Odd Lots - An Emerging Markets Fund Manager Describes What's Happening In Turkey Right Now

Episode Date: August 20, 2018

Are you confused about the crisis in Turkey? Today's episode will get you cleared up. This week on Odd Lots, we spoke to Paul McNamara, an investment manager at GAM Investments, and a long-term veteran of the emerging markets world. He explained the mechanics of the Turkish currency plunge, and what aspects of the turmoil are unique or similar to other emerging markets crises that he's seen in his career.See omnystudio.com/listener for privacy information.

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Listen on Bloomberg Radio, stream the show live on the Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, and wherever you get your podcasts. Hello and welcome to another episode of the Oddlots podcast. I'm Joe Walsenthal.

And I'm Tracy Allaway. Tracy, it's great to both be back because last two episodes we had to do it solo. It's been a long two weeks. It has been a long two weeks. And in these last two weeks, while we sort of alternated who was on vacation, a very interesting and important eco-market market. story has been bubbling up. Yeah. Shall I go ahead and tell everyone what it is? Yeah, you can do the big reveal. Thank you. For anyone who hasn't been watching the markets at all for the past couple of weeks,

we've seen really a global sell-off, but sparked by what's been going on in Turkey. Yeah, absolutely. And Turkey is one of these stories, the currency plunge there or the political situation there that seems to be jumping out of the finance realm by which, I mean, people who don't normally pay attention to emerging markets and currencies are sitting up and paying attention. And so I think that makes for an excellent topic for our podcast. Yeah, it's pretty hard to ignore when a country's currency falls by, I think, 25% on a trade-weighted basis. That's pretty amazing.

And you've seen some really dramatic scenes in Turkey. For instance, we've seen tourists lining up outside of luxury handbag stores in order to buy those bags on the cheap before the stores actually have a chance to adjust their pricing. So clearly, a lot going on, a lot of human interest in the story as well, and a lot of economic and financial interest, some people even drawing the parallel to the 1997 Asian financial crisis. Right. And beyond just the vivid images, also some very interesting geopolitical. stuff, given turkeys where it sits geographically, it's a NATO member, the antagonism between Erdogan and Trump, part of it due to the holding of a U.S. pastor. So just lots of interesting threads to pull on kind of a complex situation. And so because of that, I'm very excited about the guest we have on today who will explain it all to us. Yeah, our guest for today is an emerging

markets veteran, really, and someone who has been a warning, let's just say, about the situation in Turkey for some time. So it should be a really good discussion. Absolutely. So today we have the pleasure of talking to Paul McNamara. He's the investment director of emerging market debt at Gam and a longtime watcher of Turkey and other emerging markets. I can't think of a better guess. So Paul, thank you very much for coming on. Thanks very much, Joe, and Tracy. So, Paul, before we dive into the situation specifically in Turkey and your perspective on it, Tracy and I have known you a long time.

People on Twitter know you're one of the sort of more outspoken and clear observers of emerging markets. But for those of you who aren't familiar with you, what is your background? How did you get into covering emerging market debt? Well, I kind of drifted into it. I spent a couple years after university in Poland when that country was going through all its changes, the move over to capitalism and kind of whetted my appetite. And then I managed to luck into a job at what ultimately became gam. I mean, the most memorable thing was I started the job in March 1997. You know, there was huge pressure to buy something. And what I decided to buy was Indonesia, which promptly collapsed. fell from 2,400 to 17,000 to the dollar. So we're going to have to ask you about all the people seeing parallels with what's happening in Turkey versus what happened in 1997 in Asia. But before we do, whenever we talk about emerging market investing, the thing that always comes up is,

oh, there's no such thing as emerging markets as a whole that each country is special in its own kind of way. So I guess just run us through what it means to actually be an emerging market investment director. I think there's a couple of things which distinguish EM from developed world. I mean, until recently the politics, but I suppose in the era of Trump and Brexit, we get wacky politics in both EM and DM. Two is the, you know, the institutions are not as strong. You know, a contract doesn't mean what a contract would necessarily mean in a developed country. there's a lot more reliance on trust and there's a lot less trust in the system.

And the other thing is, and that that kind of spills over into how the economies work. I mean, one thing you could say is that a developed country is one where interest rates go down when the country goes into trouble. And an emerging market is somewhere where they go up when it gets into trouble. So just to your point about contracts and trust, if you own a stake in an oil company in the U.S. or in the U.K., you feel almost certain that under that under all circumstances that equity share or the debt you have will be honored, whereas in many EMS, you have to wonder when in a crisis, a country could be

nationalized or something happens and you have to sort of factor that into your risk model. Absolutely. I mean, you know, there's a range. There's, you know, places like Brazil where the system more or less works, but the banks will maybe cut themselves a sweetheart deal ahead of other creditors, you know, and to the other extent, there's somewhere like Russia where the, where the government or people connect to the government might just outright expropriate what's a privately held company. And regards to what you said about in a downturn in the U.S. or in a developed market, you do see people pile into save havens like government debt. In EM, it's just the opposite. But what is the, why is there that sort of mechanistic difference? I think, again, it comes down to trust. I mean, it's, you know,

Safe is a relative thing. The US treasuries are the gold standard. And this is what we tend to find is that when Americans panic, they buy US government bonds, that's their safe haven. But when Russians or people from most other countries panic, they also buy US government bonds, which means that they sell the local currency, and in order to protect the currency, interest rates go up.

So on top of whatever crisis is causing people to panic, You also have, you know, tighter monetary policy, which in most cases makes things worse. So I have one more emerging markets in general question before we move on to Turkey. But when you're investing in emerging markets, if you have that EM investment mandate, what do you actually choose to invest in and how much are you beholden to what the big benchmark indices say is emerging market? So, you know, what JPM says are emerging market bonds or what MSCI says are emerging market equities. Yeah. There's really, I think, two ways of trying to make money in emerging markets.

There's the one which is kind of the center of all our presentations, which is we take advantage of the progress stories. We try and find, you know, that first you had the first round of Asian Tigers and then sort of the second round, Thailand and so on. And you try and ride that progress up. And that is part of it. But, you know, the flip side is, I think, kind of. what we're looking at Turkey now, which is you try and find something which is a disaster area, but still cheap. What you tend to find is that the great returning stories in EM tend to be to buy the disasters. So that's a decent part of the job as well. The indices are a huge issue.

There's a range of investors. We do bonds, so we're probably slightly more closely tied to benchmarks than our equity counterparts. But the fact that Turkey this year has fallen from the 10% of the key local market index to just 3% just because of the collapse in the lira and the collapse in the price of bonds. That does play a part in our thinking. All right. So you talked about disaster areas. So I think we've got to get right into the situation in Turkey here. For the people who don't really aren't finance people, haven't really paid attention to this. Someone asked you at a bar, what's going on in Turkey? Why are things so bad? what do you answer to them?

They're running out of dollars. The banks have borrowed a huge amount of dollars. They've lent those dollars on to local companies who, generally speaking, aren't exporters. Quite often, their property and construction companies. So you've got people trying to use lira rental revenues on a shopping mall in a third-tier town in Anatolia to repay dollar debt. And at the same time, they're importing a lot more than they export, even counting their tourism revenues as exports. And just to put the icing on the cake, they have the least adequate level of foreign exchange reserves of any major market. So really, they need another source of dollars fast.

The president thinks the population should chip in and convert their dollars into lira, but they don't seem terribly enthusiastic about that idea. I wonder why. Weird, isn't it? So this is something that comes up again and again in emerging markets, this idea of external and internal imbalances, which is kind of what you're talking about with the dollar borrowing. Why do emerging markets and why did Turkey specifically decide to borrow in a foreign currency? Because the interest rates are lower. I mean, you know, even at their lows, Turkish interest rates were in double digits. You know,

when you have a period of stability for the lira, the thinking typically comes well, I can pay 12% for my lira loan or I can pay two or three percent to borrow from a European bank. And so they go, with the European banks. And against the background of QE, the European banks have just been very, very keen to lend to the Turkish banks. Kind of marriage made in hell, to be honest. So when it's going up, when growth is happening and things are stable, it's a pretty great trade to borrow cheaply in dollars, build a new shopping mall or an apartment center, collect rent in lira, which in good times may be appreciating. and then you pay back, you convert it back, pay off your dollar loans, you make money.

This situation has been going on for a while, and it's not like any of these imbalances are new or suddenly just spring up on people. What catalyzes the downturn? There's a bunch of things in the case of Turk, and it's really quite hard to say which is it. I mean, we've had a little bit of an economic slowdown, which sort of impinges on profits. It means that non-performing loans are ticking up a little bit. We've had general worries about credit globally. That's not helping either. And then you've just got the increasingly bizarre behavior of the politicians.

There was a quote unquote coup in Turkey a couple of years ago. That's been used as a pretext to really dismantle democracy. I think a big part of it and something that we haven't heard enough about is that there's capital flight that the political changes in Turkey have prompted, I think, a lot of rich Turks to decide that their money is better off in London. or Switzerland than it is in Istanbul. But it's really a bunch of very negative things happening at the same time. And it's quite hard to point to one specific one, which is more important than all the others. Right. But this gets to what you were saying earlier about what distinguishes emerging

markets is that weakness in institutions. And it feels like in Turkey, you kind of have that in spades now, right? You have the central bank basically afraid to raise interest rates because it doesn't want to upset Erdogan or get on the wrong side of Erdogan. You have Erdogan's son-in-law now installed as, I believe, it's finance minister. How much has that played into sentiment towards Turkey, both locally and internationally? I mean, I think the key thing has been the crackdown after the coup. It's not at all clear what did happen during the coup, but it's being used by the government, both to persecute people they're not very fond of, and also to do a certain amount of economic looting on the side, you know, that we've seen various businesses turned over

to either the government or government-collected parties, which just encourages people to move their money away. We've also had, obviously, the row with the United States about the priest, Andrew Brunson, and obviously American evangelicals are an important voter bloc in a U.S. election year. It's when Turkey's luck ran out. It sort of luck ran out in lots of different ways at the same time. Going back to the currency mismatches and imbalances, this gets to, I think, kind of the nub of a very important thesis that people put forth that tightening of central banks in developed markets, particularly the Fed and also maybe the ECB. When they go into tightening cycle is that that can kick off a pain and maybe sometimes crises for emerging markets because if businesses were

premised on borrowing cheap dollars and dollars get less cheap than that hurts. How much of this is about central banks in your view and how much is that just sort of used as a story? I think it's mostly story. The one macroeconomic development, which I think has made a huge difference, has been dollar strength this year. I mean, that's the one thing that has put all EM currencies on the back foot so that while we've avoided a lot of damage by staying out of Turkey, we've, you know, we've been smacked around from South Africa to Brazil. That part of it, I think, I think is genuine. In terms of the Fed hiking cycle and weakness in treasuries, I think that's pretty much narrative. Emerging markets, you know, can find their way into trouble in any

circumstance, no matter how benign. And I think at the moment, global interest rates are still very low, credit conditions are still pretty loose. I mean, it's a lot. It's a lot. It's a lot. I mean, it's to say that this is, you know, this isn't like the Volcker tightening where, you know, the U.S. suddenly went nuts and really crushed global liquidity. This is a pretty mild hiking cycle. And the ECB on the up and is hardly doing anything at all. So just to follow up on that point, Paul, I know you're saying that you think the notion that the U.S. tightening monetary policy having a negative impact on EM is overblown, at least in this instance. But if it wasn't, do you think the Fed would care?

at all about the impact that its monetary policy has on the rest of the world? Absolutely not. I mean, you know, the Fed has always been very clear in the past. I mean, I remember that it was last raised, I think, in Argentina was going down the tubes in 2001. You know, and the Fed's very clear. It's the old thing, you know, it's our currency, but your problem. The Fed is not interested in what happens in the rest of the world, except to the degree to which the rest of the world affects the US, which means that you've got a super strong dollar maybe affecting trade. That makes a difference at the margins. But, no, the Fed's not going to rescue anyone here.

I'm Francine Lacqua, an award-winning journalist. And I've got a new podcast, leaders with Francine Lacqua from Bloomberg Podcasts. I've interviewed everyone from Heads of State to fashion icons about the news of the moment. But I've always been curious, who are these people as leaders? I don't think there's one right way to be a leader. Make decisions. A poor decision is always better than no decision. Listen to new episodes every other Monday. Follow leaders with Francine Lacroix wherever you get your podcasts. Paul, what is the data that you look at? I mean, sometimes you get these crises that are kind of simple.

Maybe it's a sovereign debt crisis and the country is the government's debt. Maybe they're running out of money. But obviously, it's not nearly as simple when it's about banks, and private sector borrowing and the reserve data. What are the data points that you look at as a fund manager to sort of gauge the health and vulnerabilities of a given country? In Turkey, it's very clear. All we're looking at is the rollover rate, you know, that I think the Turkish banks have about $70 billion of loans coming due this year. And so they need to borrow 70 billion plus to keep that going. So, um, We use the syndicated loan search function on the Bloomberg terminal.

That's the single most important piece of data we look at. We appreciate the plug. That justifies today's entire episode. So, I mean, on that note, Turkey facing this wall of debt that's, well, that will need to be rolled over in some way. What are the chances that international investors step up to actually do that? I say the chances are a lot lower now. I mean, I think the thing that really sent things spiraling on Friday was the report in the Financial Times that the ECB is concerned about the level of European banks exposure to Turkey. I mean, in particular, BBVA, which owns one of the biggest private banks in Turkey, I think BNP are involved as well. The thing that has, I think, been frustrating for us, given that we've been quite negative on Turkey for a long time, is that the people who make these syndicated low,

were quite happy to keep rolling them over. I think what's really going to change now is when it's embarrassing for a bank CEO in Europe to explain how much exposure they have to Turkey and that they're going to try and take steps to roll that back. And we're beginning to see signs of that, even, you know, that prime brokers are looking to reduce the amount of lira exposure they have on the prime broking books. So it does begin, it's beginning to look as if European banks are beginning to wind this in a little bit. So then what does recovery or stemming the bleeding or stopping the crisis look like?

Because one of the things that I think has been interesting about watching Turkey is a certain, I was going to say unwillingness to adopt the sort of traditional crisis fighting measures you often see. But it's not just an unwillingness. It's a very aggressive antagonism towards those. So we don't see those massive emergency rate hikes and the sort of typical things you would see in the play book, given what we know about the Erdogan administration and what they've said about economic policy, what could a crisis fighting measure look like? Like, what is the endgame here? Well, I mean, Turkey's problem is a shortage of dollars. And, you know, and to be fair to earlier, and, you know, they've hiked quite aggressively. That hasn't helped. The Argentines have hiked even more

aggressively and it's not done them any good at all. If Turkey needs more dollars, there's really two places that can come from. Number one is the IMF and our base. cases that we get an IMF program, which unfortunately that's a big loss of faith and that's quite difficult to sell politically. The other one would be that Turkey tries to sign up some of their international allies, places like Russia or China or Qatar, and kind of get a kind of substitute IMF, substitute for an IMF package source of dollars out of those countries which are very significant reserves. But as far as we can tell, those countries are maybe slightly less enthusiastic about that than the Turks are. We said earlier that you are, of course, an emerging market investing

veteran. Is there anything that surprises you about the Turkey situation? Is there anything highly unusual compared to other EM crises in history? Not really. I mean, I think the big surprise for us was that it went on so long. I mean, you know, we've been bleeding money for, you know, for months before this began, this began to work for us. It's a very patient world at the moment. you know, with very low interest rates, you know, and banks were willing to take, you know, unsuitable risks for kind of four and a half, five percent yields that maybe they wouldn't have been in another environment. But otherwise it's, you know, you've got the nutty kind of semi-dictator.

You've got obscure activities in state banks. You've got the president's son-in-law has made finance minister. You've got an unsustainable property boom. I mean, you're really ticking an awful lot of standard boxes that we've been seeing all the way back to, say, Thailand in 1997. So I think if there's one word that's on a lot of people's minds these days with regards to Turkey and what it means for markets, it's the word contagion. And everyone's trying to figure out whether Turkey, and again, to use a word that you hear a lot, is an idiosyncratic case where, as you say, it's just about the, quote, nutty dictator and so forth. or whether it says something about other vulnerable emerging markets like South Africa, like Brazil.

How do you think about this question? I mean, generally, when something like this happens, we try and find, well, what other markets have the same problem, especially that blend of a lot of private sector debt, a big current account deficit and inadequate FX reserves. And really, I mean, Argentina kind of ticks two out of three, but otherwise the rest of EM, you know, it has problems with growth, they have problems with exports, but they don't have this kind of debt pile up. They don't have this financing problem that Turkey has. So EM is having a very rough patch at the moment,

but we think that's got a lot more to do with just the strength of the US dollar because EM currencies always do badly when the dollar is strong. We don't think Turkey specifically. I mean, you know, Venezuela's been blowing up for years. We've seen Ukraine default. Contagion doesn't look like it's a major thing. at the moment. We did see a little bit of weakness in the South African Rand, for instance, once the Turkey situation started really deteriorating. So some people were pointing at that as a

sign of contagion. When contagion happens, is it about people doing that fundamental analysis that you just explained and looking for parallels with the Turkey situation? Or is it about people having portfolios of correlated emerging market assets that they now have to do something with. There's an element of both, but I mean, we, you know, we haven't had time to see significant withdrawals from EM funds, so I don't think it's that what's triggering. I mean, the South African Rand is always a high-vol currency. Also, I think there was something of a fat finger trade in Asia, which we saw a much bigger move than we'd normally expect. I mean, South Africa goes all over the place. It rallied nearly 15% earlier this year on some fairly minor political changes.

I would have to concede there is clearly an element of this, you know, I mean, especially kind of macro hedge funds, well, what other EM currency can we short? But for the moment, I think we don't see a lot of contagion and we don't expect to. But as I said, we've been wrong before. Paul, I mean, you mentioned the South African rant, you know, moving by 15%. Is emerging market investing just inherently, let's say more entertainment? or more dramatic than developed market investing? Oh, yeah. I mean, I do remember when the Swiss franc revalued a couple of years ago and, you know, everybody was, everybody on the DM end of our floor was jumping around. But, you know, it's the sort of thing that we see every few months. It's definitely more entertaining.

It's probably harder on the nerves, though. Paul, you said something earlier in the conversation that I thought was interesting when you said that you tried to. to look for this point where bankers start to feel embarrassed about the idea of extending further loans into Turkey, or they can't justify it, or they don't want to be associated with it. In the world of investing, how much does that factor into decisions and opportunities where maybe the best opportunities come about because just nobody wants to say they have exposure to ex-country, even if the fundamentals may start to be turning around?

I think it's massively important. I mean, it does tend to happen nearer the end of a crash than the beginning. But, you know, what you'd call kind of career risk or, you know, when you get to the point where the chief investment officer has seen something in the FT about Turkey, you know, that it begins to reach out. But I do think it's not that we can't justify losing money. We can't justify losing money in Turkey when everybody knows Turkey is terrible. And that tends to be quite close to the turning point because people are, when people stop looking at the

economics, things overshoot and value opens up. But it's usually better to be a little bit late to that process than a little bit early. You also mentioned earlier about the idea that some of the biggest gains from EM investing can come when you're buying, you know, the deep wreckage that finally gets cheap. So not saying we're there yet, but in a situation like Turkey, as an investor, or maybe going back to Asia after 98 crisis or after a decade crisis or after a lot of, the taper tantrum, whatever it is, what do you look for to say, okay, this is what true wreckage looks like? This is what blood in the street actually looks like. It's usually just the sign of extreme distress and having a decent grasp on what we think the fundamentals of the problem were. So, I mean,

if you go back to, say, 2014 on Russia, it was, you know, there was a lot of noise about Ukraine, but it was mostly about the oil price. Once the oil price turned, you buy the ruble. In Turkey, as I said, it's the dollar shortage. I think an IMF package would be the time to buy Turkey. Well, on that note, I think that is a good place to stop. So we'll see how this crisis progresses. And if there is a IMF package at some point, Paul McNamara, so great to get your perspective. Always love talking to you. And thanks for finally coming on the odds lot of time. Thanks very much for having me on. Cheers, Joe. Cheers, Tracy. So Joe, I thought Paul was really the perfect guest to come on and talk about emerging markets and the situation in Turkey.

And what he was saying about the point at which it really, really becomes disaster when international investors have to start explaining to their bosses why they invested in a country that has these kind of problems. That seems spot on to me. Yeah, I love Paul's explanation. And I have to admit, you know, my first question in him about Turkey. was like, oh, explain it to someone who's kind of doesn't pay attention and maybe you're explaining it to someone in a bar. But I have to admit that was actually kind of for my sake, because as much as I purport to pay attention to this stuff or talk about this stuff, I still find the mechanics of a lot of these things, particularly the sort of currency

imbalances and the role of the banks and the rollover. It's not easy stuff to wrap my head around, but I feel like Paul is really good at the crystal clear explanations of this stuff. Oh, absolutely. And I mean, to your credit, not that I'm making excuses for you, but there's a lot going on and it's still happening. So Paul was mentioning this notion that some of the prime brokers, you know, these are the big financial institutions that provide services to hedge funds and other investors that actually allow them to trade. When they start retreating from providing, you know, liquidity and financing for Turkish trades, it has the potential to be a self-fulfilling sort of downwards. spiral. Yeah, there really are a lot of moving parts to all of these crises. And I think Turkey is a particularly confusing one. The other interesting thing I think that maybe people don't appreciate is they might look at Turkey and they see rapid growth and they see all these apartments going up and they're like, oh, this is a country developing. This is a country that's becoming richer. And what they don't appreciate is that the process of becoming richer comes at the expense of,

of these financial imbalances, which really makes sort of the conventional approach to looking at a country, I think, very difficult for the average person. Yeah, it's one of those things where you can kind of keep borrowing as long as you have the economic growth narrative to support that borrowing. But again, it gets back to the bankers. Like, if you can no longer go to those lenders and say, oh, look how fast we're growing, give us more money, then the whole House of Cards kind of starts to fall apart. Absolutely. Well, the Turkey story is definitely, I don't think it's going to be over for some time. I don't know, maybe like in a month or two we should have a Paul back again and sort of get an update because I feel like we don't need that.

I think we'd have a lot more to talk about, to be honest. I don't see the Turkish headlines and news flow going away anytime soon. Yeah, I don't think so either. All right, should we wrap it up there with that pessimistic. Yeah, let's do it. Enough talking turkey. Sorry. This has been another episode of the Oddlots podcast. I'm Joe Wisenthall. And I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. Oh, and you can follow me on Twitter at the stalwart. And you should follow our guest, Paul McNamara, on Twitter. He really is one of the best people on Twitter. And that is no exaggeration because he really knows this stuff. and he's very forthright in a way a lot of investors aren't.

His handle is M underscore Paul McNamara. And follow our producer, Tofer Forges, on Twitter at Forges T, as well as the Bloomberg head of podcast, Francesca Levy, at Francesca today. Thanks for listening. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Moscow here to tell you about our new on-demand news report, delivered right to your podcast feed. Bloomberg News Now is a short five-minute audio report on the day's top stories.

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