La Perla is a slum in the heart of the tourist district of Old San Juan, Puerto Rico.Credit Christopher Gregory for The New York Times Related Links Forget, just for a moment, what you have heard about sharp-elbowed hedge funds, seizing Navy ships from deadbeat nations or pushing for federal investigations into the companies they are betting against.
In Puerto Rico, the hedge funds are there to help.
No, really, they say.
A group of 28 hedge funds and other investment firms are dispensing unofficial advice, providing public relations support and offering to lend money to a Puerto Rican government besieged by high unemployment and mistrust in the municipal bond market.
Hedge funds including Perry Capital, Fir Tree Partners and other members of the self-styled Ad Hoc Group of investors have bought $4.5 billion — roughly 10 percent of all the Puerto Rico government guaranteed and tax-supported bonds — making them a financial and political force on the island.
A goal of many of the hedge funds is to bolster the value of their bonds, many of which they snapped up at a discount when mutual funds and wealthy individuals — the typical holders of municipal bonds — dumped their holdings, fearing that the island was near financial calamity. The rosier picture the hedge fund group can paint, the more likely their investments gain in value, as other investors step in to buy the bonds.
"The hedge funds are controlling the narrative, and the government is a willing participant," said Robert Donahue, managing director at Municipal Market Advisors, a research group.
Acting as part sleuth and part coach, one of the hedge funds pointed out, for instance, that Puerto Rico was using outdated economic indicators — arguably making the fiscal picture look worse than it actually was, people briefed on the matter said.
Some of the others funds told officials that Puerto Rico had possibly shortchanged itself on as much as $1 billion in federal grants that the commonwealth never applied for. No detail seems too small: The government's sometimes rambling investor presentations should be more focused, one of the hedge funds advised.
The hedge funds are also offering to lend the island more money in case banks and other traditional lenders refuse. This standing offer could be put to the test in the next several weeks, when Puerto Rico is expected to sell about $900 million in short-term debt, according to people briefed on the matter. If JPMorgan Chase, which is likely to arrange financing, has trouble completing the deal, the hedge funds could step in.
All of this, of course, is not being done out of some deep-rooted affection for the Caribbean island, but to make money. The same hedge funds rooting for Puerto Rico's recovery have used less-friendly tactics in other recent investments, like shorting, or betting against, the euro and suing Argentina to pay its debts.
Indeed, the budding romance between Puerto Rico's leaders and hedge fund managers could be short-lived if the commonwealth strays from its efforts to balance its budget, shrink the government work force and reinvigorate the economy. Any financing by the hedge funds would probably force Puerto Rico to pay substantially higher interest rates than lenders have required in the past.
Publicly, finance officials in San Juan say they welcome any and all investors. The hedge fund suggestions, they add, are not that different from the unsolicited advice other investors have made in the past. Privately, the officials view the hedge funds with caution.
Last fall, when the hedge funds started investing in Puerto Rico, they talked directly to officials at the Government Development Bank, the commonwealth's fiscal agent. Now, the officials prefer that the hedge funds communicate their ideas to the development bank's financial adviser — Millstein & Company, the restructuring firm founded by a former United States Treasury official, Jim Millstein, people briefed on the matter say.
Still, the hedge funds are not shy about their willingness to help.
"The Ad Hoc Group has the capacity to assist Puerto Rico with potential funding needs, while the commonwealth continues to make necessary reforms to balance its budget, strengthen the economy and shore up the finances of its public utilities," the group's spokesman, Russell Grote, said in a statement.
Some of the island's politicians are also looking to tap that generosity. Last month, a candidate for governor of Puerto Rico in 2016 invited hedge funds and other asset managers to a fund-raiser at the Peninsula hotel in Midtown Manhattan, where the suggested contribution was $2,600 a person.
A year ago, hedge funds were bit players in Puerto Rico and municipal bonds in general, long regarded as a sleepy market dominated by mutual funds that buy and hold the same bonds for years.
Hedge funds began descending en masse to Puerto Rico last fall, after a wave of bond selling — particularly by rich Puerto Ricans — caused prices to fall. The funds made frequent trips to the island — visiting shopping malls in San Juan, meeting with government officials and speaking with pharmaceutical executives with major manufacturing plants there.
To show how irrational the municipal market had become, one hedge fund pointed out this summer that Puerto Rico bonds were trading at higher yields than Iraq and Ukraine — values that suggested that the commonwealth was riskier than a war zone.
Over the last year, the hedge funds have bought the government's general obligation bonds, bonds used to prop up public employee pensions, and bonds that built the island's highways.
Big-name hedge fund firms like the $20 billion BlueMountain Capital and David Tepper's Appaloosa Management scooped up debt owed by the island's electric power authority.
In total, 60 hedge funds have come to hold about $16 billion, or 22 percent, of the island's $70 billion of public debt — both government and public corporations — according to the ratings firm Fitch.
The bet seemed to pay off, as yields on many Puerto Rico bonds — which move in the opposite direction from its prices — began to fall through the winter, according to Thomson Reuters Municipal Market Data.
But their faith was tested in late June, when the government enacted a law to restructure the debts of the island's public corporations, a right the commonwealth previously lacked. Like states, Puerto Rico cannot seek federal bankruptcy protection.
The new law split the hedge funds into essentially two camps. The majority of the Ad Hoc Group's holdings are general obligation bonds and the government development bank's bonds, which are exempt from restructuring. The law, however, allowed the government to cut billions of dollars of debt owned by some of the island's public corporations that provide services like electricity.
BlueMountain, which manages funds that own $400 million of the electrical authority bonds d sued the governor, arguing that the restructuring law violated the United States Constitution.
The electrical authority recently agreed with BlueMountain and other creditors to come up with a voluntary restructuring by next March. That most likely sets up a showdown between the island's powerful public worker unions, representing the electrical workers, and the hedge funds and banks over which group should take the biggest cuts.
Still, the prices of some bonds have been on the rise, as traditional investors have started to tiptoe back into the market — potentially giving the hedge funds their exit, said Mr. Donahue, the municipal market analyst.
"There are a lot of portfolio managers who could be tempted by the hedge funds' spin," he said. "But they will be looking through rose-colored glasses."
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