Gramercy founder sees more dislocations, volatility

Emerging markets have evolved into a markedly different asset class than 25 years ago, when Robert Koenigsberger founded Gramercy Funds Management LLC. And "the theme I have the most conviction on today is volatility. It will continue," said the founder of the firm with $5.3 billion in assets under management.

Since its founding in 1998, Gramercy has grown from a boutique emerging markets debt firm into an investment adviser with multiple hedge funds, separately managed accounts and a multiasset fund that represents best picks from four hedge fund strategies — long-only emerging markets debt, alternative credit, special situations, and capital lending/private credit in emerging markets.

"What emerging markets were back then (in 1998) were countries and corporations in default," said Mr. Koenigsberger, the Greenwich, Conn.-based managing partner and chief investment officer of the firm which he launched in the wake of Russia's debt crisis.

"The first decade we were a hedge fund. We chased the financial flus around the world, starting with the tequila crisis, Asian debt crisis, vodka crisis, tango crisis," he said. "Now, we've gone from being a hedge fund that's relevant some of the time to a product suite relevant all the time."

That includes Gramercy's global multiasset portfolio, or GMAP, which pension funds have invested in "because it can prevent them from being whipsawed by the volatility" of emerging markets debt, he said.

With the assistance of a pension fund consultant, Gramercy created separately managed accounts a decade ago to offer returns from best ideas among its four strategies.

"Pension funds often get emerging markets wrong. A lot of them get washed out," he said.

Over the past 25 years, emerging markets experienced at least 11 major dislocations, he said, the two most recent being COVID-19 and Russia's invasion of Ukraine in 2022.

"Markets dropped on average 20% each time, but the good news is they're back up 18 to 24 months later. Then consultants say 'look how great returns are,' and pension funds allocate at the end of the cycle," missing the bulk of the gains, he said. A composite return of its sovereign and quasi-sovereign positions across its flagship and other diversified strategies, since inception, has been 18% annually, through the peaks and valleys of all those dislocations, according to an investor. Gramercy's AUM has risen to $5.3 billion as of June 30 from $4.6 billion in 2020.

"What we do hear from pensions is 'don't buy this country. We lost money there.' And many pension boards, for example, don't want China risk. That's the most common worry now. A lot of people got burnt on sanctions against Russia in equity and fixed income. Now China is definitely the question we get the most: Is it investible or not? Do we want to own China after what just happened to us in Russia? That's more relevant than frontier or non-frontier."

He added that he has "every reason" to think dislocation will continue, whether specific to one country or systemic such as COVID-19.

"There's clearly been a change in policy regime. The Fed's facing a tri-lemma," he said, that is, lowering inflation without undue damage to economic activity while maintaining financial stability. If and when the U.S. dollar turns weaker, that may also act as a tailwind for emerging markets.

"We expect volatility and dislocations. It's great if you anticipate it and embrace it. It's compelling."

For example, Gramercy sold out of Russian and Ukrainian debt just a few months prior to the February 2022 invasion. The firm's analysis in late 2021 correctly predicted Russia would invade a few months later.

"We owned zero Russian and Ukrainian sovereigns before the invasion," he said, although Gramercy has since started buying Ukrainian debt again when it hit around 16 to 17 cents on the dollar.

In the 1990s, the G-7 imposed severe haircuts on both Poland and Bulgaria’s sovereign creditors, and “when we look at Ukraine, we don’t predict it will happen, but we have to account for that possibility. Iraq (bonds) also got an 85% haircut, driven by politics. ... With that in mind, we wanted to make sure we underwrote the political scenarios that could lead to restructuring.”

The potential upside: “The closer we get to 15 cents, the more comfortable we get owning it.”

Gramercy has been selectively trading in and out of Chinese property developers, which were slammed by COVID-19 and a slowdown in GDP, but which the firm believes are too big to fail.

Overall, Mr. Koenigsberger said “I’m not a China bull.” However, Chinese developers such as Country Garden and Evergrande sold off so sharply that Gramercy began buying their debt in 2022.

“This is a very idiosyncratic. It’s not a top down view on China. And again, one of the risks of China is it’s hard to predict if sectors will be sanctioned.”

After visiting Asia and speaking with chief financial officers and trading desks, Gramercy found property developer bonds trading at values equivalent to under 10 cents on the dollar.

“Property is a substantial portion of China’s GDP. So we identified five or six developers who might make it to the other side, when the bonds would be worth more. The mistake other investors made in China property was looking at liquidation values. All this stuff today trades at or on top of liquidation value. And yet none of them are in liquidation.”

He believes China’s ruling party under President Xi Jinping won’t allow major failures in the property sector, since it represents one-third of the country’s GDP.

“The chief financial officers are all talking about trial balloons for debt restructuring, which for us is just a classic emerging markets restructuring,” he said.

One bond issued by Country Garden was trading at 8 cents on the dollar, was still performing and paying a coupon. The bond went on to rise in price to 70 cents on the dollar. Gramercy bought and has since sold these bonds.

“We saw a huge pop, got out of most of it in the fourth quarter of last year, and now we’re going back again,” he said.

Mr. Koenigsberger compares the Chinese property crisis to the U.S. mortgage crisis of 2008.

Based on the June Chinese inflation figures, he believes, “There will be more stimulus and more toward the property sector.” China’s core inflation, which excludes food and energy, slowed to 0.4% from 0.6%. Producer prices fell 5.4% from a year earlier.

Gramercy for years has negotiated or led emerging markets debt restructuring deals with governments such as Argentina. The firm structures complex deals that can take months to put together.

“We’re known for that, especially special situations which we structure like call options and less like bonds,” he said.

Many hedge funds avoid lending to corporate borrowers in emerging markets, lacking the experience of analyzing creditworthiness. Gramercy lends money through platforms in many emerging markets, say, to suppliers to Mexican petroleum giant PEMEX, at 15% to 17% interest, using PEMEX guarantees as collateral.

“We end up with higher returns, less risk, while giving up a little liquidity,” he said.
The firm’s funds also invest in litigation securities such as ICSID claims, issued by the World Bank’s International Center for Settlement of Investment Disputes. In Puerto Rico, rather than buy sovereign debt, the firm funded litigation against insurers including AIG and MAPFRE of Spain for hurricane damage claims.

Through June, the multiasset strategy GMAP has returned 9.6%. In 2022, while the S&P fell 18%, and the J.P. Morgan EBMI Global Diversified Composite index lost 17.8%, GMAP fell 3%. Since inception as its own fund in June 2021, it has returned 7.6%, according to hedge fund databases.

When it comes to ESG investing, Gramercy doesn’t believe in divesting, but sees opportunities for greater improvement in emerging markets.

“Once you pull your capital, no one cares. But if you give someone money and ask for things, we’ve proved our capital has a much bigger impact.”

The governance part of ESG has “always been an important part of what we do. We look at ESG as being part of credit. Because if someone’s a good ESG citizen then they’re a better credit.”

One example was a Turkish ready-mix cement manufacturer, for which Gramercy did a $28 million rescue finance deal in 2018, lending the firm money at 18%.

“But we don’t want to just get paid on the assets, but on the success of the business. We told them to get a Big 4 accounting firm, a CFO who speaks English, and get a certain percentage balance in your workforce between men and women,” all of which the company did. “We get good returns and drive good ESG outcomes.”

The Turkish company ultimately went public in an IPO.