moral issues of owning Venezuelan government bonds.) Morality, on this theory, is a matter for index providers to judge. Investors -- index funds, yes, but also active funds that benchmark to an index -- are bound to follow the index, so if anyone is going to make a moral decision about what bonds to avoid, it is the index provider.
I am not sure the index providers would agree! JPMorgan is not in the business of saving you from moral anguish. An index is just a list. Venezuela is an emerging market. It has bonds. Its bonds are emerging-markets bonds. If you are writing a list of emerging-markets bonds, you could quite sensibly put Venezuelan bonds on that list. What is the problem?
But one thing that we talk about a lot around here is the human construction of investment indexes. The central idea of indexing, of passive investing, is that you own the entire universe of assets rather than making choices about what to buy. But in practice it's never that simple. Most actual indexes aren't really "the entire universe of assets"; they're a particular subset of that universe, U.S. large-cap stocks or emerging-market bonds or whatever. And even within that subset, the membership criteria have to be defined by a human, with some room for judgment calls. And increasingly judgments by index constructors are overtaking judgments by investors in importance: If investors give up their agency to index providers -- if the index providers are the only people actually making decisions about governance or profitability or morality -- then the index providers had better make good decisions.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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