Dictatorships are on a hot streak in the bond market.
In the past year, sovereign notes from emerging markets under autocratic rule have returned 15 per cent on average, compared with just 8.6 per cent for securities from developing countries considered democratic, according to data compiled by Bloomberg. They also have better returns over the past two years, though beyond that the advantage fades.
For all the ugliness that often comes with authoritarian governments – the human-rights abuses, the curbs on free expression – they often can be very rewarding for bondholders willing to turn a blind eye to those things in exchange for the stability that they can foster.
This isn't necessarily a brand-new phenomenon, of course, but a pair of events last week served as a reminder of the outsize gains and losses it can trigger. On April 12, Venezuela's creditors reaped large returns when President Nicolas Maduro made good on $2.5-billion (U.S.) in debt payments even as he struggles to come up with enough money for food imports. Two days earlier, El Salvador, a democracy for the past quarter-century, defaulted as a feud between the president and an opposition party – a "high-stakes game of chicken," as Nomura Holdings Inc. strategist Benito Berber called it – left the government unable to make a $29-million payment to a local pension fund.
"Investors typically view the bonds of an autocratic regime very negatively and assign a very high default probability," said Victor Fu, the director of emerging-market sovereign strategy at Stifel Nicolaus & Co. But "in an autocratic regime, the government remaining in power is considered more important than people's welfare. Since a bond default likely will raise the risks for the government to be thrown out, the ruling party will do its best to prevent a credit event."
Over the past year, investors in sovereign dollar bonds from Venezuela pocketed 55-per-cent returns. That's more than the 34 per cent from Ghana, the top-performing democratic country. In fact, bonds from 10 of 15 governments labelled "not free" by Washington-based Freedom House returned at least 10 per cent these past 12 months, compared with a third of bonds from emerging-market countries the watchdog organization labels as "free."
Non-democratic states can take many forms, according to Freedom House. In Azerbaijan, President Ilham Aliyev succeeded his father and has clung to power via three questionable elections. Meanwhile, royal families in Qatar, Oman and Saudi Arabia are among the few monarchies still standing. In Egypt, Abdel Fattah el-Sissi rose to power after a coup in 2013.
Turkey, which Freedom House deems "partly free," may be the latest example of bondholders benefiting from a turn toward one-man rule. The increasingly autocratic government under President Recep Tayyip Erdogan has proven creditor-friendly, according to Mr. Fu, with its sovereign dollar bonds outperforming the emerging-market average in 2017 after a wave of credit-rating downgrades fueled a sell-off late last year.
Of course, the rally in bonds tied to dictatorial governments is in part a reflection of the recent hot stretch for the riskiest assets – democracies tend to have better credit ratings. While emerging-market notes from countries under autocratic rule have outperformed those under democracies by an average of 5 percentage points over the past two years, bonds from democratic countries have the edge over three years and five years.