Will Wall Street’s Most Famous Vulture Batter Ukraine?

BY DAVID FRANCIS

Franklin Templeton bond manager Michael Hasenstab wants Kiev to pay back money it doesn’t have. If he stands firm, Ukraine’s fragile economy could implode.

In  recent months, Ukrainian government officials have been crisscrossing the globe, asking Ukraine’s creditors for relief on $23 billion in debt the country says it can’t pay. Without relief, Ukraine’s economy could sink into the financial void. That puts Michael Hasenstab, the boy wonder of distressed debt management, front and center in a financial crisis that could determine the fate of a country Russian President Vladimir Putin covets with eager eyes.

Hasenstab, 42, represents the investment firm Franklin Templeton as one of the four members on the Ad-hoc Committee of Bondholders to Ukraine, a panel of representatives from three U.S. mutual funds and one Brazilian bank. The debt-holders have to decide whether they will acquiesce to Ukraine’s demands and allow it to pay 40 percent less than it owes. As the largest holder of Kiev’s debt, Hasenstab, chief investment officer of Templeton Global Macro, stands to lose billions of dollars if that occurs.

Ukraine is in desperate need of economic growth, something it has been severely lacking in recent years. Investors have been spooked away by the continuing civil war with Russian-backed separatists in the country’s east, as well as by years of endemic government corruption.

Ukrainian officials are promising reforms, but those reforms won’t come soon enough to attract the new investment necessary for broad economic growth. They’re also squabbling with the European Union and the International Monetary Fund over broader questions over what types of painful austerity measures to accept in exchange for a financial lifeline. To access a $17.5 billion bailout from the IMF — money Kiev desperately needs to stay solvent — Ukraine and its creditors have to agree on how, and how much, Ukrainian Prime Minister Arseniy Yatsenyuk’s government would pay back on the bond payments over the next three years. It’s clear Kiev doesn’t have the money to pony up what it currently owes; as of the end of 2014, it only had $7.5 billion in reserves, the lowest level since 2004.

That puts Hasenstab in a powerful position. He could mimic Paul Singer, the hedge fund maven at Elliott Management, who refused to take a so-called “haircut” — a creditor agreeing to allow a borrower to pay back less than what it borrowed — on about $100 billion in Argentine debt in 2001. When Buenos Aires couldn’t pay its debt, Singer’s intransigence ultimately caused the largest sovereign debt default ever. This sent the Argentine economy into the worst recession in its history, leading to unemployment of more than 20 percent, a GDP drop of 11 percent, and riots on Argentine streets that left 27dead and more than 150 injured. Argentina’s president at the time, Fernando de la Rúa, had to declare a “state of siege.” He was forced to resign and had to escape Casa Rosada, Argentina’s executive residence, in a helicopter as his country’s economy collapsed. To this day, Singer continues to fight for what he’s owed in American courts and through less traditional methods; in 2012, he persuaded a court in Ghana to seize an Argentine naval vessel, Libertad, as partial repayment of some of Argentina’s debt.

That kind of economic and social chaos could erupt inside Ukraine if it defaulted, putting Hasenstab — who declined, though a spokesperson, to comment — in a difficult spot. If he gives into Kiev’s demands, he’ll take a steep loss on his $6.5 billion investment there. He has already taken a loss of $3 billion. Yet he has refused to budge on a haircut. If he doesn’t budge, he might never get paid, just like Singer, and Ukraine’s economy, which would then not receive the IMF bailout, could sink into even deeper despair. Months of talks between Hasenstab and his Ukrainian debtors have gone nowhere. A meeting in March of this year ended with tense verbal back-and-forths between the two sides, including Ukrainian Finance Minister Natalie Jaresko hinting that the terms of the deal would only get worse if talks dragged on. A new round of negotiations is ongoing.

Franklin Templeton spokesperson Stacey Coleman referred Foreign Policy to two recent letters to the editor sent by Hasenstab on behalf of the Ad-hoc Committee of Bondholders to Ukraine that make clear that Hasenstab has, so far, ruled out debt relief.

In one, published by the Financial Times on June 17, Hasenstab wrote, along with the other creditors, “A haircut sends the wrong signal to global capital markets when Ukraine can least afford to be shunned.” In the second, published by the Washington Post on July 12, he wrote, “We believe Ukraine’s financial troubles can be resolved for all parties without creditors immediately writing down the value of their bonds.”

Hasenstab is taking what, from his perspective and that of many finance professionals, is a reasonable position. He wants the money Ukraine promised to pay back. But Ukraine insists that Hasenstab and the country’s other creditors have to recognize that Kiev is not in a position to do that.

In a recent interview with Foreign Policy, Jaresko, a financier born in suburban Chicago, said Kiev’s negotiators are making progress with “some of the creditors.” The unresolved debt issue “holds up the certainty of our financial and economic health,” Jaresko said. “We’re trying to focus not on the destabilization that this enabled, but real growth. It’s a linchpin of our financial health.” It’s a hard sell for one simple reason. Ukraine is quickly becoming associated with two words that have consistently spooked markets for the last five years — especially this summer — and have sent investors running: distressed debt, or loans a country can’t pay back.

Hasenstab, based in San Mateo, California, manages Franklin Templeton’s Global Bond Fund and Global Total Return Fund, and he has been a so-called “vulture” investor — someone who buys up distressed assets, hoping to sell them for a big profit down the line — for years. These funds are where he made big bets on Ukraine’s ability to pay its debt. He’s the largest holder of Kiev’s bonds, with about $6.5 billion under management; in 2012, his position was $8 billion.

It’s a short-term loss for a money manager who likes to play the long game. But the Kiev gambit has investors spooked. In 2014, a record $14 billion flooded out Hasenstab’s two funds. According to Morningstar, an additional $2.5 billion left the Global Bond Fund in the first four months of 2015.

Franklin Templeton data indicate that as of June 30, the Global Total Return Fund has $8.3 billion in total net assets, while the Global Bond Fund has $66.5 billion.

A comparison with the Greek financial crisis is inevitable because Greece is also seeking a haircut from its creditors, the IMF, the European Central Bank, and the European Commission. Ukraine wants relief from a debt load of $23 billion between 2015 and 2018 — a paltry amount when compared with Greece. According to Reuters, as of the end of June, Athens is in hock to the tune of some 243 billion euros, or $266 billion.

But the stakes of the Ukraine debt standoff are arguably just as high as those in Greece. Ukraine wants the group of four creditors, holding about $9 billion in its distressed assets, to accept the 40 percent haircut. In June, the creditors’ committee rejected the proposal. Negotiations are ongoing, and without the IMF bailout, Ukraine is likely to go broke. The last thing the United States wants is a failed economic state that has areas Putin claims to be part of Russia. If Hasenstab is forced to take a loss, he’ll be in unfamiliar territory. According to Bloomberg data, his Global Bond Fund has averaged annual gains of 10.1 percent for the last decade.

But his bet on Ukraine could end that streak. As of June 30, the Global Bond Fund was down 1.93 percent. Last year, it also was down nearly 2 percent, ranking Hasenstab 54th among other global debt managers, Bloomberg data shows.

Hasenstab took an unconventional path to the top of the Wall Street food chain. He grew up in Olympia, Washington, and went to Carleton College, a small, academically rigorous liberal arts school in Minnesota. From there, he went to the Australian National University, where he received a master’s degree in economics. He then chose to get a Ph.D. in economics from the same university, shunning more traditional economics powerhouses like Harvard University or the University of Chicago. In 2001, he took a year off from Franklin Templeton to complete his doctorate. According to his biography on Franklin Templeton’s website, he climbed to the summit of Mount Everest in 2013. A Barron’s profile said he also trekked up Mount Kilimanjaro on his honeymoon with his wife, Mary Ann.

He also lacks the conceit that his wealth could afford him. A 2011 article in Citywire Global, a magazine focused on bonds, said Hasenstab “does self-effacing charm like nobody’s business but at times you almost will him to be a bit of a diva, more cut-throat, or for a man with such huge assets at his disposal, at least have a hint of arrogance about him.” The same piece compared him to money management legend Bill Gross, who founded Pacific Investment Management and ran its $270 billion Total Return Fund, once the world’s largest debt fund. Gross left for Janus Capital Group in 2014.

A 2014 Wall Street Journal profile quoted someone who described Hasenstab as a “monk” who often spends years before deciding to invest. He spends two-thirds of the year on the ground in countries he’s considering investing in. To beat jet lag, he jogs.

His money management style is also unconventional. Bond fund managers traditionally like to play it safe; returns on investments in debt pale in comparison to what can be made in the current six-year bull market. Hasenstab does the opposite of most of his peers: He makes his name by placing risky bets that countries close to financial ruin will return to growth and that emerging markets will actually emerge. In 2010, when investors were running from Europe’s sovereign debt crisis, he snatched up Irish government bonds at a low price after the bloated housing market there imploded. Hasenstab, who has been with Franklin Templeton since 1995, made a handsome profit when the European Central Bank bailed out Dublin. The Irish economy has now stabilized, something Hasenstab predicted would happen in a 2011 Wall Street Journal op-ed.

He did the same thing in Hungary, buying up its bonds on the cheap. He then watched his profits soar when Hungary’s dollar bond funds averaged a 54 percent return over the past three years. Hasenstab also made bets on debt in South Korea, Poland, and Uruguay.

Hasenstab’s strategy is celebrated by the financial press. In June, Forbes called him one of its “new money masters.” In 2014, the Economist called him the financial manager who invests “where others fear to tread.” He was named the top global bond fund manager by Bloomberg Markets magazine in 2010. That same year, Barron’s called him a “new world explorer.”

“He’s a brilliant guy,” said Alex Petrovic, a financial planner in Kansas City, Missouri, who has his clients’ money in Franklin Templeton funds. “But it’s a ‘what have you done for me lately’ business. I’m pulling for him because we have a pretty good slug of money with him.”

Petrovic compared Hasenstab to a star baseball pitcher taking the mound on the opening day of a new season. His past performance hints he’ll perform well, “but you can’t be sure what the results are going to be,” Petrovic told FP.

Complicating the debt talks is Russia. Kiev owes Moscow a $3 billion bond payment, due in December. In January 2015, Anton Siluanov said he could call for an early payment because Kiev’s debt-to-GDP ratio exceeded 60 percent of Ukraine’s GDP.

Hasenstab has been bullish on Ukraine, despite Putin’s meddling there. In an April 9, 2014, research note, published just weeks after Russia annexed Crimea, Hasenstab cited Ukraine’s debt-to-GDP ratio at the time — just over 40 percent — as one of the reasons he believed it would become a success.

“We think the current government has done an exceptional job, not just of tackling the short-term issues, but also setting the stage for Ukraine to potentially flourish over the next five to 10 years, putting in place very difficult but very important structural reforms,” Hasenstab wrote in the research note.

In an interview with FP, U.S. Commerce Secretary Penny Pritzker cited these reforms as reasons for U.S. companies to ignore the debt uncertainty and invest in Ukraine. She said fighting with forces backed by Putin is limited to a small portion of the country, and she disputed the broad perception that Ukraine is mired in chaos.

“Allowing Ukraine the opportunity to re-engage with the investment community is an important part of what the United States can do to help a country going through an extremely challenging and complex transition,” Pritzker said.

For years, corruption has been endemic in Ukraine. Transparency International’s Corruption Perceptions Index, the most trusted indicator of global graft, ranks Ukraine 142nd in the world, below Russia, which is ranked 136th. Politicians and businessmen have plundered state budgets: According to Reuters, from 2010 to 2014, one-fifth of the country’s national output was lost to illegal dealings.

“It’s profoundly in the self-interest of the United States to see Ukraine emerge … as prosperous, democratic, independent, and reform-oriented,” U.S. Vice President Joe Biden said at a July 13 Chamber of Commerce eventto urge American businesses to invest in Kiev’s economy. “Ukraine has a strategy and new laws to fight corruption.… Now they’ve got to put people in jail.”

Ukraine’s public is all too aware of its government’s shady dealings. In 2004, street protests helped pro-Europe presidential candidate Viktor Yushchenko push back against an attempt by then-Prime Minister Viktor Yanukovych, who is unabashedly pro-Russia, to rig an election. Yushchenko claimed he was poisoned in the run-up to the vote, and suspicion soon fell on Russia. In late February 2014, demonstrations on the streets of Kiev forced Yanukovych, who won the presidency in 2010, into Moscow’s arms. Less than a week later, Russian troops were in Crimea.

These protests have done little to effect economic change. Ukraine is now warning that its economy will shrink for a second year in a row, making the prospect that officials could come up with the cash all the less likely. Ukraine’s economy shrank 7.5 percent in 2014; Ukrainian officials expect it to contract an additional 5.5 percent this year.

But the World Bank’s forecast is direr. It said in April that Ukraine’s economy would shrink 7.5 percent by the start of 2016.

Also, Goldman Sachs predicts that Ukraine’s debt-to-GDP ratio will approach100 percent this year. Since the Crimea annexation, the value of the country’s currency, the hryvnia, has plummeted. Before Russian moved on Crimea, eight units of Ukraine’s currency, the hryvnia, was worth $1. Now, 22 are.

There are also growing concerns that Ukrainian politicians are watering down a reform package that the IMF says is needed for any bailout. The day before the July Chamber of Commerce event, Ukrainian President Petro Poroshenko promised to veto a foreign exchange loan bill if parliament failed to repeal it.

“I will defend Ukraine,” Poroshenko told Ukrainian television July 12.

Poul Thomsen, the IMF’s European Department director, responded in a statement that same day. The IMF has already given Ukraine $5 billion, but is holding back on handing over the rest of the $17.5 billion bailout.

“Reversing economic reforms for the sake of short-term gains has been detrimental to Ukraine’s economy in the past,” Thomsen said. “Ukraine needs to stay the course on reforms.”

Jaresko, Ukraine’s finance minister, said that this time, things will be different.

“We’re walking the walk. Everything we’re saying, we’re doing,” she said. “We want to continue to see more and more on anti-corruption. We’re looking for follow-through.” 

“That is our goal, to do what we promised,” Jaresko added.

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