Reasons to examine emerging markets

Currency shocks have created opportunities in markets investors prefer to avoid. Do they need to revisit their assumptions?

Private debt doesn’t really do emerging markets. More specifically, it doesn’t do emerging markets outside Asia-Pacific. According to our latest funds in market data, almost $120 billion is being sought for investment in North America and more than $56 billion for Europe. In Asia-Pacific, the total drops to less than $20 billion and, in all emerging markets outside Asia-Pacific, it’s only around $2.5 billion.

In the next issue of Private Debt Investor, we explore emerging markets private debt and have already spoken to numerous sources who question whether negative views are merited. One fund manager remarked: “Investors are so worried about the emerging markets label. They perceive a degree of risk that is overstated.”

Now, of course, caveats apply here. The fund manager quoted above, and others we have spoken to, are operators in these regions and it’s arguably not surprising that they would promote a rosier view than others. Moreover, while other alternative asset classes such as private equity engage much more with emerging markets, that is in part linked to the maturity of those asset classes. Private debt is the new kid on the block and expansion into new territories will undoubtedly gather pace with time.

Nonetheless, there is plenty of food for thought in the conversations we have had. For example, one talking point is the surprising extent to which legal jurisdictions and creditor rights have improved. One source estimated that the gap between emerging and developed markets in this respect has approximately halved since 2013.

Progress has been very mixed, with some countries – such as South Korea – having undertaken bankruptcy reform around 20 years ago, while others have only done so over the past couple of years. But far more countries are now seeing good bankruptcy regimes as a vital part of well-functioning capital markets – in turn, crucial in dealing with the problem of indigestion in many banks’ balance sheets.

Another point to consider is that, in many emerging markets outside of Asia-Pacific, there has been dramatic currency depreciation since 2011. This had led to a capital shortage and opportunities to invest in situations where bankruptcies and restructurings can obscure the true value of assets, particularly real assets and infrastructure.

Hence, “there has already been a catalyst for distress in emerging markets,” says one source. This is ironic, since fundraising for emerging markets distress is a struggle. By contrast, distress globally (almost all of it targeted at developed markets) was the most popular private debt strategy last year, accounting for 36 percent of all capital raised. Yet investors proclaim frustration at slow capital deployment with opportunities in developed markets currently thin on the ground.

As well as distressed opportunities, debt providers can also step into a gap left behind by banks in countries hit by economic or financial shocks, such as Brazil or Turkey. Banks in such places may decline to renew existing facilities, including working capital lines, even though the companies are often in good health. There is also an opportunity now becoming apparent to lend into economies affected by the coronavirus outbreak.

So far, most investor support for emerging markets private debt is coming from ‘agile’ organisations such as family offices and endowments – those willing to think opportunistically and adopt a contrarian approach. The reward, say those on the ground, is that returns in the mid-teens are easily achievable. The likes of pensions and insurance companies, however, will still need a lot of persuading, and only they really have the financial muscle to move the needle.

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