Argentina’s history is one of recurring promises and painful resets. Nicolas Dujovne has lived that cycle from the inside, serving as Finance Minister during a rare attempt at fiscal repair before markets and politics turned against it. Now, as CIO of Tenac Asset Management, he reflects with Alan Dunne on why economic reform so often falters, how short-term pain fuels long-term instability, and what it would take to finally break the trap. Beyond Argentina, the discussion widens to emerging markets at large - their hard-won stability, the new risks born of geopolitics and demographics, and the shifting fault lines of globalization.

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Episode TimeStamps:

02:24 - Introduction to Nicolas Dujovne

05:32 - Key reflections from Dujovne's former role as ministry of Treasury in Argentina

11:43 - How dollarization could change the overall dynamic of the economy

14:52 - How Dujovne's role as minister has shaped his investment process

16:56 - The state and outlook of emerging markets

21:13 - The relationship between central banks and emerging markets

23:33 - How the current globalization impact the investing landscape

27:43 - Evaluating the U.S from the lens of an emerging market investor

33:25 - How markets respond to fiscal dominance

37:16 - Are we going into a secular decline?

39:19 - How demographics impact emerging market investing

42:35 - Cheap manufacturing chains in emerging markets

44:17 - Finding investment opportunities in emerging markets

46:45 - The maturity of emerging markets

48:14 - The preconditions for structural outperformance of emerging markets

51:08 - How important are commodities for emerging market trading?

52:48 - The energy demand for emerging markets

54:44 - Themes that will dominate the emerging market space in the coming years

56:12 - Advice for other emerging market investors



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Nicolas: 00:00:07

What we are facing right now is, you know, again, we have a new administration that is delivering in the right policies in terms of the fiscal, but the cost that the population is bearing in the short run is clear.

So we are in the midst of this process in which without a shift in the way in which the opposition thinks the economy, it will be very difficult to exit the trap. So we have clearly a fiscal problem, but that needs a political solution.

Intro: 00:00:46

Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more.

Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund fund managers in the world so you can take your manager due diligence or investment career to the next level. Before we begin today's conversation, remember to keep two things in mind.

All the discussion we'll have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance.

Also understand that there's a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran hedge fund manager Niels Kaastrup-Larsen.

Niels: 00:01:41

Welcome and welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective.

This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy.

Niels: 00:01:59

And the geopolitical cycle.

Niels: 00:02:02

We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macro driven world may look like. We want to explore their perspectives on a host of game changing issues and hopefully dig out nuances in their work through meaningful conversations.

Please enjoy today's episode hosted by Alan Dunn.

Alan: 00:02:26

Minister of Argentina between: 2017

Nicolas: 00:03:00

Very well and thanks for invitation. Alan. It's a pleasure for me to speak with you here today.

Alan: 00:03:06

Good stuff. Well, we haven't had a Finance Minister on before. So that's definitely a first.

So fascinated to hear about your background in policy and in economics and markets. How did you get interested in economics and the markets in the first place?

Nicolas: 00:03:22

Well, I think that I was strongly influenced by the longstanding history of instability of Argentina. So when I was a child I was always thinking, why don't they fix this? We were always in the midst of volatility on the effects, high inflation quotas.

I remember being a child and having to do my parents having to do a lot of stuff to get effects in the midst of capital controls so as to be able to travel abroad.

So I was raised in an economy that was dysfunctional and I think that generated my interest on the processes that led to that instability and how that can be fixed.

And it's not a surprise that many, many Argentinians that are now in academia are tilted towards more to macro than to micro than other economists of the rest of the world. And maybe it's this interest in fixing the country. So I grew with a strong interest in politics and economics.

At some point when I was at high school and was thinking on my career, my doubt was going to law school or to economics and I was more inclined to economics. I really enjoyed maths and that's why I think that I was tempted to study economics.

Alan: 00:05:34

Very good.

I mentioned obviously you're well known as being a former finance minister in Argentina and you've already alluded to the fact that there's kind of long standing cycles of crises in Argentina that seem to recur periodically. And we're kind of in the midst of a, maybe not a crisis, but a period of volatility at the moment.

I mean, looking back at that experience now as finance minister, any kind of key reflections, are the problems intractable in an economy like that or can they be fixed or is it very much, I suppose the political side of things that's the challenge as much as the economic?

Nicolas: 00:06:17

a trap, I think in the early: 2000

But departing in 05 06, the administration that was in charge at that time started to a process of increasing the size of the government in Argentina, driving the size of the government as measured in terms of GDP from roughly 25% of the GDP to 42 in just 10 years. So we almost double the size of the government in Argentina. Argentina is a country of middle, middle, high Income.

And countries like Argentina with that degree of income, well, typically they do not collect taxes for 40% of the GDP. You will not find not even one example of that.

Typically middle, middle high income countries can collect between 25 and 30 something of the GDP at best. So having raised the government expenditure from 25 to 42 meant that Argentina had to finance its deficit well with the reserves of the central bank.

Once reserves of the central bank were depleted with indefiniteness.

And when we reach a limit on indebtedness, basically by printing money, those three ways, the abuse of these ways of financing generate a lot of trouble. But the rules is fiscal. And to bring down again the size of the government expenditure to a level in which it can be financed by taxes.

Well, you have a political problem, a problem that we experience under Macri administration, because we started to eliminate subsidies and we launch a Social Security reform. And of course in the short term that can create some pain in the process of adjustment.

When President Mackley took office, the price of the electricity that the households paid covered just 15% of the bill.

Same for water provision, for transportation, urban transportation, in the case of the urban railways, in urban trains, the price paid by the users just covered 5% of the cost. So we started to correct these imbalances at the beginning.

That generates, well, a change in prices, a temporary raising in inflation while you are passing all these increases. And eventually at some point, fixing the fiscal will deliver growth and that will be rewarded by the voters. But it's a non linear process.

And after four years of efforts, we were defeated in the next election. And again the people that drove the size of the government to double its level took office again and they started to bring money.

inish their administration in: 2023

But you can do a lot of efforts, but it's very difficult for the population to see the fruits of the effort in four years and to reward the administration that is delivering on the adjustment.

So we need that the opposition improves also, because what we are facing right now is again we have a new administration that is delivering in the right policies in terms of the fiscal, but the cost that the population is bearing in the short run is clear. And the risk of the populism coming back to Argentina is preventing investment to pick up, because the political risk is too high.

So the risk of a new default or capital controls.

So we are in the midst of this process in which without a shift in the way in which the opposition thinks the economy, it will be very difficult to exit the trap. So we have clearly a fiscal problem, but that needs a political solution.

Alan: 00:11:43

Fair enough. I mean, as you say, you do need to kind of circuit break these cycles, these virtuous and vicious cycles.

One thing that you sometimes see, and obviously has been mentioned a bit, is dollarization.

And that if you dollarize the economy, would be a shock to the economy, I guess, but would be critical in bringing down borrowing costs and stabilizing inflation. Is that something that could be, could, could change the, the, the overall dynamic or not?

Nicolas: 00:12:12

Well, it's a possibility. But somehow thinking about dollarization is also like thinking in magic.

First, Argentina does not have the resources to dollarize the economy because you have to, you know, buy all the pesos circulating in, in the economy.

But in the process of dollarizing the economy, all the peso debt that is very short term will be converted into dollars and you will not have a buffer at the central bank for it to have as a lender of last resort.

So Argentina is not in a position in which can dollarize and with the appropriate buffers to have the liquidity to convert the peso debt into dollar debt and to have a central bank that can act as a lender flash resort. But in theory, let's assume that you have the money and you can dollarize the economy.

Now the politicians will not be able to overrule the equilibrium in the budget because they don't have the way to finance it. They will be converted into a better politicians.

And maybe it's too ambitious to think that by just applying the magic of dollarization we will shift the mindset of all the political system in Argentina. So maybe we will be in a more rigid scheme in which the same politicians will be trying to break it.

And at some point, if you try to break the equilibrium in an economy that is dollarized, well, it can happen, maybe not, but it can happen that the costs can be higher than the ones that you have in an economy that is not tolerant because eventually your mistakes can be converted into a deposit freeze or a default rather than a hike in inflation rate. So one does not have to be dogmatic when analyzing dollarization in Argentina because eventually it can be a shortcut to stabilize the economy.

But it's a political decision of a leader and it can work and maybe it cannot because of the caveats that I mentioned before.

Alan: 00:14:53

Fair enough. So obviously you've left policy making now and you are managing an emerging markets macro fund.

I mean, how has your experience as finance Minister helped inform your investment process. I mean, you talked about the political consensus or lack thereof in Argentina.

I guess that's a key dynamic you're assessing when evaluating emerging market credits. But any other ways the experience has informed your approach to investing in emerging markets?

Nicolas: 00:15:26

Well, clearly it provides you with more experience and it allows you to be in the boots of the policymaker of the other country. And you know the political restrictions that they are facing, you suffer them.

And maybe you can be more realistic in analyzing the menu of possibilities that the policymakers have when delivering their policies.

On the other hand, having been in office and negotiated the problem with the imf, I learned a lot about how the programs with multilateral work it's conditionality. And it is more easy for me now to analyze what type of policies will be delivering.

A country that engages, for example, with the IMF in terms of FX policy, which are the options in terms of the FX regime that can be choose what the conditionalities will look like. And clearly the experience of having been there is very valuable in terms of analyzing potential programs.

Alan: 00:16:57

Sure.

So I mean, looking at emerging markets more broadly now, if you look at the, the last number of decades, I guess, of emerging market investing going back to the. I suppose it started in the early 80s and Brady Bonds, et cetera.

And then we had periodic crises, obviously the Asian financial crisis and the Tequila crisis back in the 90s. But things have been more stable. I think. Obviously individual countries have had issues, but not a widespread emerging market crisis.

And I guess more recently a number of the emerging markets have, I suppose now they're hearing more that policy is more credible maybe in some emerging markets than say in the US So there seems to be this kind of heightened sense of positivity. I mean, what's your perspective on that?

Is it a structural trend towards lower yield spreads and em, or is are we just in a point in the cycle now where it's favorable?

Nicolas: 00:17:56

Well, I think, you know, emission markets, generally speaking, are. Most are more stable than, you know, 20, 30 years ago.

I have two reasons which are fundamental in explaining why EM is much more stable than it used to be.

One is that basically vis a vis the fall in, in the improvement of the fiscal position of the economies and the falling inflation rate, most of the countries in EM started to finance the biggest part of their deficits or their financial needs in local currency in the domestic markets. So the mismatch of currencies is much lower than it used to be, typically in the 80s with very tiny capital markets and still with high inflation.

Rates the financial needs of emerging markets were covered with hard currency debt.

So eventually when terms of trade shock came or a financial shock came, countries were faced with a mismatch in terms of the flow of futures income due to tax collection and the stream of payments that was denominated in other currency. And that generated a lot of defaults.

The other stabilizing factor is that most of the countries in em, not all, but most of them, adopted floating exchange rate regimes. And the floating exchange rate regimes are acting also as a buffer to external shocks.

So the combination, okay, now I can float because I don't have the balance sheet problem of the mismatch of currencies, so I'm more free to float.

And the adoption of floating exchange rate regimes generated slightly a higher volatility in terms of the nominal effects rate, but a higher stability in terms of the real economy on how the GDPs behave. So the cycles were less pronounced.

And I think that those two factors are mostly the ones behind the explanation of why EM is doing much better in terms of growth stability and the rate of defaults that we are seeing than the ones that we had in, in the past. And I, I think that you know, it's, it's remarkable.

And of course when you take A look at DEB to GDP in EM is let's say it's somewhere between 55 and 60% the, the median debt to GDP as compared with levels north of 100 in, in advanced economies.

So there's an appeal also for, for EM coming from, from you know, lower dips and with the advantage now that most of those debts are denominated in local currency.

Alan: 00:21:15

And I mean obviously central bank independence, inflation targeting is very topical at the moment and we might talk about that with respect to us later. I mean where do you think central banks and EM score on that? I guess there's a variety wide spectrum across the different EM credits.

But in general, is it fair to say there's been a trend towards more independent central banks or not or at least policies appears to be more credible than maybe it has been in the past.

Nicolas: 00:21:42

Clearly, clearly we are seeing that that process in which central banks are in the process of gaining credibility. So, and you know, that credibility arises from legal aspects.

For example, the Central bank of Brazil was formally declared independent by law just two, three years ago. It acted as if it was independent, but formally still it was under the scope of the Ministry of Finance until the law was was modified in Mexico.

The independence of the central bank was able to withstand a change in office towards a more populist administration when President Lopez Obrador took office.

In the case of Peru, we had a shift in the presidency that was very traumatic with zero impact on the economy, basically because of the credibility of the central bank that has close to between 30 and 40% of the GDP in reserves. So in my view, the process of the increase of the credibility of the central bank's NEMO is ongoing.

Some countries are more advanced than others in that career, but it's clearly an improvement that is bearing its fruits.

Alan: 00:23:34

Okay. I mean, one of the big features of the global landscape has been globalization through the last four decades, up until recently.

And so the idea was for, you know, companies in the west to outsource production to cheaper emerging markets, which was a source of growth, which would then raise the standard of living in emerging markets.

I mean, what's your perspective on that dynamic now that globalization is somewhat in reverse and we're into a more bifurcated world with China being more dominant in some emerging markets and obviously the U.S. you know, very close to Argentina, but maybe less so with other emerging markets. How does that impact the kind of investing landscape?

Nicolas: 00:24:18

Well, we are seeing a geopolitical change, especially since the first administration of President Trump in the US in which a lot of attention was put in terms of the reassurance of the provision of inputs, as if that provision can be disrupted for political reasons in the future. After that, we had the pandemic of COVID that also generated a lot of disruptions in the, in the supply chain. In the supply chain.

So either for political reasons or because of the lessons generated by the disruption under Covid, a lot of advanced economists started to pay a lot of attention on securing the supply chains of inputs.

And also in the actual administration in the US not only for security reasons, but for a very old style version of import substitution like in Latin America in the 70s. The administration is focusing producing America all that they can, which in my view is, is something that in the long run will damage productivity.

But you know, it's, it's the idea of the administration. So at some point, yes, this, this is impacting the way in which investment is flowing to, to other countries.

And the factors in determining investment in other countries now are not based on pure economic reasons, but also in political reasons.

And that is generating, you know, a lot of changes and at some point some instability in terms of how to think FDI in the next few years in emerging markets.

Alan: 00:26:40

Okay, so do you think it's that that aspect is less favorable then in terms of the outlook for em, will we see less FDI at some point?

Nicolas: 00:26:53

Yes. At some point? Yes, because with less visibility in terms of in which countries it's okay to invest as opposed to in which countries it is not.

Given that there's a lot of volatility in terms of tariffs, let's assume that you invest a lot of money in a country and then the administration decides to raise tariffs to that country. Well, your investment will not work as expected.

So it will be very unlikely that in the midst of this volatility, we don't see even a slight or mild toll to pay in terms of FDI in emerging market.

Alan: 00:27:49

So obviously, I mean, when you look at the EM space, you assess the individual credits, but they are obviously heavily influenced by the outlook more generally in markets.

And I guess we've seen quite stable yield levels in the US over the last while, notwithstanding the kind of concerns around debt levels in the U.S. when you look at the, the U.S. from the perspective of, you know, I guess from the lens of, of an EM investor, presumably it is. The outlook is becoming more worrying given the usual scorecards you would use. But what is your evaluation?

Nicolas: 00:28:30

Well, first. Well, the, the US is experiencing, you know, two phenomena at the same time.

One is that the inflation that was generated by the excess of demand due to its monetary and fiscal policy in the aftermath of COVID is gradually receding.

In our view, there were policy mistakes in, in that period, you know, in a period in which supply was suffering, you know, a contraction due to the pandemic, the authorities pushed the demand very heavily, both by monetary and fiscal policies. And in my view, the part of the monetary policy was totally unnecessary.

The help of the authorities should have been focused on, you know, providing the necessary goods and services to the population that was affected by the pandemic, but trying to compensate on the demand side.

The contraction in the supply side generated by the pandemic was clearly a mistake that explains a big part of the inflation differential that we saw in the US as compared to some EM economies or even Europe.

We have to blame in part the Federal Reserve for starting late to adjust its monetary policy and because of the excess of expansion at the beginning of the pandemic, but also the treasury that was too expansionary during the pandemic and its aftermath.

But at this point those policies are fading away and we are seeing that some components of the inflation rate that were affected by these policies are starting to receive clearly shelter that was very difficult to break in terms of coming to price increases that were close to the target of the Federal Reserve now is converging to a level that is compatible with the objective of the Federal Reserve. But we are suffering a temporary hike in the inflation rate due to the increase in tariffs that were delivered by the administration.

ion rate that was provoked in: 2122

So when we analyze the yield curve of the US well, we are more or less comfortable with rates slightly above with 4%. We don't think that eventually we will see rates going up again.

The real rate component of that four and something percent is very, very high as compared to the past. In the midst of an economy in which real rates should be the result of real supply of savings as compared to real demand of investment.

It's a real phenomena we are not seeing now a process of a sharp pickup in investment.

So real rates are high and one should ask why real rates are still that high in the US and maybe it's because of the perception that the political influence on the Fed is going up and eventually that can be pushing the Fed to bring down the short term rates too rapidly and eventually that, you know, that can lift the long term inflation rate by an, you know, an overheating. So that, that explains in part the steepening of the curve.

But apart from that, on the balance of risks, we are okay with long term rates right now, which are basically one of the most important factors when decided on your portfolio of investments in. Yeah, because both the, you know, the boom and volatility of the 10 year yields and the level are a key component of that decision.

Alan: 00:33:27

And obviously we've heard a lot about fiscal dominance and that as you alluded to the concern in the market, the steepening curve, I mean, do you think that's a real feature? Now are we into that point of fiscal dominance or is it the market anticipating this problem down the line?

Nicolas: 00:33:44

The market is anticipating it eventually. If the US does not correct the fiscal, we will enter into a process of fiscal dominance in the future. Not, not yet.

And I don't think that we are there yet.

But of course it's clear that some concerns increase about that because you know, in the last 20 years we saw a regularity that was, you know, when the Republicans were in office. Well, they lower taxes, they increased the deficits.

Then the Democrats came and the guys that were supposed to be more responsible in economic terms were the guys that fixed the fiscal. It happened during the Clinton administration in which the US stopped issuing 30 year treasuries because the debt was shrinking.

Then we had the Bush administration which deficits went up again, had a great financial crisis in which some increase in the fiscal was necessary to fix the financial mess.

And then the Obama administration drove the fiscal deficit down by roughly 1 percentage point of the GP per year and finishing its administration in a very some position.

And thing is that after Trump won, in which again we had a push in the fiscal, the Biden presidency broke the regularity and the Democrats this time didn't fix the inherited problem from the Republicans. And clearly I don't see a serious discussion now in the US on how to fix the fiscal.

And eventually it's a discussion that needs to take place, as you say.

Alan: 00:35:59

I mean in the experience of Argentina it's the political consensus is important for addressing deficits and that's obviously not in place in the US at the moment. But at the same time it sounds like you're not worried about kind of an imminent fiscal crisis with yields spiking, et cetera.

That doesn't seem to be on your radar.

Nicolas: 00:36:17

No, not yet. Clearly not yet. Still the US is in a position in which it can finance its deficit.

And still the inflation rate did not converge to the target of the Federal Reserve. Nominal GDP is growing at at the higher level than the one that we should see in equilibrium.

And transitorily this is making the fiscal problem to seem less worrying than it will be in the future when the inflation rate converges to a lower level and nominal GDP grows at a slower pace. So debt to GP will start to climb more rapidly if they don't fix the fiscal. But still I think that problem lies some years ahead of us.

Alan: 00:37:18

Okay. The other factor that tends to be very influential for emerging markets and the outlook there is obviously the US dollar.

And we've had a decline in the dollar this year. And coupled with concerns over Fed independence and credibility, there's a concern, at least there was in the market for a while.

It's about the dollar's reserve status or even just a rebalancing away from the dollar, particularly with the rising gold as well in the last while. Is that an ongoing theme?

Do you buy into that argument that we're into a secular decline and presumably that would be a positive for em more generally if that's the case.

Nicolas: 00:37:59

Marginal, yes, marginally, yes.

And this derives both from some decrease in the credibility of the Federal Reserve because of the interference of the executive and also this process affecting the US Dollar stems also from the fact that in this new geopolitical world, some countries are finding that investing in gold or other currencies will prevent them from suffering sanctions from the US that can generate freezing of their assets.

And the war between Russia and Ukraine also was a process that affected at somehow the role of the dollar and its reserve status because of the shift that that generates in terms of some preference for gold for some central banks, especially China, in my view.

So it's not only the attacks on the independence of the Federal Reserve, but also some shifts in geopolitical terms that are generating marginal demand from other currencies.

Alan: 00:39:22

Just thinking about some of the other kind of structural factors that are influencing markets more generally and how they may influence EM in the context. Obviously demographics is a big theme in the West.

The western economies grappling with aging populations, which will naturally translate into slower labor force growth and weaker growth in the absence of immigration. That's not the case in many emerging markets and places like Africa, et cetera, on a different trajectory.

I mean, taking a positive perspective, that's a very positive factor for em. But is it that simple or how do you think about the demographic angle on EM investing?

Nicolas: 00:40:08

It's a difference, clearly, because at the end of the day, if you perform some growth, accounting growth comes from labor, from investment and from productivity.

And on the labor side, you know, while in advanced economies we are seeing a decrease in the population, in em, still we are seeing healthy, a healthy increase in labor growth. So that's a major shift. And clearly that generates a different trend, for example, in housing and industries directly linked to demographics.

So yes, it's a factor of dynamism that helps to sustain this differential growth rate that EM is displaying against developed markets.

Alan: 00:41:06

I mean, I guess coupled with that is the whole AI productivity and the growth of robotics, et cetera. And we talked about how maybe historically in that kind of era of globalization, manufacturing got outsourced to emerging markets.

And maybe that would be less the case going forward if robots can perform those tasks. If demographics is a marginal positive, is AI from that perspective and automation and negative or you see it?

Nicolas: 00:41:39

I, I don't know. You know, it's very early to understand the impact of AI in many aspects of our lives.

I think at the end of the day, you know, every time the humanity experience a jump in productivity due to innovation, you know, we saw more prosperity, not less. So I tend to have a very optimistic view on the future, but clearly there are a lot of moving pieces.

So it's Very hard to understand how this will display specifically. But from a fundamental standpoint, higher productivity, but it should mean higher real wages and more prosperity.

That's my fundamental view of this process.

Alan: 00:42:37

Yeah, and obviously in China we've seen the evolution from kind of manufacturing and cheap manufacturing goods to progressively moving up the value chain. Is that something you're seeing elsewhere in em, if you look at Indonesia or India, places like that? Or is it more a China phenomenon?

Nicolas: 00:43:00

It's clearly stylized fact of the evolution of every economy.

Typically at the beginning the increase in production is based on manufacturing industry in adding value to mining, to, to the agricultural or to manufacturing. But then you have all the connected services related to these industries.

The services sector starts to expand and then typically the share of the economy or the value added in every economy that is permanently growing, explained just by primary or manufacturing activities, tend to decrease as a share, not a value, but as a share. And that's something that you are seeing in Chile, Mexico, in Brazil, in the successful stories of Africa, in Egypt.

And you know, it will always look like that.

Alan: 00:44:19

Yeah, I meant you give a number of examples there. And I mean economists and market practitioners often split em into kind of frontier markets and more developed em, et cetera.

I mean if you're looking at the landscape, is that how you think about it or how do you kind of, or is it more from a geographical perspective or how do you kind of slice and dice it in terms of the investing opportunities?

Nicolas: 00:44:48

In terms of our investment opportunities, I don't find useful to separate between frontier and non frontier or the rest of em. You know, every country is a different history and you will have or not investment opportunities depending on fundamentals and prices.

And that is not determined by being frontier or not being frontier. The only way which maybe the classification between frontier and the rest of VM can be useful is in terms of the sizing of the positions.

Because typically in the frontier or the so called frontier economies, okay, capital markets tend to be smaller and liquidity also to be smaller. And so the positions in a portfolio should tend to reflect that. But that's not always the case.

For example, one of the key or star histories of the last one or two years is the local market of Egypt, which with a stable effects and with inflation coming down is delivering very sound results in terms of generating high yields as measuring effects for holding local tables. And you have plenty of liquidity to invest in that market. So it's a market that can be suitable for even large firms investing in em.

So you know, eventually, you know, the Division between frontier and EM can, can act as a guideline in terms of liquidity, but not always. Not always. Sometimes you have frontier economies that have the adequate liquidity.

Alan: 00:46:47

Yeah. And with the, I suppose the, the, the maturation of emerging markets, does that change how you approach it from an vesting perspective?

Obviously you know when, when they were more prone to big cycles and crises that created risks, but I guess opportunities in the immediate aftermath in a more stable environment. Are returns more predictable, bit less, bit more boring or not? Or is there still enough volatility in the space?

Nicolas: 00:47:14

Yes. No, no. Typically as, as, as fundamentals improve, volatility decreases.

So the countries which much better fundamentals join the more like beta space than the alpha space. So their returns are more explained by the general movements in rates in developed markets rather than specific factors.

Good for them because they are much more predictable and they can attract more capital. But you will find clearly more juicy yields in countries that are still in the process of stabilization.

When you find the country that is doing the right thing but still didn't gain full credibility from the markets and you can anticipate that that's where finding that is a key component of the return of an EM investment.

Alan: 00:48:18

I know you're more focused on the EM debt side, but I think on the equity side, periodically we hear this discussion about decoupling and can EM perform in the face of. If DM is struggling, could EM genuinely decouple? I don't know if we've ever really seen it.

What are the preconditions for a structural outperformance of em?

Nicolas: 00:48:42

Well, first you have to find value. So you need to see an increase in productivity in the countries in which you are investing.

So if productivity goes up, it means that margins will go up and you will find more value in that countries. And specifically, when you take a look at what's happening with equities in EM in relative terms, maybe it's the most undervalued asset.

If you perform the comparison between the evolution of the equity markets in EM as compared to the equity market in the us so the diversions in returns in markets in EM as compared to the market in the US is much bigger than the diversions that you will find in any other asset that is traded in em, meaning currencies, local rates or currency credit.

Alan: 00:49:58

Why is that do you think?

Nicolas: 00:50:00

Well, I think for a very, very long time there was no other equity market in which to invest rather than the S and P or the nasdaq. And basically investors did not put their eyes and their Focus in a lot of opportunities that are still there.

On the other hand, in the last two, three years we saw a sharp rebound in the terms of trade in em. So and as EM is a net producer of commodities, the relative price of commodities vis a vis other goods or services improved a lot.

And that is generating an improving profitability in many companies in emerging markets. So there's a lot of hidden value there and value that can be captured by investors that put their eyes on EM equities in the next three years.

Alan: 00:51:11

Yeah, I mean you mentioned commodities and historically EM have often been seen as a commodity play. I mean, how important is that to your process? I mean commodities are as you say, prices have increased for certain commodities like copper, etc.

Less so for on the energy side. I mean, is that part of the structural bull case or not?

Nicolas: 00:51:34

For EM is a part because even when EM economies have diversified a lot in the last couple of decades, still is a commodity play. Is still a commodity play.

Especially in terms of determining how stable will be the FX rates because are very important in terms of the value added of the EM economies, but are more important in terms of the sharing exports of of the EM economies.

And as many of the EM economies are floating, they have floating exchange rate regimes, the increasing of commodities determines stability or a real appreciation of the real exchange rates. And that generates again vis a vis an increase in the value of the companies producing commodities.

So clearly is a key component of the bull case of here.

Alan: 00:52:52

And on the energy side, just curious to get your thoughts on that. There's a lot of debate about are we seeing this peak energy demand for oil and gas, et cetera.

I mean we're definitely seeing in the west, but on the the flip side is demand in em. I mean our em, obviously China has been at the forefront of transitioning into solar, but still a heavy user of coal.

I mean, what's the perspective on the rest of em? Is that going to be an important source of demand for oil and related products over time?

Nicolas: 00:53:34

You take a look at demand for oil is pretty stable. It grows at the pace of the global GDP and the deviation on the demand side is very small as compared to how the global GDP grows.

And that's why small variations in supply generate large shifts in prices because demand is pretty stable. So even when we are transitioning from, you know, oil to alternative sources of energy, that's a very long term process.

And you know, for the next 20 years it is clear that the impact of the production of energy in EM will still be a key component of its exports. So in the long run of course EM economists should prepare for another scenario. But they have plenty of time to do that.

Alan: 00:54:45

Sure, just conscious of time and we're coming up to the hour looking at the em. I mean a whole wide space. Obviously you manage your fund from a very tactical perspective. It sounds like you see a structural case.

Is it possible to pick areas, sectors, themes do you think that are going to dominate over the next three to five years?

Nicolas: 00:55:06

We don't have a general view on themes or sectors in our process. We are always screening more into countries to find anomalies in terms of the relationship between fundamentals and pricing.

When we find that anomaly, we did dive into that history so to understand it better.

But we don't have like guru view of fundamental processes going on because that tends to generate impacts in prices that very long term, very unpredictable. So basing our process of investment in long term structural shifts has a problem how to trade that in the very short rap.

Alan: 00:56:14

Yeah, makes sense.

And I mean more generally for people who are interested in em, people who are maybe early in their career or interested in being an EM macro investor. Any advice or think, obviously your policy experience has been very helpful, beneficial for you, but not everybody's going to get that.

What advice would you give to people if they want to get more proficient in EM debt, EM macro investing?

Nicolas: 00:56:39

Well, there's plenty of material to study international economics and finance and plenty of authors that devoted their careers to study what happens in em.

So from the early works of Rudy Dorbusch, Stanley Fisher to Maurice Hobtfeld or Ken Rogoff or Carmen Reinhart or Guillermo Calvo, plenty, plenty of literature to study and to understand crisis and the way which these economies perform over time.

Alan: 00:57:27

Very good. Well, we've had Kenneth Rogoff on before and I'll be interviewing Morris Obsfeld coming up soon. So listeners stay tuned for that.

Nicolas: 00:57:39

That will be very, very interesting, you know.

Alan: 00:57:41

Yeah, very good. Well Nicholas, very much appreciate you coming on today. It's been great to get your perspective on all things emerging markets.

So obviously you're managing your Tannic asset management so people can follow your progress there. But thanks for coming on. And from all of us here at Top Traders Unplugged, stay tuned for more episodes coming up and we'll be back soon.

Nicolas: 00:58:06

Thanks Al.

Ending: 00:58:08

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