We may be late cycle but we are still seeing some interesting ideas emerge out of the woodwork, especially in the world of alternative credit and income. EFA Group, for instance, has just launched a specialist, institutional focused, Financial Institutions Debt Fund. The target return here is 10 to 12% mainly from a portfolio of short and mid-term loans to leading banks and financial institutions, providing a unique exposure to Developing Asia. These countries include up and coming places such as Georgia, Sri Lanka, Bangladesh, Cambodia, and Armenia. So, it’s a potentially risky strategy, obviously, but the central idea here is that the sovereign debt ratings for these countries are generally pretty damned terrible whereas many of the domestic financial institutions are actually very creditworthy. Thus, investors are arbitraging the national credit risk against the specific corporate credit risk.
More generally though outfits like EFA are at the front line of global markets – the real markets not the slightly fake one dominated by huge investment banks and their partners in financial crime, the central banks. In this real world of trading, we can spot much more interesting trends, rather than worrying about what will happen to credit swaps or central bank interest rates. We see instead the real hot spots and potential crises lurking beneath the surface of news wires dominated by talk of Trump and the Fed.
Take Turkey for example. Amongst other strategies, EFA runs a book of trade funding centered around secured invoices. Currently, the hottest geography for this strategy is the Gateway to the Middle East, namely Turkey. At a macro level, investors worry about all sorts of things in Turkey: the despotic tendencies of Erdogan, the evolving relationship with Russia, and the growing evidence of systemic corruption at the state level. But back in the real world, EFA reports that there is a real dearth of lenders in Turkey offering USD working capital liquidity to local SMEs.
This represents, in their view, a huge opportunity. They observe that in an economic downturn the investor is better getting exposure to the credit side as a senior lender (EFA are currently charging mid-teen rates for senior secured loans); in upturns, the equity side provides more interesting risk-adjusted returns. They also observe that in direct lending interest rates between borrower and lender are sticky. The time to enter the market is when liquidity is scarce. When liquidity returns, the lender will still benefit from higher rates negotiated in illiquid times.
But here’s the crucial insight.
According to EFA “the current economic and currency environment is positive for Turkish exporters (hard currency revenues but local currency operating costs). Many cannot capitalize on this opportunity by increasing production because they are starved of working capital”.
Now, this really matters for Turkey because as a national economy it is a country of trading SMEs, in effect the offshore manufacturing hub of Europe. One typical business currently in the EFA portfolio is a canned tuna producer, which saw roughly flat year-on-year sales in the local market. It’s responded by focusing more on the export market where it was able to increase year-on-year exports by 50%, with higher per-kg pricing in the Export market.
And this story isn’t unique. If we are honest Turkish entrepreneurs are probably fairly immunized to political and market volatility. This, Afterall, is a country that has spent decades fighting soar away inflation and military juntas.
The bottom line is that according to EFA the macro Turkish economy historically tends to return to the black after 3 quarters of negative growth. The chart below shows how these recoveries have tended to play out in the past. So, time perhaps to look again at Turkey, see through the macro horror stories and start to scout out the hotspots of value? Starting first perhaps with some forms of corporate credit?