Economics & Growth | Emerging Markets
Podcast Transcript: Robert Koenigsberger on What Everyone Gets Wrong About Emerging Markets
- By Bilal Hafeez
- 40 min read
This is an edited transcript of our podcast episode with Robert Koenigsberger, published 14 April 2023. Robert is Founder, Chief Investment Officer and the Managing Partner of the $5bn EM fund, Gramercy. He founded Gramercy in 1998. Robert has 36 years of investment experience dedicated to emerging markets with a specialization in distressed opportunistic credit strategies. He is a member of Gramercy’s Management Team and is Co-Chair of the Risk Management Committee. In this podcast, we discuss common misconceptions about EM, why the safest EM may not be attractive, illusion of liquidity, and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.
Introduction
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Now onto this episode’s guest, Robert Koenigsberger. Robert is the founder, chief investment officer and the managing partner of the $5 billion emerging market fund, Gramercy. He founded Gramercy in 1998, and Robert has over 36 years of investment experience dedicated to emerging markets with a specialisation in distressed opportunistic credit strategies. Now onto our conversation.
Bilal Hafeez (01:29):
Hello, Robert, and it’s great to have you on the podcast show. Welcome to the show.
Robert Koenigsberger (01:33):
Thank you very much for having me. It’s a pleasure.
Bilal Hafeez (01:35):
Now, before I go into the meat of our conversation, I do always like to ask my guests something about their origin stories. So tell me, where did you go to university? What did you study? Was it inevitable you’d end up in finance?
Robert Koenigsberger (01:47):
Sure, yeah. And I feel lucky that I was able to start at university, have it anchored in emerging markets, if you will, and still be doing it 35, 40 years later. So, I’m from California. I went to University of California in San Diego. Interestingly, I went there for two reasons, one to study business, but also it had a great beach right in front of the dorms. And so I always knew I wanted to be in business, but I didn’t know really what that meant at 18. They had something called management science there, and it turned out to be not business, but some form of economics, which was not that exciting to me at the time. So, I started taking courses in political science and history of Latin America and a minor in economics, and I did that because my family is originally from Guatemala, and I just wanted to understand a little bit about where my family was from and from there I just really loved both sides, the history, the politics and just kept going with that.
Bilal Hafeez (02:44):
That’s great. And then what was your first job out of school?
Robert Koenigsberger (02:47):
So my first job was interesting because as I got to the end of my studies at UC San Diego, my parents told me I had to get a job and I’d also been invited to do an honours thesis. So being the lazy individual that I am, I tried to put those two things together and I said, okay, well, what are the jobs in Latin America today? What’s it all about? Unfortunately, the biggest issue in Latin America in 1986 when I did my thesis was the Latin American debt crisis. So, I did my thesis on the historical origins and implications of the Latin American debt crisis. And along the way, I met a gentleman who had been the finance minister of Peru. So I did a case study on Peru, and ultimately I was able to lever that into my first job working with this small boutique in California dealing with the resolution of the Latin American debt crisis.
Bilal Hafeez (03:38):
Okay, so you did showcase in Latin American, history at university, then you jumped straight into analysing the debt crisis in the region at the time as well. Presumably that was the start of your financial career then, and so I mean, what was it about the financial industry that made you want to stay in it, and you’ve been in it ever since then?
Robert Koenigsberger (03:58):
Yeah. That’s a great question. And to be honest, I didn’t come at it from finance per se. I came at it from Latin America first. And quite frankly in that first job, which I did for about three and a half years, I realised there were a lot of financial aspects to dealing with finance in Latin America. And that’s why I actually decided to go away from liberal arts and towards a master’s in finance at the Wharton School after my first four years. And that’s when I realised I really want to be Latin America. I really want to be emerging markets and I really want to do finance. But I had no formal training in finance, so that’s kind of why I went back to school in early ’90s.
Bilal Hafeez (04:33):
Okay, great. Good. Good. And then in terms of asset management, where did you get your formative experience?
Robert Koenigsberger (04:41):
So after I worked for this gentleman for four years and had done graduate school, I did something I didn’t think I was going to do, which was I went and worked on Wall Street for a couple of years, and I ultimately thought I’ll just stay in New York and the East Coast for a couple of years and then I’ll go back to California and start a boutique, I wouldn’t have called it a boutique asset management firm, but a boutique dealing with Latin American finance, whatever that might mean. And at Merrill Lynch, then Lehman Brothers, I kind of ran their sovereign debt restructuring businesses and deployed bank capital, but also went alongside our clients.
And I started realising that it’s difficult to advocate for capital and for clients at a bank because there’s so many different conflicts of interest, investment banking and research and what have you. And that’s ultimately when I decided to start Gramercy, was back in 1998 when I remember sitting with the Russian Federation when they were an obligor to the bank. And this was actually in ’95, ’96 when I was at Merrill, and I was just concerned about getting the capital of the bank and of our clients back. I had someone from investment banking next to me and they were actually literally calling the Russians the client. And I’m, ‘No, no, they’re the obligor.’ And then that’s when I realised there’s so many conflicts to manage in an institution. And I started Gramercy because I just wanted to be myopically focused on one thing, which was getting returns for our clients without having any institutional constraints to doing so.
Bilal Hafeez (06:03):
And then you said you started Gramercy where you’re still at Gramercy today, to this day, in 1998. Now obviously 1998 is quite a famous year. We have the LTCM crisis, the Russia deval. Why did you start in ’98?
Robert Koenigsberger (06:16):
So it’s interesting. So I decided to leave Lehman in about February or March of 1998 and had been offered or promised Steed Capital from a client of mine that ironically was highly invested in Russia, and they said, ‘Hey, Robert, we’re looking to diversify from Russia. So if you leave, we’ll seed you, we think it’s interesting the way you’re approaching the market.’ Well, so I left Lehman in April or May, and I waited around for the check. By June they said the check’s not coming, which seemed catastrophic at the time. I just quit my job. I’m building a house. I just had my second kid. But actually it was really fortunate because had we launched in June or July, we would’ve been suffering from perhaps what you mentioned, long term in Russia and what have you. So the frustrating part was it took until April ’99 to raise capital to start the firm. The good news was we got to buy things on the other side of both those crises and turned out to be quite fortunate.
Bilal Hafeez (07:11):
Yeah, that’s great. And then we had a few more EM crises around that time, Brazil, I guess Turkey and Argentina, I suppose, in the early 2000s. So you’ve had other minefields to navigate as well.
Robert Koenigsberger (07:24):
Yeah, and quite frankly, when we started managing capital in ’99, we looked around and said, okay, well, there’s this index that JP Morgan has created, but we felt that it quite frankly created too much legitimacy to an asset class that was still fledgling. And we felt, to your point, all these crises going on, it felt like the patient going in and out of the emergency room and not a place where you should be thinking about a strategic allocation to emerging market debt. So our first decade, we basically chased this flu that went around the world starting with the ‘tequila crisis’, the Asian debt crisis. I guess the crisis in Brazil, the vodka crisis in Russia, and ultimately the tango crisis in Argentina.
So we used our capital and our skillset, and we were very much a hedge fund back then, an emerging market hedge fund. And we did that in total global financial crisis when I would argue that distress was no longer idiosyncratic, but it had become systemic. And then we stepped back and we said, well, one, emerging markets have evolved quite a bit. We’re distressed. Do we just do distress globally around the world? Do we do NPLs in Portugal? Like no, we are emerging markets. And that’s when we hit the tagline, We Are EM. And since then we have really been on a path of transforming from an emerging market hedge fund to an investment management firm dedicated to emerging markets and with a lot more people, return streams, and basically having all the tools in the toolbox that we and our clients really need to be able to manage emerging markets intelligently.
Common Misconceptions About EM
Bilal Hafeez (08:54):
Now, many investors still have this association to EM of crises often from the ’90s and the early 2000s. That’s their association that they have, whereas the way you’re describing it about evolution, you reframed how you should look at EM, where it’s much more mature, there’s more diversification across EM. So it’s not the old EM that people may have in their memories. So what would you say are some of the big misconceptions about EM today that you think are not relevant or not appropriate?
Robert Koenigsberger (09:28):
And look, these crises continue. I mean, in the 25 years that we’ve been at Gramercy, there’s been 11 dislocations starting from Mexico all the way to, I guess, Russia, Ukraine last year. So I wouldn’t argue that it’s matured to the point where those dislocations won’t occur. What I think for us has matured is the approach, and that gets into the misconceptions, which is, it’s funny when we look at some allocators, they make this assumption that the safest way to go into emerging markets debt is to just buy the liquid emerging market debt. Hey, we can change our mind in three days and we can get all our capital back and it’s liquid.
And the challenge I have with that is, one, most of these investors are going to have a long-term allocation to emerging markets. So then one has to think about, well, what’s the opportunity cost of parking in liquidity? And in a place like Mexico, Pemex, maybe you get 5% for a bond, but if you go slightly less liquid, you can get kind of mid-teens to lend to Pemex suppliers and get better collateral than what you have with Devon. So I would say there’s like a thousand basis points of opportunity cost in that example. So, one, I think they give up a lot of return, but, two-
Why the Safest EM May Not Be Attractive
Bilal Hafeez (10:37):
And just on that example, let’s just talk through that example because you suggested that in some ways, well, I guess you are saying it’s safer. So Pemex trades, say 5%, and what you’re saying is a better trade actually is to go long supplies to Pemex and get them to offer collateral. So it’s a collateralized lending that you do to them, and then you can get a thousand basis points over.
Robert Koenigsberger (11:03):
Exactly, doing direct loans, a bespoke direct loan that we structure. You pick up Pemex receivable as your correlated collateral, but then you get uncorrelated collateral, maybe property or a hotel, whatever the family group might have is uncorrelated collateral. And look, we don’t want that uncorrelated collateral, but we know that the sponsor or the owner of the company does. So I would argue that in that instance you have higher yield, like you said, a thousand basis points over, but you have less risk because of all this collateral. So of course there’s got to be some give. The give is you give up some liquidity. Now we’re not talking about a 10-year infrastructure bond, we’re talking about nine to 12 months. And again, this gets back to the opportunity cost.
Now the other side of that, however, is remember people are parking in liquidity because if they want liquidity, they believe it will be there. And the challenge has been, and if you go back to all 11 of those dislocations that I talked about, the average dislocation was like 20, 22%. It happens relatively quickly, peak to trough, like five months. So the challenge has been that when people go to get their liquidity, it’s there, but it’s down 20%. And I guess that gets into the whole ETFs as well, which is, I don’t think that just because an ETF is supposedly liquid that the underlying portfolio is liquid. You’ve seen in times of crisis, particularly these ETFs go to liquidate their positions. Well, it’s down quite a bit. So I don’t think you can create liquidity where liquidity doesn’t exist. And I don’t think you should rely upon it, particularly if you’re going to be strategically allocated for a long period of time. And a thousand basis points is quite a bit. And we have that example all over emerging markets, whether it’s Turkey or Mexico or Peru or Brazil, what have you.
Bilal Hafeez (12:44):
In order to structure those deals, do you need to have people on the ground? I mean, presumably you have to know the whole legal set-up of the country because they’re private deals and you need to have some confidence in the system in order for the contract to be watertight.
Robert Koenigsberger (12:59):
Yeah, absolutely. So the way that we approach it is we have our own direct lending platforms in these countries. They tend to be partnerships with people that have a really good skillset, really good pipelines, really good ability to manage the risk locally, but they lack the capital. So it makes for a very complimentary relationship. For example, we have a group in Turkey called Crescent. They do trade finance, I would argue they actually do trade, they have warehouses and they keep the collateral in their warehouse and they’ll give a little bit of the underlying commodity, if you will, and then get a receivable from off door. So it’s very secure, but it’s a lot of work. Our partner in Mexico, MNJ, has close to 75 people doing the supplier finance. So it’s labour-intensive, but there’s a lot of extra yield to be had.
The Problem With EM Indices
Bilal Hafeez (13:46):
Yeah. Okay. So that’s a clear one where you’re essentially saying that the simple liquid trade, there’s actually better returns that you can get. And then secondly, the illusion of that liquidity, it’s an illusion that liquidity often isn’t there at the price you want it in any case. So there’s a different way of looking at that. So that makes sense. What are the misconceptions you think there are about EM?
Robert Koenigsberger (14:10):
Well, look, I mean emerging markets as a label, to me, is a misconception. So if you go back to the period you talked about before in the ’90s, it was much more of a homogeneous asset class and things kind of went up and down together. Today, any given theme for emerging market countries, corporations, quasi could have different outcomes. I mean, just take energy at a hundred and energy at zero where we have energy exporters and we have energy importers, take any commodity, take food stuffs, what have you. So we’re starting to see a dispersion of actual outcomes in emerging markets relative to global themes that is perhaps a little bit different than when people say EM, they go, ‘Well, that’s bad for EM.’ Like oil at $80 is bad, it’s inflation. Well, I don’t know, the Mexicans think it’s pretty good. They’re exporting. So I’d say it’s become a difficult label or misconception.
Bilal Hafeez (15:06):
And presumably-
Robert Koenigsberger (15:07):
China and Sri Lanka both are called emerging markets. It tells you there’s a lot in between.
Bilal Hafeez (15:13):
Absolutely. And I often think China, I mean, while it’s kind of classified as EM, it’s not really EM. In many ways, it’s the second-biggest economy in the world, and in some ways it’s more important for the global economy than Europe is. But in terms of asset allocation then, people often, the way they look at EM is they’ll put a 5% allocation to some EM index often like EMBI, some external debt one or some local market debt one, and it’s a very sort of static approach. Now you have a different approach to asset allocation than that type of approach. Can you talk a bit more about that?
Robert Koenigsberger (15:47):
Yeah, and I think there’s a couple of things to unpack there, which is, one, an index-based approach to our market to begin with, emerging markets debt. And I think indices are, again, people feel safe in an index, but actually in emerging markets debt, I think indices have been cruel to investors. And what do I mean by that? So when we started in 1999, we looked at the index and the index had 18% weighting to Argentina. Now we were already writing analysis internally. Our research was saying that this country’s going to default. It looked like the slowest train wreck in history in terms of heading towards the wall default. So why would we want to put 18% of our capital there? Now remember, to not have anything in there is also risky, because you’re short 18% of an index. So it forces behaviour that isn’t necessarily consistent with your analysis. So that’s one challenge.
The approach we’d take, if you give us a blank piece of paper, is to take much more of a multi-asset approach to it to be dynamic. If a market’s going up and down, do you just want to be whipped around all the time, or do you want to think about an asset allocation that could put you in different return streams that have proven to be uncorrelated and be able to take advantage of that volatility? And so the way we think about it is a bit of a barbell. On one end, we have high conviction private debt that I talked about, the example of the Pemex supplier, and high-conviction investment grade and high-yield debt in emerging markets. And that’s kind of like a constant source of yield that’s always available in the marketplace. That’s a pretty good place to anchor because if you think about it, hey, you’re getting 12% on average for your private debt and 8% for your high-conviction public debt, eight plus 12, 20, divide by two, that’s 10. That’s a pretty good source of current yield that’s always there.
And then on the other side, take advantage of this volatility, this distress that can be idiosyncratic, it can be a Turkey, it can be an Argentina, or it can be systemic, it can be COVID dislocation or whatever it may be. And to be able to look at opportunistic credit and special situations, which are more like alternative sources of yield or energy, it’s not always raining. It’s not always windy. So you can only tap into it when it’s there. When it’s at the base, you’ll peek into it, but when it goes up to the peak, you can turn it off and go somewhere else.
So when we have this multi-asset approach to the market, it relies upon this private credit. That’s the special sauce. That’s the huge differentiator. And the way that we’ve constructed these multi-asset partnerships with our clients, it also solves for, really another big challenge in asset allocation in emerging markets, which is most allocators lack the governance and the courage to allocate. So what I mean by the governance, if I go to a typical sovereign wealth fund, pension fund, what have you, it’s a lot of work to underwrite a manager, to underwrite a return stream. And that’s why it ends up as a strategic five-year allocation. But when you go to them and say, ‘Hey, in the future,’ like we did… Mohamed El-Erian and I wrote a piece in the end of 2019, ‘We think the market’s going to dislocate, it’s overvalued, and we’re not sure what’s going to create it, but when it does, it’ll then be the 10th dislocation we’ve seen and you should get ready for it and attack it.’
And so I remember calling people in April and May, we had no idea that COVID would be the straw that broke the camel’s back, but I remember conversations with, ‘Yeah, you’re right, Robert. It totally makes sense. We can lean in here. It’s April, I think I can get you into our October board meeting.’ So one of the reasons that we’ve got these multi-asset partnerships is so that we can solve for that governance issue. And also there’s the courage issue. It’s like, as you said before, people have had challenging experiences in emerging markets, and I think it’s because they’ve taken the wrong governance construct and the wrong lack of asset allocation approach or tactical asset allocation. So that’s how we try and solve it, with our approach to the top down, if you will.
Working With Mohamed El-Erian
Bilal Hafeez (19:46):
And you mentioned Mohamed El-Erian, so I should just mention he’s the chairman of Gramercy, hence you mentioned his name.
Robert Koenigsberger (19:53):
That’s right. So Mohamed, he was first an investor with us at Gramercy back in the late ’18, ’19 era, kind of leaned in and said, ‘Hey, it’s really interesting. There’s something different going on here.’ He became a senior advisor first and a senior advisor with real meat on the bones. He really helped us think about how do we decode what’s going on in the world, how do we have that information and influence our portfolios? And maybe from time to time, maybe even impose a view. And quite frankly, I never had the confidence as a, I’m not an economist, and so I never felt like I have a better understanding than all the other portfolio managers on the platform. So get out of this or go into that.
But with Mohamed, we were able to kind of institutionalise a top-down framework so that we had that confidence, myself as the CIO, but also the PMs, that we were not buying good homes in bad neighbourhoods and that we understood what was going on. Probably the best thing that happened to me during COVID was Mohamed was sitting on the West Coast and he’s like, ‘Hey, we’re all on Zoom now. I think I could have a bigger impact on the business and on the portfolios.’ And so that’s when he became chair. And so we feel very fortunate to be with him every day. And it’s great to have his mind as we vet some of these issues. I mean, I wasn’t thinking about what a sudden stop in an economy meant in 2020 and how difficult the startup would be in supply bottlenecks. He’s really helped inform and influence our portfolios.
Why Volatility Is Your Friend
Bilal Hafeez (21:20):
No, that’s great. No, that’s great. And yeah, you’re very fortunate to have someone of his level of experience involved in the company. Now you’ve been recently writing about different themes that you’re focused on. There’s some of the usual ones like recession watch, inflation and so on. But one that you did mention is about volatility, which struck me. So can you talk a bit more about what you mean by volatility and why in your eyes it’s a source of opportunity for you?
Robert Koenigsberger (21:47):
Yeah, I mean, I think volatility was one of the six themes that we identified in our most recent top downer and at year-end. And it’s interesting because in the era of quantitative easing and financial repression, everybody bellyached that expected returns are so low and there was no volatility, nothing to do here, it’s like everything’s boring. And now there’s volatility and everybody’s bellyaching again. And we actually, as we wrote in the piece, it’s like, I think volatility is your friend if you embrace it, if you anticipate it and you embrace it and you plan the trade and trade the plan, as we like to say. Volatility in emerging markets tends to present itself as these big dislocations. And one has to understand why these dislocations occur because typically it hasn’t been some endogenous risk in emerging markets. It’s been some sort of exogenous factor. But what it’s really been is a structural change in the way liquidity is provided in our market or not provided that creates this volatility. So what do I mean?
When inflows come to emerging markets, there’s inelastic supply. So there’s always an issuer that’s willing to sell a bond at a price. Brazil has been at four, at 14, and everything in between. However, when there’s an outflow, there’s not inelastic demand, the market gaps. There is no buyer of last resort. And when I traded at Lehman Brothers in, say, 1997 during the Asian debt crisis, I remember creating the Russian benchmark bond on 27 different price handles continuously with quarter point bid offer spreads. Today, it just gaps the whole 27 points and then it restarts. That’s the opportunity to embrace the volatility on both sides.
And we also wrote about that at the end of this quarter and end of last year, which is fourth quarter last year, we said, ‘Hey, all aboard. This volatility, this dislocation is overdone.’ Well, it ripped in the fourth quarter. And we said, ‘Hey, time to be cautious here,’ which means take some chips off the table, embrace both sides of the volatility. People get giddy when volatility takes them to higher levels. But again, remember what it felt like at those lower levels. And what do they say? Bulls make money, bears make money, and the pigs get slaughtered. So plan the trade and trade the plan.
How to Trade Ukraine
Bilal Hafeez (24:04):
That’s great. And of course, we have had some EM-specific issues over the past year. The most noticeable one, I suppose, is the Russia-Ukraine war. So can you talk a bit about how you approached, well, what your positions were going into the invasion, and then how you look at things since and its impact on broader EM?
Robert Koenigsberger (24:22):
Sure, yeah, a bit to unpack there. So the first part is pre… The invasion was February 24, 2022. And when Russia invaded Ukraine, Gramercy had zero sovereign risk of Russia and Ukraine. And we feel very fortunate, but also it came from the analysis that Petar, our analyst did. And he came to one of our investment committees in early January, and he said, ‘I think there’s a 40% chance that Russia will invade Ukraine. I think it’ll probably be a small invasion, it’ll be the east, Donbas, et cetera. And then prices will drop 10 and 20 points.’ And all we heard was invasion and we’re like, it sounded like a coin toss for invasion.
So, for us, it was pretty easy in January to say, you know what, let’s look at prices. Russia is trading at 100 to 150. There’s one bond, the Russia ’28s trade at 150. Where’s that bond going to go if it invades? And we’re like, it could drop 50 points. It actually ended up dropping 50 to 80 points depending on the bond. And then where was Ukraine trading? And if we were wrong about invasion, maybe Russia would just stay flat or go up five points. In Ukraine, the bonds were trading at 80 cents. So okay, no invasion, maybe it’s 85, but invasion, maybe it’s 20. So it just made no sense to be involved.
Bilal Hafeez (25:44):
Was there a playbook you were looking at? Because you said 80, 20, you’ve got numbers in your head. Was that just from sort of intangible experience or was there some reference point historically that you were thinking this is just like that event?
Robert Koenigsberger (25:57):
It’s a combination. And one of the things that we’re fortunate to have is kind of a distressed DNA and to kind of understand what happens when Humpty Dumpty falls off the wall. We started that analysis with default and recovery and then you overlay illiquidity on that. So we weren’t necessarily saying that Ukraine would default, but typically what happens in these gaps is things go down towards default. And if you look at assets that aren’t in default today, they price like default in part because of liquidity. Argentina at 30 cents or Ecuador, El Salvador, you name it, Pakistan or what have you. Things don’t hang out in the 50s anymore. They just kind of go down to the 20s and 30s. So that was kind of the analysis that we did. It’s funny, it’s like in emerging markets, either things trade at the yield they’re supposed to trade at or they just start trading at dollar price. There’s just nothing in between, right?
Bilal Hafeez (26:52):
Yeah.
Robert Koenigsberger (26:52):
So at 150, Russia ’28s were trading at some spread. At 50 cents, it’s just 50 cents. It’s not about yield or spread anymore. So then as we think about post invasion, Russia and Ukraine, one of the very first investments we did in Gramercy in 1999 was to buy Russian default to debt at 6 cents. So if you told me that in 2022 that there would be Russian debt trading at 30 cents and that we weren’t buying it, I wouldn’t have believed it. However, in our opinion, Russia became uninvestable. First, legally became uninvestable here in the United States.
So from an OFAC perspective, from a US treasury perspective, analysing Russia became a theoretical exercise because you couldn’t execute on it anyway, which quite frankly, I think is fortunate because I think that it’s also uninvestable fundamentally. We have no clue what post-Putin Russia is going to look like. I actually think it depends on whether Russia is treated like Germany after World War I or Germany after World War II, i.e., is it ostracised or embraced? And it reminds me of the Yeltsin days back in the ’90s when Yeltsin would get sick and go to the hospital, you had to determine which hospital because one hospital was where he went to get sober and the other one was where he went to have cardiac surgeries and what have you. And the reason it mattered because if he had a heart issue and he didn’t make it, none of us knew what post-Yeltsin Russia would look like. And I think we’re full circle again today, which is we have no idea what post-Putin Russia looks like. So, how do you think about investing? I think that becomes uninvestable.
Ukraine’s a little bit more simple. Get back to that 20 cents and recovery value. We stayed out of Ukraine unless it was in the 20s early on. We were opportunistic at one point. And then when we started thinking, unfortunately, this war has gone on and on and on, there’s been massive amounts of aid that has come from the G7 and what have you. And one needs to start thinking about the geopolitics of what a debt restructuring might look like, not just the debt sustainability. If you look at a typical analysis of an analyst on the street, they’ll do the pure debt sustainability, which is kind of funny because how do you even know what their GDP is going to be when you don’t know what their territory is going to be? But let’s just say they can figure that out and they’ll say that they only need a 20% haircut because that sustainability looks okay.
I would argue that there’s going to be geopolitics that when the IMF comes in, there’ll be debt burdens, PSI, private sector involvement, but the G7’s going to start to impose its will and it’s put in tens of billions of dollars. It will put more hundreds of billions of dollars into the reconstruction of Ukraine. And there’s going to be a condition precedent, which is Poland and Bulgaria, ’93, ’94 were so important to the West that they actually gave a 50% haircut and imposed that on commercial accreditors. In Iraq, it was 85% NPD debt reduction after that war. So until Ukraine got closer to Iraqi levels of 15 cents, to us it was uninteresting. 16, 17 cents, it starts to at least warrant consideration.
Bilal Hafeez (29:57):
Yeah. But that’s very interesting. And in terms of the Ukrainian restructuring, what’s the timeline on this?
Robert Koenigsberger (30:04):
I mean, nobody knows, right? And the other thing they don’t know is what the posture will be of the government in Ukraine on the other side of peace and what peace looks like. But I wouldn’t be surprised if it happens relatively swiftly because re-accessing the capital markets in a period of reconstruction will be really important. Having a reliable risk-fee rate for all the investment in FDI that will come into Ukraine on the other side of war becomes important. But swift doesn’t necessarily mean low haircut.
Bilal Hafeez (30:36):
Okay, understood. Yeah, lots of scars that you’ve had from previous periods around that.
Robert Koenigsberger (30:42):
And look, I mean the role that we’ve taken in these debt restructurings for 25 years at Gramercy is to be consensual and constructive. And I think there’s something that we’ll be able to offer in the Ukrainian thing, which is there’s going to have to be some notion of patient capital, like to partner with Ukraine on the other side. And there’s structures to do that. They’ve done it in the past where you can provide a haircut, you can provide a window for the recovery of Ukraine, but you can also partner with them in that recovery and exchange a haircut maybe for some sort of GDP recovery warrant. And so we’ve got some ideas. We’ve been doing this for quite some time and hopefully from a peace perspective it will be sooner rather than later that we have the opportunity to sit down. But many folks didn’t think it would last as long as it has.
Finding Value in China Property
Bilal Hafeez (31:26):
Yeah. If we pivot to another part of the world, China, in your latest automatics, you mentioned China reopening. Aside from the macro, what are for you the credit opportunities within China?
Robert Koenigsberger (31:38):
And there’s this matrix, there’s this theme that keeps winding in your questions, which is there’s a lot of things that indices have done to people. So I talked about Argentina, I forgot to mention that I think if you were index long, just market weight, Russia and Ukraine, it cost you about 800 basis points last year. China’s another great example. There’s been big weights to China property in the emerging market corporate index. For us, looking at China, and we think from a broad perspective, China is challenging, particularly when you can’t, well, there’s issues around property rights and bonds are a collection of property rights, so it’s really hard to affect those particularly on an offshore basis. But also, the rules of the game seem to change there. So to make a big macro call and say, ‘Hey, we like China, it’s really cheap.’ I think it is really challenging.
For a very long time we stayed out of China property because it traded at 100, traded at par. There were bonds issued by offshore SPVs that had no assets, so asymmetry in your face. But that changed last year when a company like Country Garden started trading at 8 cents and it was still performing and is still performing to this day. It felt like the fear and the illiquidity had all come together to provide an opportunity, an opportunistic investment potential in one little sector of China. And for us China property, the call we had to make in the fourth quarter when we got involved was, one, that the property sector was too big a part of the economy to have happen what many feared, that they would just toss the keys and that all these projects would become zombie projects and what have you. It’s 25 to 35% of GDP depending on how you calculate it, and it’s also an integral part of the value chain within China itself.
So we felt that, one, it’s too important. Two, access going forward to foreign capital is going to be important to the sector. A bank can’t lend to the mortgager, to the person buying the house and lend to the company. You can’t have two loans against the same sets of production and collateral and what have you. So part of our thesis was that they’re going to want to re-access the capital markets. Well, how do you do that? You have consensual debt restructurings, and that’s what we’re starting to see. Evergrande and Sunak and others have started to come forward with debt restructuring.
And that was the third thing that we had to get right, which is, when we spoke with CFOs and CEOs in China, and remember they were in lockdown. I remember one in particular was in his bathroom with the shower screen, and it’s kind of like what you have behind you there, the background. And I realised that these people had never done a debt restructuring before. There’s certainly constraints, so you can understand why things are going slower than would’ve been expected. But none of them were talking about tossing the keys. None of them were talking about insolvency. None of them were talking about liquidation, yet it was trading at liquidation values. And we saw that in Evergrande because now the liquidation value has been calculated at 6 or 7 cents, and that’s where the bonds were trading. So there seems to be good option value in something other than liquidation, which isn’t a base case by any means.
The Politics of Latin America
Bilal Hafeez (34:44):
Yeah, understood. Yeah, there’s opportunities everywhere, I guess. And you need to, I suppose, look at what the market’s pricing and the realistic outcome. Now Latin America is really interesting this year. We have an election in Argentina, there was an election in Brazil, and we’re kind of seeing the repercussions of that. Mexico’s interesting as always. So how do you look at Latin America at the moment?
Robert Koenigsberger (35:07):
Latin America’s always about the politics and the politics have been volatile and the politics always seem to be the pendulum swings in one direction or the other. It wasn’t that long ago there was this clear line between the Pacific Alliance and the other countries. Peru and Chile were like the Switzerlands of Latin America and they were priced as such, and both have had political disruptions. Peru’s had a series of political disruptions, but Chile with their new president, their attempt at rewriting their constitution, it’s created political volatility. Again, volatility is an opportunity if you embrace it. Columbia with more left leaning government as well.
You mentioned Mexico and we just talked about China. And one of the things that we learned about the combination of China and COVID was that it wasn’t just about just in time and lowest price anymore, that manufacturers were going to have to think about resilience and the ability to deliver goods no matter what happens. And then you take the geopolitics of what’s going on with the United States and China and Mexico is just a big winner. And as challenged as we thought the AMLO administration would be, they behaved well for the most part as it relates to the expectations of the markets, but they become this huge beneficiary of this whole onshoring and what have you. So we think Mexico, even the peso is going to benefit from that. And so we think it’s a great example, one of the winners. We think Mexico’s going to be one of the winners. That’s one end of the barbell.
The other end of the barbell is maybe something like Argentina, which has its challenges, but it’s more than priced relative to those challenges. There’s an election in Argentina this year. We see bonds, I think they paid around 30 cents. I’ve never been involved in an Argentine debt restructuring that wasn’t worth at least 32 cents. Back in ’05, which was a ridiculously 66 and two-thirds haircut. So it seems to be overpriced, but we have a light at the end of the tunnel, that’s not necessarily a train, and that’s an election in October. We wouldn’t be surprised to see a repeat of what happened when it went from Cristina Kirchner to Macri. And now when it goes from Alberto Fernández to someone in the opposition, we think you’ll see maybe history won’t repeat, but it will rhyme and we would expect these 30 cent securities to be worth materially more, maybe 45, 50. There’s not a great story there today like maybe there is in Mexico, but I think there’s great potential given where things are priced.
Bilal Hafeez (37:33):
Okay. And Brazil, Lula came in at the macro level. There’s been some questions around the fiscal side versus the central bank, so it’s been a bit rocky. How do you see Brazil at the moment?
Robert Koenigsberger (37:46): Yeah, it’s interesting because it probably hasn’t played out exactly the way I would’ve expected. I remember Brazil 2002 Lula, and we were all really, really concerned about this guy coming from the left, and all of a sudden he’s surprised to the upside. And so you had all the chaos and all the dislocation before the election or during the election. And I think the market got comfortable that the second coming of Lula is going to be okay. And as you mentioned, there’s been all sorts of challenges. And so I would’ve thought that maybe the market would freak out a little bit about Lula during the election period, and then he would outperform those low expectations. It seems like expectations were too high and now he’s underperforming those expectations. The global economy is very different in 2023 than it was in 2002 when he came in.
Turkey’s Elections
Bilal Hafeez (38:36):
Yeah. And another election that is coming up is first my side of the world in Europe, Turkey. Turkey’s been a challenging market in recent years with FX markets in some ways being shut down for external investors. We have elections coming up. What are your thoughts on how to approach Turkey, at least as an outside investor?
Robert Koenigsberger (38:57):
The approach, the outcome, the outlook, the expectation for Turkey has been very volatile. I spend a lot of time in Turkey. My wife is Turkish. We’re there probably four, six, eight weeks a year. And Turkey’s a place that we’ve definitely relied upon private credit and asset-backed credit as opposed to public credit. I think Turkey’s got a great credit culture, but I think it’s got some challenges for credit and the currencies you mentioned going forward. The country did the exact opposite of what you would’ve expected with hyperinflation to keep lowering rates. So there’s definitely some pent-up demand for dollars. There’s been very soft creeping capital controls in the country.
So the hard part, when I was there in Turkey last summer, it was clear to me that unfortunately two sides of the population were really hurting, the pensioners and the youth, people in college. And if you had conversations with those sides, you’re like, there’s just no way that Erdogan’s going to win. And then the challenge has been that the opposition has been so challenging to itself in terms of being able to coalesce, and then that’s created an opportunity for Erdogan to go up, but then the earthquake hit. So there’s just so much volatility. It’s really hard to call. I mean, one of the challenges, if you wanted to express a short view in Turkey today, it’s virtually impossible, hard to borrow securities, to borrow equities like 15, 16%.
So I just wonder, it feels like they’ve got their finger in a lot of different holes kind of trying to stop the leak. And I guess there’s four possible outcomes. And I just don’t know which one it’s going to be. Erdogan wins peacefully. Erdogan wins unpeacefully. It’s a challenge. The opposition wins peacefully. And the opposition loses peacefully. It’s just really hard to predict the outcome. But I think we’re trending towards a much weaker currency. It seems more likely than not that the opposition is going to win, but we still have a month to go and we’ll probably have a second round. So I think you guys sit on the sidelines here, quite frankly.
Bilal Hafeez (41:02):
Yeah, when I speak to our clients, hedge funds, asset managers, people are unsure about who’s going to win the election, and plus people are unsure about what would happen to markets in all those four outcomes as well. There’s so much uncertainty about the sequencing of everything. And do you let the currency go initially if the opposition wins just to stabilise things, or do you hold the currency constant as a sign of confidence and let interest rates go? I mean, there’s so many uncertainties. So it’s a challenge.
Robert Koenigsberger (41:29):
And what does Erdogan do if he wins? Because one, you could say, okay, well, they just did all this just to get victory. Now they’re going to be economically more rational. Or maybe they just believe this is the right path, or he does, right? Yeah, I think they’re running out of tools in the toolbox to keep financial stability. So something’s got to change.
How to Play India
Bilal Hafeez (41:47):
Yeah. And one country we didn’t talk about was India. Amongst not just emerging market, but just global investors, India’s viewed as, it’s almost like a megatrend that for the long-term India, you want to be long India. It’s growth rate’s been fantastic over the last five, 10 years. Stocks have done very well also. I mean, what do you think of the India story in general? And also as an outside investor, how do you approach, can you access India in the way you want?
Robert Koenigsberger (42:12):
So from our perspective, India is much more of an equity story than a credit story. And part of it is it’s very hard to access credits, it’s hard to move money around for credit. When you think about private debt that I mentioned, we’ve analysed that several times and there’s a pretty deep market in local currency, and it’s very challenging and volatile for dollar-based investors to go into a market like India and not be able to lend in dollars. So, for us, there’s a lot of headwind. Remember, credit’s about understanding what happens when credit goes bad because that’s your anchor recovery value. And quite frankly, that’s been a challenge notion in India if you look at some of the precedents, Essar Steel way back when, one of the worst investments we ever did in India is we bought at 24 and we got out at 32. It’s just the brain damage it took to be involved in a debt restructuring there and all the federal and local regulations that were put up or constraints that were put up against debt restructuring.
So it’s a challenging credit environment, bankruptcy environment, which all matters to credit investors a lot more than equity investors. We worry about what happens when things go wrong. Equity folks get to worry about what happens when things go right. They’re long to call and we’re short to put, so to speak. So it’s challenging from that perspective. And then the other thing I’ll tell you, we’ve been oftentimes told that we should get comfortable with Indian credit because the legal system is based upon the UK. And the challenge I have with that is the only thing that we’ve noticed that’s the same is the cost of the lawyer, about 1,500 quid per hour. So it’s not a market we’ve been very active in, we keep looking at it to make sure that we’re not missing something. Currency challenges, credit challenges, bankruptcy challenges, just for the most part are not for us.
Bilal Hafeez (44:02):
Yeah, I mean, I’ve heard that from other investors as well. People just trade the equity there more than anything else. Now, I did want to ask you some non-market questions as well. One is, what’s the best investment advice that you’ve ever received?
Robert Koenigsberger (44:15):
I mean, I don’t want to sound cheeky, but buy low and sell high.
Bilal Hafeez (44:19):
Keep us in form.
Robert Koenigsberger (44:19):
I think people forget that, and I’ve evolved that to plan the trade and trade the plan, but anticipate what may happen and when it happens, remember that you anticipated it. Investing is about psychology as much as anything. We can all do financial analysis. I’d say some of the advice that I received in emerging markets that has really resonated with us is emerging markets credit, it’s about people. We have to underwrite credit, but we really have to underwrite people and their credit cultures and what happens when things go wrong, how they behaved when things go wrong to predict what will happen in the future. And that was certainly good advice as well.
Bilal Hafeez (44:57):
Yeah. And another question I wanted to ask you was what advice would you give to young people who are about to leave university, perhaps later this year to enter the job market? What advice would you give them?
Robert Koenigsberger (45:08):
Well, the most important thing I think is since COVID there’s been this whole, I guess, movement towards work from home, and nobody wants to go to the office. And I think that’s particularly damaging for young students coming out of university. So my advice for them would be go to the office, presence matters. Particularly in our business, God invented trading desks to be open architecture so you could learn from the people, not even if they’re explicitly teaching you, but you’re implicitly absorbing. That absorption doesn’t happen while you’re sitting at home on Zoom. So that would be one.
And two is to be patient and not jump around so much. I think kids today, it’s like, ‘Well, I’ll try this and I’ll try this and I’ll try this,’ which is okay, but try and have some logic to your story so that when you’re interviewing, it makes sense to the person you’re in front of them. Like, ‘Oh, I did auto manufacturing and then I went into finance and then I went into rockets.’ Try and have a story that’s evolution, not revolution.
Books
Bilal Hafeez (46:11):
No, that’s really good advice. And then are there any books that really influenced you?
Robert Koenigsberger (46:16):
Yeah, I mean there’s been plenty on the investment side, but I’ll put my managing partner hat on for a moment. And also the processes that we have around portfolios. I mean, I think one or two books in particular for me, were more about the management of a business and people. Our industry forgets that. We’re all finance geeks and we all just think about the ZZ column of a spreadsheet. But there’s a lot of assumptions about people in the management of an organisation that go into that spreadsheet, whether you’re analysing somebody else that you’re going to invest in or managing your own company.
So one was Good to Great by Collins. I think it was all about getting the right people on a bus and getting everyone in the right seats and the leadership of the driving of that bus. And so that was influential. And another one that’s probably a little less known was Being Strategic by Erika Andersen that has really provided a framework for how to visualise where you want to be and how to create strategies and tactics to get there. And it’s been really useful for us as a company, but then we do the same process with our people. So we have a strategic plan for the company, but then Gramercy Career Management is about a strategic plan around each one of our employees. And it’s really simple. They always start with a challenge question. ’08 it was, how do we go from being a hedge fund to an investment management firm? For our employees it’s, how do I simultaneously contribute to the vision of the company, but move my career in a desired direction? And so Erika’s book provided a lot of framework for those processes.
Bilal Hafeez (47:45):
Yeah, that’s great. Those are excellent answers to those questions and excellent conversation earlier as well. How can people follow you?
Robert Koenigsberger (47:53):
I guess on LinkedIn, myself and the firm, we have a presence there. We’re pretty active with our website. We put out quite a bit of… We pride ourselves in there’s a lot of content at Gramercy that we need for our analysis, but we like to share that with our clients. And so that’s done on our website, whether it’s emerging market insights or videos or what have you. So between social media and the website a pretty good start.
Bilal Hafeez (48:16):
That’s great. I’ll add links to the show notes as well. So with that, thanks a lot, Robert. That was excellent. I learned a lot and good luck for this year in this volatile year.
Robert Koenigsberger (48:25):
Great. Thank you very much. It’s been a pleasure to be with you today.
Bilal Hafeez (48:30):
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