Episode 14: From Conviction to Capital

As investors face a crowded developed market, Felipe Berliner, Co-Founder and Head of Structuring, and Brad McKee, Head of Private Credit, unpack what our latest EM Private Credit study reveals about shifting investor intentions and growing interest in emerging market allocations.

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Transcript

SPEAKER_02 0:07

Hello and welcome to Gemcast. Today we're talking about our latest EM investor survey from Conviction to Capital. It's the second edition of the survey. We've been to speak to 250 institutional investors representing $21 trillion in AUM to ask them about their perspectives on the development of the private credit market, where they're allocating to, and specifically how they feel about emerging markets. To discuss this today, I'm joined by Brad McKee, the head of private credit and senior portfolio manager, and a newbie here to GemCall Capital, and Felipe Berliner, who's an old hand on the podcast here, if I've dragged in with me again. So, but before we start, Brad, you have to answer the question that everybody on the podcast has to answer, which is tell me a little bit about yourself and your passion for emerging markets.

SPEAKER_00 0:56

Well, thank you for uh allowing me to be here. Um, I am a senior portfolio manager and in charge of private credit at Gemcorp. Yeah. Um, my background has been leading teams who have been sourcing, executing, and investing in emerging markets, and in particular in Latin America. What I like about emerging markets, I think really the diversity, the diversity of the markets, the culture, it really leads to inefficiencies that we believe that we can find and attract. And as we'll discuss today, there is a value proposition in private credit in emerging markets.

SPEAKER_02 1:35

Awesome. Thank you very much, Brad. So look, the the kind of one of the headline takeaways that we had from the from the survey results were really around some of the feelings that investor sentiments had around develop markets. So, you know, 54% of respondents cited rising defaults as a major challenge. 51% cited concerns around overcrowding. So lots of concerns about the end private credit. It's something that we've discussed on a number of occasions here, Felipe. So we're gonna labor the point a bit here. But how does that square off with kind of our impression from a market perspective, but also the impression you've had from clients?

SPEAKER_01 2:11

I think the the interesting thing of this specific uh podcast that we're doing today is the data, right? When we started GemCast about a year ago, that was one of the first things we talked about, right? What was happening in developed markets that people were not seeing yet. The concentrations, the conversions uh to the high yield and uh broadly uh syndicated loans, uh, the compression of the spreads. We we talked about all that. We talked about the covenants getting lighter, the leverage going higher, the underwriting standards going down. But that was all anecdotal. Yeah. Okay. Since then, a lot happened. You started to have a couple of high-profile defaults. Yeah, you had the wave of gatings from the from uh various BDCs, and uh and another wave of uh bad press, let's put it this way, around the asset class, which I explained last time. I do not think this is uh private credit specific uh catastrophic scenario, uh nothing like that, but very specific to BDCs, mid-market, sponsor-led um funds from a certain vintage in the US that was very concentrated in the software and healthcare, and uh therefore, because of all the AI transformation, they got heavily affected. But we talked about that. What is interesting to see now, um, with data in front of us, and this document has a lot of data, which is useful, is that this perception is now widespread. Yeah, and people start to understand a little bit better what's happening on the developed market space and corroborates the the view that we have been um trying to explain for for quite some time now.

SPEAKER_02 3:53

Okay. Now, Brad, you're based in New York. So that's kind of, I would say the sort of the epicenter of where a lot of these issues have been emerging in the US. Is there any perspective you can bring from sort of on the ground, anecdotally speaking to peers? Like what's your perspective on on kind of how you feel about that sort of DM move, but also that how LPs are feeling about it, that sort of sentiment shift?

SPEAKER_00 4:13

Well, I think as Philippe has said, there there has been a lot of noise within the developed market's private credit, um, and it has been mostly headline. And I think the fact that the developed market private credit and the BDCs attracted retail investors, which created this gating issue. Yeah. Um, if you look away from those BDC issues with the institutional investors, which by the way is the type of investors that we in emerging markets cultivate, um, there has been a lot less noise associated with it. And I think when we think about emerging markets, private credit, we have not seen this volatility that has existed primarily in the US. It's been pretty steady state in in terms of our approach.

SPEAKER_02 5:01

Okay. So I guess you've got that push factor into EM from sort of that lack of or kind of souring sentiment on DM. And sort of that's kind of really one of the key takeaways from this survey, good for us, is that EM is definitely in focus. So, you know, 40% of the respondents said they're planning on increasing their allocations to EM private credit. You know, they've signified it, they think it's the highest growth any region. And 79% crucially believe it has a return premium over DM. So what's kind of what's driving that? Do you think that that represents the conversations that you're having with clients? You know, why are investors really increasingly looking at EM private credit as an opportunity?

SPEAKER_01 5:44

I think what I'm hoping to see now, and uh I'm expecting to see, is an increase in the conversion between intention and action. Yeah. Right. Um, I believe that over the last year there there was a serious increase in the intention to invest in emerging markets private credit. I believe as well that investors starting to understand a bit more the benefits and uh differences between uh private credit in emerging markets versus versus in developed markets. But what we haven't seen is still the proper adoption in scale that we want to see. This will happen eventually. And uh it will it may take time, it may take education. But like as you said, the push factor being the situation in developed markets, you have on the other side an increase on our numbers here on the perceptions of positive macro tailwinds coming from uh emerging markets, yeah, which has been one of the key factors that people were saying, like, why would I invest in emerging markets private credit at stage? It looks like the economies are more stable, the institutions are better. There's still not enough asset managers that know how to do it properly. They're still very fragmented and regional, and and the larger locators are looking for that larger, more institutionalized approach to allow them to deploy into emerging market space in a way that they are used to and comfortable with.

SPEAKER_02 7:14

Thanks, Felipe. Brad, with your sort of US hat on, you specialized in Latam, how does that sort of represent how you think US investors think about allocating to Latam? Because I know that that's sort of been the first stop, as it were, for a US institutional investor looking at EM. Do you think that's representative of the way that Felipe's positioned it?

SPEAKER_00 7:33

Yes, I I do, and I think there are some interesting trends that that exist today that maybe previously didn't. And when you look about Latin America uh vis-a-vis other regions, the geopolitical risk associated with Latin America is a is a lot more muted than other places. And on top of that, um, as you've seen, the Chinese have been very focused on Latin America over the last 20 years. But importantly, now the Trump administration uh sees Latin America as as its backyard. And I think that has various implications. We've seen what's happened in Venezuela in terms of um uh liberating uh the current uh situation there. Uh the rare earth slash uh green tech is is a very important theme within the Trump administration, and it's it's viewed that Latin America is key to that development. Yeah. And you still have the theme of near-shoring uh with Mexico, the importance of security and the importance of immigration. So Latin America has has become even more important under the current administration.

SPEAKER_02 8:44

One of the other themes that came up that well, I thought was interesting was around diversification. So I think historically, you know, investors have often looked at EM as sort of high-risk, higher return market, um, but maybe not always as a diversifier, right? So, you know, in the survey we had 62% of the respondents believed EM private credit offered superior diversification. So where do you think that's coming from, Felipe?

SPEAKER_01 9:08

The the fact that EM is not uh, and I repeat repeating myself like from the the previous um uh podcast here, the uh emerging markets is not a single asset class, right? You have uh different regions and different products that you can do inside private credit. Uh, we're not talking only about direct lending, we're talking about infrastructure, there's real estate, that there's asset-backed, commodity financing, trade finance, all these can fit inside a diversified portfolio of um private credit in emerging markets, and each region has their own peculiarities. So when people are looking for diversification, if you have a portfolio investing in private credit, emerging markets that in itself is spread across different regions, across different products, you get the best out of it rather than focusing, okay, mid-market, um, developed market space, um, private credit. And then you went, if you go into emerging markets, you focus on a single region, uh, single strategy as well, then you don't get the best out of it. Yeah. Okay, because you're very subject to certain uh idiosyncratic risks from that region. But when you do have this diversification from region and product inside emerging markets, the amount of different products that you have access to is a great diversifier to any portfolio.

SPEAKER_02 10:31

Brad, do you think investors are waking up to the fact that there's quite a maybe a lack of diversification inside their developed market private credit portfolio? There's a lot of overlap in the risk, you know, with sponsor back deals, lots of US mid-market software. You think that that's part of the drive here? Is that people are waking up and saying, actually, EM is a diversifier?

SPEAKER_00 10:50

Clearly, I think the the whole example you raised on software, where some of these BDCs had 20 to 30 percent of their portfolio uh focused on software. And that's due to the fact that there wasn't attractive opportunities in in other sectors. Yeah. So I think that's a key point for investors to think about when they allocate globally into private credit. You know, some of the themes that we see in emerging markets, we see as less emerging markets themes, but more global themes. Okay. Like uh the commodity super cycle that we're in is is clearly it's a global theme that involves all areas uh of the globe. Um, you know, infrastructure, um, both digital and traditional, as well as a key area of growth that that we see throughout emerging markets, but it's a global theme. So I think the opportunity for diversification is in thinking about um where is the best asset class globally and how do I articulate it in my essence.

SPEAKER_01 11:56

I think that uh I would add here on this point of the risk perception that uh that you initially asked about. From the results of last year um white paper that you publish and uh this year, I think it there is not enough reduction on this perception. Yeah, it's still there, the perception that emerging markets is riskier than developed markets. And it's it's a very generic approach, especially for someone that is not yet an investor in emerging markets. The the natural answer is, oh no, emerging markets is riskier than developed markets. But you have to look into the details. You have to compare uh the same kind of assets uh and what you're trying to achieve. If you are comparing a very frontier market with like an infrastructure deal core in developed markets, yes, but is there a fair comparison? Not necessarily. Um emerging markets, you have like a lot of investment grade countries. Um Eastern Europe, for example, that has gone up in the in the rates uh from last year, it's mainly investment grade. Yeah, Poland Czech. We have unbelievable um uh quality of bars, but uh lower as well. Yeah. Um and again, the metrics that you achieve in emerging markets are significantly superior than those of the developed market, mid-market um uh private credit. Less leverage, better covenants, not so many lenders, uh hostility, uh, right, in the in the capital structure. And another um one of the features that we saw here in the in the in the data is that the perception that covenants are weaker in emerging markets is significant. Yeah, it's very significant. Yeah, and it's exactly the opposite. You have very light covenants on the developed market space simply because there's way too much capital fighting for the same deals, and you have the strongest possible covenants when you're the sole lender in an emerging market. Yeah. So this for me was the one point that caught my eye and said, wow, this is this is really wrong. Yeah. And uh, it shows the difference between perception and reality very well.

SPEAKER_02 14:06

The really interesting thing as well is that investors who actually have a meaningful exposure TM, they believe that the risk is lower. Yeah, so there's an interesting thing, which is once somebody invests and they get to know it and they've done the work, okay, and they've done the research, they then understand the risk. So it's kind of interesting. Now, that begs the kind of million-dollar question. So, Brad, what what needs to happen to make it scale? So it seems that there's conviction. So we kind of talked about the appetite, people are understanding it more. There's still a lot of misconceptions. So, from your perspective, how do we scale EM private credit? How does this become a mainstay in institutional portfolios?

SPEAKER_00 14:47

I I think you know, one of the advantages is having a global approach within emerging markets, as Felipe highlighted. Um, there are opportunities in different markets at the same time. So having a manager that can uh can can has the expertise in the markets and the ground and can select the opportunities that that make sense. Yeah. Um, those those situations are very interesting. The other thing that we have expertise on in terms of scaling is is identifying local themes within markets. Yeah. Um, it could be within the infrastructure infrastructure or commodities, uh, where we team up with local partners in given countries and and we have uh and we create our own moat uh per se of of sourcing attractive deals that have a standardized approach similar to what we have in in DM. I mean, what DM has is more of a machine of syndication private credit. We tend to think it gets commoditized, and as Philippe highlighted, a lot of the over uh capital that exists is pushed terms much weaker from an underwriting perspective. Um we believe that through our partnerships that that we can create scale but still retain kind of the structural downside protection that we have. Okay.

SPEAKER_01 16:12

But um I think complementing this with data again from the from the report, a lot of the respondents mentioned the um the limited number of specialist managers.

SPEAKER_02 16:26

I mean come on, huh? Come on, yeah. If you're watching if you're watching your podcast and you answered that question, then I'm yeah, then we go back.

SPEAKER_01 16:34

But but that's true. Like the um there is a concern of the there's not enough specialist managers that really understand emerging markets and treat that as a side strategy simply to raise some money on the bandwagon of private credit. Yeah, right. So, yes, sure. You there are those that have the DNA and then those that are doing that just to ride away. And hopefully by now people understand that we uh that this is really our DNA. But other than that, let's go a bit more into the details of this. If you're talking about large allocators, they need size, they need critical mass. They don't want to be 50% of a fund. Yeah, so if you have a fragmented fund that invests just in SMEs in a given country, yeah, and uh the fund is a $200 million size, you're not gonna get an allocation from the large institutionals. Yes, it may be for ESG reasons or for impact, but not for the economic reasons. Okay, I want to diversify my portfolio. Here's an opportunity of a manager that's specialized, uh, that knows what he's doing. Um, so the lack of availability of different products, I think is still uh one of the key factors that that respondents mention as a barrier to invest further. And hopefully we're changing that.

SPEAKER_02 17:51

Yeah, yeah. I mean, look, you're right. 57% said they didn't have any specialist managers, and 47% cited the fund size was uh was an impediment. Does that represent what you see in the US, Brad? You've worked at some big shops as well. Do you feel like that's like a barrier? It's a bit like I can't find the manager, I can't find the right product, and then it all just becomes a bit too hard.

SPEAKER_00 18:10

I I think it's definitely an issue in terms of it's the chicken and the egg as is the the opportunity set versus the manager. Uh and some of these allocators need to write big big checks. Um, but I I I think as you know, as as the uh survey highlighted, uh only a small percentage of total AUM of private credit is in emerging markets, but it's a big opportunity to to increase that size. And um, you know, I think scale begets scale in the sense of um the asset class will just continue to increase as investors grow and expand in the market.

SPEAKER_02 18:51

So just to take that one step further, you know, one of the parallels that I think is relevant is, you know, what can we take from the EM public markets here? So EM public markets 20 years ago, that was a bit of a backwater, wasn't necessarily a lot of institutional portfolios. You know, fast forward to today, pretty much all institutional investors will have some kind of allocation to EM public credit in their portfolio. Do you think that's the path that we can expect for EM EM private credit, Felipe?

SPEAKER_01 19:18

I think that's a very interesting point, Tom. Um, I think, and I think it's more than 20 years ago. Like I'll go back to the 80s and uh Brady Bonds, like uh the waves of default across all emerging markets, absolute chaos in uh those heterodoxic macro plans to save the currencies and cutting three zeros every six months to bring the currency back to normal levels about being Brazilian. I've been through at least five currencies before I was 15. But things changed. Yeah, right. Emerging markets today have uh not a lot of foreign debt compared to the developed markets. Um it's more domestic, it's under control. Yeah, they are much more fiscal responsible than they used to be, and that reflects in the allocations, okay? But the allocation is still 15 years ago. Yeah, the way to invest in emerging markets is still kind of bureaucratic. Let me put my 5% here split between MSCI Global for Equities or an MB tracker for the debt. And no one is actually, not no one, obviously, but uh it's uh uh a small number already jumping into the conclusion that uh there are better options than just uh a passive fund, uh, an index tracker. But that parallels not only with emerging markets public debt, that's a parallel with the private credit in developed market space. Yeah when it started, it was also the the first movers, uh larger locators in the US that started believing, okay, in that environment of race to zero fees and and all that, there is a kind of product that gives me diversification and correlated returns and better performance than just investing in another uh ETF that charges 0.01 uh fee. And today is mainstream, today is widely adopted. Yeah, and hopefully that's what we will see in emerging markets uh private credit, given the size of the market opportunity that is not uh being explored yet.

SPEAKER_02 21:27

Okay. Brad, there's an LP in the room or watching. What's the message that you would like to deliver them to say, okay, right, how do we get from kind of conviction to capital?

SPEAKER_00 21:37

Well, we I mean we've seen the private credit market and the trend is is been a one-way train, right? And you have asset managers participating, the LPs are very active. Uh, you've also seen global banks who've really committed to the asset class themselves. You know, they've gone from reducing lending to now having groups that are dedicated to private credit. Um, you're seeing that with sovereign wealth funds and and groups globally. So this trend is is only one direction. Yeah, as Philippe mentioned, we see small asset managers in individual countries who play certain niches like local currency. Um, we think we're in a sweet spot of being a global EM provider, yeah, but dedicated. So we're not uh a 5% allocation of large global asset managers to 100% of who we are. And that uh provides a unique perspective for investors to invest in that in emerging markets. Awesome.

SPEAKER_02 22:43

Thank you very much, Brad. Thank you very much, Felipe.

SPEAKER_00 22:46

Thank you.

SPEAKER_02 22:47

For those of you who want to download the survey, learn more, visit wwwgmcopcapital.com where you can download the survey and read all of the results and all the data points yourself. And thank you very much for listening. Bye bye.