Increased market fluctuations provide a rationale for investing in emerging economies rather than abandoning them.
In a world teeming with trade spats, geopolitical drama, and the looming specter of a potential US economic downturn, it might seem foolhardy to delve into investments in the turbulent waters of emerging markets. Yet, instead of running for the hills, this tumultuous climate is an opportunity to lean in, especially when we're talking about emerging market credit!
Traditional index-based strategies in public credit markets can be like blunt instruments in a surgeon's hands – they don’t cut it in today's precision-driven era. Emerging markets aren't all cut from the same cloth; some economies, sectors, and investments are riskier than others. For instance, a bet on Mexico's auto parts sector carries a different risk profile compared to a dollar-backed corporate loan in Turkey.
Indeed, conventional indices can put investors in a tight spot by lumping winners and losers together, often with unfortunate timing. Remember the plunge in the value of Russian and Ukrainian debt in 2022, post the invasion of Ukraine, or Argentina's almost 20% weighting in the JPMorgan Emerging Market Bond Index before the country's debt default later that year? These events resulted in widespread losses for investors compelled by the index to hold such significant weightings.
Avoid these pitfalls by employing a "barbell approach" that centers on high-conviction public credit trades and strongly secured private credit. After all, private credit has expanded to around $1.5 trillion by 2024, and it's now an alluring emerging markets opportunity too, given its high yields and secured loans!
Dollar-denominated, direct lending also sidesteps the risk of unfavorable currency swings, while hard collateral, such as factories, headquarters, or personal real estate, provides a buffer against default risk. Collateralized loans drive a sense of urgency to pay, ensuring proper outcomes, even when times get tough. For example, the owner of a family conglomerate is highly motivated to meet obligations if the family villa, passed down through generations, is on the line!
Sure, there are concerns about a slowdown in global growth. But remember, every cloud has a silver lining:
- Mexico's peso has remained resilient despite the ongoing trade drama, signaling continued investor confidence in the country.
- Eastern Europe, with Germany ramping up defense spending and economic activity, stands to gain from increased capital inflows and supply chain diversification.
- The Mercosur bloc's trade agreement with the EU offers economic fortitude to Latin American exporters.
Moreover, banks in emerging markets never completely reversed their retrenchment since the 2008 market meltdown, leaving small- to mid-size corporates starved of capital. No matter what happens with tariff negotiations or global economic conditions, well-structured credit remains in high demand, making Latin-American companies, such as Brazilian agriculture giants and European family conglomerates, prime candidates for working capital loans collateralized by inventories, assets, or cash flows.
With properly constructed legal covenants for enforcement of payment, investors can meet these needs while gaining exposure to dynamic, fast-growing industries in emerging markets in a secure manner.
Embrace uncertainty! By combining top-tier public and private credit in a barbell investment strategy and capitalizing on market swings for liquidity, investors can not only defend themselves in uncertain times but also thrive. Already, big-league investors are deploying this hybrid strategy in developed markets. Why not adopt a wiser approach to investing in emerging markets too?
Gramercy is an enthusiastic investor in emerging market public and private credit!
The barbell approach is a risk management strategy that strategically divvies up capital between opposing ends of the risk spectrum – typically ultra-conservative and high-risk assets – while avoiding moderate-risk, intermediate options. This creates a "barbell" shape in portfolio allocation, with the majority of the portfolio holding low-risk investments (core), while a smaller portion targets high-conviction, high-reward opportunities (satellite).
How the barbell approach works- Core allocation: 70-80% in stable, diversified assets, such as short-term bonds, cash equivalents, or investment-grade debt, to ensure liquidity and capital preservation.- Satellite allocation: 20-30% in high-risk, high-reward assets, such as long-duration bonds, emerging market corporate debt, or frontier market equities, to capture asymmetric upside.
By intentionally avoiding intermediate maturities or "middle-ground" assets, the strategy maximizes the benefits of both ends: stability from the core and growth potential from the satellite.
- The barbell approach in investing, as employed by Gramercy, strategically distributes capital between ultra-conservative and high-risk assets, such as short-term bonds and emerging market corporate debt, to maintain liquidity, ensure capital preservation, and capture asymmetric upside.
- The tumultuous climate of emerging markets, while challenging, offers a compelling opportunity to lean in, especially if investors adopt a precision-driven strategy like the barbell approach, which focuses on high-conviction public credit trades and secured private credit.
- Embracing a "barbell approach" means investing 70-80% in stable, diversified assets like short-term bonds, cash, or investment-grade debt for liquidity and capital preservation, and allocating 20-30% to high-risk, high-reward assets like long-duration bonds, dollar-denominated, direct lending, or emergent market corporate debt.
- By eschewing moderately risky assets, the barbell approach maximizes benefits from both ends, providing stability through core allocation and growth potential via satellite allocation, as demonstrated by the resilience of Mexico's peso and the attractiveness of Latin-American companies for working capital loans.
- In the midst of geopolitical drama and economic uncertainties, investors should consider adopting the barbell strategy not just in developed markets but also in emerging markets, as it offers a means to not only defend against market volatility but also prosper through well-structured, collateralized credit opportunities.
