Investment opportunities in emerging markets are worth pursuing amidst global instability, rather than abandoning them.
Investing in emerging markets might seem daunting given the turmoil of tariff disputes, geopolitical tensions, and potential US recession. But instead of running for the hills, now could be the perfect time to lean in - if you know how to play the game.
Embrace the turbulence by opting for emerging market credit as it offers prime opportunities to thrive amidst chaos rather than merely survive. The key lies in avoiding the "index trap" in public credit markets, which often promises disaster in the face of volatility.
You see, not all emerging markets are the same; Mexico's auto parts industry holds different risks than a dollar-backed loan to a Turkish corporate. Yet indices carelessly lump winners and losers together, sometimes at the most inconvenient times. Take, for example, the Russian and Ukrainian debt crisis in 2022, following the invasion of Ukraine, or Argentina's heavy weighting in the JPMorgan Emerging Market Bond Index in 2001, just before their debt default.
A smart strategy that circumvents such pitfalls is the "barbell approach," which zeroes in on high conviction public credit trades and strongly secured private credit. While the former has exploded to about $1.5tn as of 2024 and remains a compelling opportunity in developed markets, private credit in emerging markets is in a similar stage of development as lending in developed markets was about 15 years ago.
This market offers lucrative yields and collateralized loans with senior levels of security. Dollar-denominated, direct lending sidesteps the risks of negative currency swings, while hard collateral like factories, headquarters, or personal real estate offers downside protection against defaults. Collateral makes payment more likely and secures positive outcomes, even under duress.
For instance, the owner of a family conglomerate will likely be highly motivated to meet obligations if their family villa, passed down through generations, is on the line.
While there may be concerns about a slowdown in global growth, it pays to delve deeper into individual countries and borrowers. Mexico continues to display confidence despite tariff talks; the peso is up 5.5 percent against the dollar year-to-date and 2.6 percent since US President Trump's so-called "liberation day" announcement of tariffs.
President Claudia Sheinbaum has negotiated skillfully with the Trump administration, potentially leading to reduced tariffs, expanded "carve-outs" for some industries, and the continuation of the "nearshoring" boom in locating production near the US.
Eastern Europe, with Germany increasing defense spending and economic activity, stands to benefit greatly from growing capital flows and supply chain diversification. Additionally, the Mercosur bloc's trade agreement with the EU offers economic resilience to Latin American exporters.
Moreover, international banks in emerging markets have been hesitant to return to pre-2008 crisis lending levels, leaving small- to mid-size corporates thirsty for capital. Regardless of trade negotiations, US inflation, or stock market volatility, well-structured credit remains in high demand - there will always be Brazilian agriculture companies in need of working capital collateralized by inventories or family conglomerates in eastern Europe willing to pledge assets and cash flows to secure necessary working capital.
With tight legal covenants for enforcement of payment, investors can accommodate these needs while gaining exposure to dynamic, fast-growing industries in emerging markets in a stable manner.
By combining high-quality public and private credit in a barbell investment strategy and leveraging market swings for liquidity, investors can not only safeguard themselves in uncertainty but also flourish. Big investors are already deploying this hybrid strategy in developed markets. Why not extend this forward-thinking approach to emerging markets too?
Gramercy is an investor in emerging market public and private credit.
- Given the potential risks in public credit markets, it's important to avoid the "index trap" and instead adopt a strategic approach like the "barbell approach," focusing on high conviction public credit trades and secure private credit in emerging markets.
- Emerging markets, such as Mexico and Eastern Europe, offer lucrative yields and collateralized loans with senior levels of security, making them appealing investment opportunities despite global economic uncertainties.
- To fully capitalize on emerging market investment opportunities, investors could consider a hybrid strategy, combining high-quality public and private credit, and leveraging market swings for liquidity, while also focusing on individual countries, industries, and borrowers with strong fundamentals.
