Episode 280: The Right Way to Invest in Emerging Market Debt

 

Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley, I'll be your host. Hey, welcome back. After 275 episodes, I realized I had my microphone set incorrectly, so we've got that fixed and hopefully we sound better today than we usually do. And welcome back to a great podcast today. I want to make sure that everyone knows if you are an ABF real estate or infrastructure person and you are interested in meeting with your colleagues and friends in the industry and some leading asset managers, we are going to be hosting a ABF real estate infrastructure event that is open to insurance asset owners in May 7th and 8th in Philadelphia. You can get more information about that event at events@insuranceaum.com. If you need some information, that's the way to get it. We'd love to see you there.

Today's topic is a little different, and the title of the podcast is The Right Way to Invest in Emerging Market Debt, and we're joined today by Vlad Liberzon, partner and portfolio manager at GoldenTree. Vlad, welcome, welcome, welcome. How are you, sir? And it's nice to be with you. And thanks for taking some time with us today.

Vlad: Thanks, Stewart. Thanks for having me. It's a great pleasure to be here with you. I'm doing well and you?

Stewart: Good. Yeah, it's cold as daylights here in central Texas. It's 22 degrees here today and it's almost a state of emergency. We don't know what to do when it gets that cold down here. But I'm thrilled to have you on and one of the neat things about my job here is I get a chance to talk to really smart people who are experts and put you in the ‘professor for a day’ chair and really get a chance to pick your brain about a particular asset class, which it helps make me smarter, certainly it does. It informs our audience as well. But we always start these off the same way, which is where did you grow up and what was your first job, not the fancy one? And then I want to talk about how you got into your seat today.

Vlad: I grew up in Russia and I moved to the US in the late 90s, for college. My first job when I was still in Russia, I was a taxi driver. And so I think that's, like you said, not a fancy one, a real-life job. It's interesting when I think about my journey, I'm a fully assimilated American. I've lived here my entire adult life, but at the same time I have a very keen understanding of emerging markets and a personal interest in them. And I think that gives me an edge in what I do, and I've been investing in EM for the past 20 years. I think to do that you need to have a healthy dose of realism and skepticism and no biases. And I think I have that as a result of my upbringing and my experience.

In terms of my work experience, like you said, I'm a portfolio manager for EM debt here at GoldenTree Asset Management. I've always been a buy-side investor, for the past 25 years. First in a risk macro role and then 20 years ago I started investing in emerging market debt. My journey here in this asset class has been interesting because first I spent a decade at a large asset manager with really an asset gathering business model. And then now I've been here at GoldenTree for a decade and this is a smaller, more nimble and truly active alpha-oriented manager. And so that's an important contrast in how different people approach the asset class and I think that's key to what we'll be talking about today.

Stewart: Yeah, I really appreciate the background. Just for everybody's benefit, you have a BA in mathematics and economics from Brandeis University and an MBA in finance from Columbia University. And you are a CFA charter holder, as a lot of our audience is. And so thank you for that background. So tell us a little bit about EM. You've been at this over 20 years in the asset class. You gave a little bit of this, but what got you interested in EMD and how has this market evolved over 20 years? And the thing that I would come clean on is that I'm not current on this asset class. The way that I think about EMD is, I would venture to say, dated at best, and completely inaccurate is closer to the truth. So help me understand with the big broad brushstrokes, what was it about EMD that got you interested in and how has that market evolved to today's current state of affairs?

Vlad: Definitely. Stewart, you're right to point out that the asset classes definitely evolved and changed over time. 20 years ago, a position opened up in EM debt and I was happy to try. I wasn't necessarily looking to get involved, but then I realized given my personal background and my education, it was a good fit. And as I was doing more work and spending more time in EM, I realized how exciting, how fascinating, how diverse this asset class was. The space has really changed over time. When I started looking at it 20 years ago, it was just a handful of countries. All of them were commodity exporters, mostly energy, a few state-owned banks in those countries, a few state-owned energy companies in those countries. So as you can imagine, everything was correlated moving together, driven by the same things, oil, equities, global macro sentiment. It was a space that was pretty correlated and it was not a whole lot of diversity there.

And over the past 20 years, I've witnessed a complete change and the emerging market debt space has grown so much. It's now very diverse. About half of the countries that we have are commodity exporters, the other half is importers. We have 90 countries in total that are available to us to invest as foreign investors. We have everything in terms of credit quality from single A to CCC. We have a very good degree of diversification regionally. All industries and our representative will look at emerging market corporates. It's not just those banks or oil companies, it's now everything from telecoms to retailers to logistics and banks. Everything is represented. Transportation. So it's a very diverse asset class.

And most importantly related to what I started with is that correlations have come down. Now our securities and countries and companies in EM, they're not really correlated to each other anymore. It's really become a very idiosyncratic driven by their country-specific catalysts and stories and fundamentals and politics. And that makes this asset class really exciting because you can find investment opportunities that are uncorrelated to everything else in the market. And so I think this evolution over the past 20 years has been really fascinating to watch.

Stewart: It's super interesting that you bring that up. It's funny to me, we've had other folks come on and talk about EMD offering a superior risk return trade-off to US corporates, as an example, and yet a lot of insurers have not invested in EMD in meaningful ways. There's a phenomenon in insurance companies that I've experienced myself, which is they have very long memories about challenges that they have had in a particular asset class, and sometimes they vow not to go back. What is your view of why insurers have yet to make meaningful EMD allocations and what do you think that they're missing or do you think that there's some component of their view that has changed that changes the nature of the equation?

Vlad: Sure, and I think that's a great point, Stewart, that perhaps people have long memories like you said. And they have some degree of low familiarity or comfort with the asset class, they haven't kept up with. Some people may not have kept up with how this space has evolved and grown. I have some thoughts on this. For example, some of the riskier high yielders in our space, they tend to get the headlines. People tend to see that. But in fact, the majority of our space is high quality. 50% of our benchmark, the EMBI Global Diversified Index, the most widely followed benchmark, 50% of that index is investment grade and another 25% of it is BB. So the vast majority of our space is actually high quality bonds, but it's the riskiest names that tend to get the headlines. So, maybe that's one reason.

Another reason maybe is that people tend to associate EM exposure with China exposure and that is true in equities where if you look at the MSCI equity index, 40% or so of that index is Chinese equities and then another 10% to 20% are other Asian tech or other names that are exposed to China and Chinese fundamentals. But in, debt it's very different in that EM debt index that I mentioned, the hard currency benchmark, less than 5% of that is China. So it's really a different mix. And the exposure to China that people might've been concerned with in recent years is not really a driver for emerging market debt as opposed to emerging market equities.

And so I think people may not be up to speed with how this asset class has evolved and what the actual mix represents. And then in addition, perhaps some insurers that have been involved in EMD, they've had a bad experience because there are different ways of doing this. The best way to invest in EMD is via a smaller, more nimble, a truly active manager who's really focused on country and security selection. Because you really don't want to passively own a little bit of everything in EM debt. That is not the right approach. You have to be selective.

Unfortunately in my experience, especially coming from a large asset manager before, is that in this industry some managers prioritize AUM growth, they just want to grow assets under management. And as a result they become too large for the market, more passive, more directional managers, or beta managers. And they don't take advantage of smaller situations, off-benchmark situations or dislocations within the cap structure. They're just too big for the market.

So I think perhaps some insurers have had exposure via that approach and that has not been the optimal approach, especially as we've discussed, as the market has evolved in a way that correlations are down and things are moving in different directions. So you have to be nimble. It really matters what you own and what you don't own. You want to be in the right place in EM at the right time, so you want to be nimble.

And so I think that could also color the perception of some of the insurers about their own experience in EM debt. But I think they should really consider this space. It's really a valuable diversifier in one's global fixed-income portfolio. As I described, it's a different mix from what you get in US credit markets. It's a high quality fixed-income asset class now. It's a very broad set of opportunities. It's a large and relatively liquid space, so you can do a lot. And it can also provide duration to your portfolio when needed. So if you do it the right way, it has many benefits.

Stewart: And so is there an economic reason that you believe avoiding China or folks trying to limit their China exposure, or is that more political in nature of folks trying to limit? It just sounded like by your answer that there are folks who are trying to limit their China exposure. I'm just trying to figure out why that is.

Vlad: I've certainly heard clients talk about it in recent years, and feeling that they're concerned about having EM exposure because that would mean a lot of China exposure. I think they were concerned about politics, unpredictable policies. It's been hard to read some of the policy signals in China in recent years and certainly there's been a lot of volatility there in various sectors of that economy, the property sector, the tech sector, the education sector. And so I feel that many clients are concerned and once they realize that the EM debt in contrast to EM equities has very little China exposure, and you don't have to have exposure to China when you're investing EM debt, I think people take a fresh look at it. But let me highlight that we don't have any inherent biases here, we have been involved in China and our EM debt portfolios in the past. We are not at the moment, but we are always looking for opportunities everywhere. And if we feel that we have conviction and we see an interesting opportunity in China, we're happy to get involved.

Stewart: We've got some folks about 20 CIOs on our executive council and occasionally they let me borrow their CIO hat. So I'm going to try one on right now and ask you this. Let's just say, hypothetically, as a CIO proxy that I'm convinced that I should be allocating to EMD. And you mentioned this just now, it is a large and diverse asset class. The questions then become do I do hard currency, do I do it hedged? Am I investing in sovereigns, am I investing in corporates? In your mind, what's the best way for an insurance company to approach the asset class?

Vlad: That is a great question, Stewart. I think that's really important. It's really a key point to thoughtfully design your EMD portfolio. I would suggest a hard currency portfolio. If you look historically, the hard currency asset class has been a lot more stable, much better Sharpe ratios, much better returns compared to the local EM. However, there are periods in time when local EM is attractive and there are opportunities there. I would suggest a hard currency portfolio indexed to the EMBI, that index that I mentioned that is the most commonly used index. But you can have specific constraints and we've certainly seen clients do that, use the EMBI as their benchmark, but have limits on certain ratings categories or certain other parts of the universe.

But it's really key to allow the manager flexibility, to go outside the index in a risk-disciplined fashion. So you start with that hard currency portfolio using a similar benchmark, the EMBI family of indices, and you allow your manager to go outside the index if they see opportunities there. You can impose certain risk limits on that, on ratings categories or certain sectors. But it's really important for a manager to be active and nimble and not hug the index, not be constrained by the index, but use the index as a guideline and as a starting point.

The manager needs to demonstrate a very good risk process, very good risk discipline, focus on the tracking error, take the appropriate amount of risk, have specific guidelines in terms of position sizing. What's interesting here is that the EMD portfolio should not be concentrated. It is such a large and diverse asset class, as we've been discussing, that you can be fully invested without concentrating the portfolio in any particular name or region or ratings category. So you can be fully invested while at the same time you may be avoiding whole countries or regions because you don't like how they're developing, you don't like the fundamental trajectory or a particular macro theme. And this asset class allows you to do that.

Probably one of the things that I'm excited the most about in having been doing this the past 20 years is that this is such a large asset class. We are very risk disciplined with position sizing and tracking here and where we're taking our risk. We may be avoiding certain parts of the asset class, but still we tend to be fully invested because we're finding exciting opportunities that are uncorrelated as we've been talking about, and providing our clients with the duration, the spread, the diversification. So I think that a hard currency portfolio with certain nuances about how you design it and importantly, allowing the manager flexibility and making sure the manager has a good risk process, I think that is the right way to do this.

Stewart: Ideally, you want to give the manager flexibility to execute on their competitive advantages. You don't want to constrain a manager to the point where you're basically getting a glorified index and yet you've got to have confidence in the risk process so that you can provide that flexibility with confidence. I think that's a great way to answer that question. We're early in 2025 and I'm sure that a lot of our listeners as well as myself would be interested in hearing your views and your outlook for EMD. It's been a couple of good years for the asset class. There seems to be more headline risk and more uncertainty around the asset class right now. I know it's difficult to handicap what's going to come out of Washington as well, the impact to tariffs and so forth. What are your thoughts on the associated risks and opportunities as you look out right now?

Vlad: You're absolutely right, Stewart, it's an exciting market environment. It's a volatile market environment, and we have to be careful and selective about how we position. The way we've been thinking about this in recent months, and as you mentioned since the US election as the new set of policies is coming in, there's uncertainty around that. There are a few different themes that we've identified and been positioning around in EM debt. I think the first one is that we have been able to find truly uncorrelated idiosyncratic positions. And I mentioned that a little bit earlier that the asset class has evolved in a way that now we're able to find quite a number of those, and we have been finding those early this year in a number of countries, in the Americas, in Turkey and a few others where we're finding positions with a very good risk-adjusted return profile and with a very low correlation to the global macro volatility really driven by their own country-specific catalysts. And so the ability to do that has allowed us to build a very robust portfolio this year.

I think the other macro themes that have been prevalent, one is dollar strength. You've seen that right after the US election in November, you've seen the dollar very strong because the market was anticipating, tariff policy was anticipating what the market saw. Last time when President Trump was elected in 2016 and 2017, you saw dollar strength. And that was certainly a driver this time and you have to be careful with the local currency space in EM. The second half of last year was a very tough time for that space at the same time as the hard currency credit in EM did very well. So sector selection was so important around the US election at the beginning of this year as well.

Coming into 2025, looking forward a few quarters, I think the local space is still challenging, but less so. We are starting to find interesting opportunities in local currency government debt across a few countries. Idiosyncratic, like I was saying before, really uncorrelated to, or to an extent uncorrelated to what we're seeing globally. But that space is becoming interesting. And certainly dollar strength and the ability of EM currencies to perform in this environment with the tariff uncertainty, that is a theme that we're very focused on and trying to position around and find attractive opportunities and starting to find some. So that is good.

And the final one that's been also top of mind for people in recent months is duration or US interest rates. What is the direction of US interest rates? What I've noticed in the market recently is that at the end of the year, there was a lot of concern in the market about the deficit in the US and that the new administration might be irresponsible with the budget policies and the deficit would continue to balloon and send US interest rates higher. And we saw a sell-off in US interest rates at the beginning of the year right into the middle of January. And then post-inauguration, I feel that that market sentiment has shifted and US interest rates have stabilized and actually have come lower in recent weeks. And I feel that now the market focus is shifting and the deficit is no longer a concern. There's some hope that their cabinet appointments have been responsible, that the government efficiency effort will be to an extent successful.

And the market focus has shifted away from this concern around the deficit, it's now thinking about the impact of the tariff policies. Is it going to be inflationary? Is it going to be contractionary and soften US growth a little bit? That's the focus right now. And the concerns around the government debt in the US, I feel that that is perhaps end of 2025 business, certainly the second half of 2025 and maybe that is 2026 business. So that's not right here and right now, but that has certainly been another theme where we have had to be very careful and very selective. Today, we are comfortable with high quality names in our universe, BB’s, BBB's. We're comfortable with those names, we're finding value there. And we feel that EMD portfolio is providing good high quality duration to our clients at the moment.

Stewart: This may be an unfair question or one that you can't answer, but are there any examples that you could give us a way that you're positioning the portfolio to on the opportunities, or if it's proprietary, I understand, but is there a way that you could give us a couple of examples?

Vlad: Of course. No, I'd be happy to. I'd be happy. On the sovereign side, there are a few situations where among those high quality BB situations that I mentioned where we expect a continued improvement in fundamentals and ratings upgrades. Those can be Morocco, the Ivory Coast. Those are some examples of issuers where we expect ratings upgrades later this year, and last year we already witnessed a pretty strong trend of ratings upgrades across EM. We had four countries upgraded to investment grade and a number of countries last year got upgraded to single B or to BB. We are already in the midst of this ratings upgrade trend and we expect a few others like the ones I mentioned.

In addition, I think some of the smaller out-of-index situations are still quite exciting. The Bahamas is an interesting sovereign issuer, smaller, out of benchmark, but it's been a significant outperformer. And it's been a very consistent responsible fiscal management from The Bahamas over the past few years, so that certainly has been a very interesting example of an out-of-index investment. On the corporate side, we've been involved in a number of situations in EM corporates, across sectors, across countries over the past year. A recent one's been interesting, there's an exploration production deep water oil in Angola where the oil fields are offshore in Angola in that jurisdiction, but the company is owned and operated by BP and ENI, investment grade rated global oil majors.

And so it was an interesting exercise to see very strong corporate fundamentals have very strong parents and a very strong operational track record, and at the same time a tricky single B rated jurisdiction and how should the market price that paper? So that was very interesting. And what was also interesting there is that what interests were aligned with the Angola government interest because they have their state-owned oil company as a non-operating partner of those same oil fields. So it's always important in EM to have your interests aligned. So interesting examples like that.

In the local market, I mentioned there are a couple of opportunities that have popped up recently after a tough year last year in that space. One of them is in Turkey. They are very responsible on monetary policy and finally addressing their inflation problem. That was a big issue over the past year is finally coming down. And so local currency bonds and government bonds in Turkey are interesting here. And in Brazil, so after high volatility at the end of last year, we now have inflation-linked bonds, TIPS in Brazil, the 10th largest economy in the world with a very deep and liquid TIPS market. Their ten-year TIPS traded 7.75% real yield compared to about 2% in the US, 0.5% in Germany. It really historically dislocated level. On average, historically that real yield in Brazil has been in the 5.5% area.

And so that is interesting and we see signs of stabilization on the fiscal side. We see signs of an economic slowdown there, and that should support these bonds and should allow them to reprice closer to historical averages. And so you see a variety of examples from index sovereigns to out-of-index sovereigns to corporates to local government bonds. There are opportunities, and many of opportunities that I mentioned just now are not really correlated to what else is going on in global macro markets.

Stewart: That's super interesting. It's been a great education today, Vlad. Thanks for being a professor for a day with us. I've learned a lot and I know our audience has too. I've got a couple of fun ones for you on the way out the door. The first one's not so much fun as it is instructive to people earlier in their career. When you're looking at adding team members at GoldenTree or on your team in particular, are there particular characteristics, less about major and can you code in Python and more like characteristics that you're looking for when you're interviewing a candidate that you think, over time, you've been at this for a minute, have shown to be top performers?

Vlad: Definitely. No, that's a very interesting question, Stewart. And I think some of the key characteristics if you want to be able to be a good investor in EMD and beyond EMD, I think you have to be able to connect the dots. You have to be able to understand the fundamentals in the market and the academic thesis for an investment. But also understand the technicals, have the street smarts, understand the biases, understand how people are positioned. Is everyone going the same way? What are the potential drivers of this particular investment within the country as well as from outside the country? What are the correlations with other things in the market? So it's really important to be able to connect the dots, understand the history of the position and the inherent biases. And I think that comes with experience, but also it comes with a healthy dose of skepticism. Make sure you don't have any biases and approach everything with an open mind. And I think we've certainly seen in recent years in EM and global markets just more generally we've seen the benefits of having that approach.

Stewart: It's such a great point that you're making, and it brings me to a sports analogy, which is NFL linemen. It is like there's a lot of big people in the world, there's a lot of fast people in the world, but there's not a lot of big fast people in the world. What you're talking about is similar. There's a lot of academics in the world, there's a lot of people with street smarts in the world, but there's not a lot of people with academics and street smarts that can come up with a theory, understand why it ought makes sense, and then look on the ground to see why it might not work the way it does on paper to figure out. And we had somebody on that say, "We want somebody who can figure it out," and you're using the phrase connect the dots, but it's a similar idea.

Last one, super fun. You and three guests for dinner or lunch, who would you most like to have lunch or dinner with alive or dead? You don't have to use all three, you can use one, two, or three, but that's the question. Who would you most like to have lunch with, alive or dead?

Vlad: Oh, that's a great question. Probably given my focus on EM and love for EM, so focused right now on Brazil, I would probably love to have lunch right now with the current president Lula in Brazil and the former president Bolsonaro, the three of us at lunch and I will try to understand what they are. First, what Lula's plans are, does you want to run again? And the market is really sensitive to that. And to see what the outlook can be politically. And that is such a large country, it's really one of the key EM countries and has important relations with the rest of the world and the politics there in the coming two years is going to be fascinating. So at the risk of looking like an EM geek, I think that would be my choice. I would want to have lunch with those two guys and try to understand what to expect in Brazil.

Stewart: Hey, I think that's a great answer, Vlad. I love that answer. That's terrific. I really appreciate you being on today. We've gotten a tremendous education and you've made it fun for us too. So thanks so much. We've been joined today by Vlad Liberzon, partner and portfolio manager at GoldenTree. Vlad, thanks so much for taking the time.

Vlad: Thank you so much for having me.

Stewart: Our pleasure. And thanks for listening. If have ideas for a podcast, please shoot me a note at steward@insuranceaum.com. Please remember to rate us, like us, and review us on Apple, Spotify, Amazon, or wherever you're listening to your favorite shows. My name's Stewart Foley. We are the home of the world's smartest money and we look forward to see you next time on the InsuranceAUM.com podcast.