Scott is a friend and fund manager specializing in emerging and frontier markets. We had a catch up call in light of the current dollar and US equities dominance.
The discussion took us into a wide variety of topics:
- Getting paid to invest in emerging market stocks
- Investing in Central Asian banking
- Investing in Latin American oil stocks
- The current situation in the country of Georgia
- Increasing regulation in the West
- The potential for capital controls in the West
- War, conflict and their impact on capital flows
- A potential consequence of Western sanctions on China
- Real estate in Cambodia
It’s a short, yet intense discussion.
Scott has a really good Telegram channel in which he posts regular updates on investing in emerging and frontier markets, along with some specific stocks he personally invests in. It’s free. You can sign up here.
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The Wandering Investor.
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Transcript of “Capital rotation into emerging markets. Why?”
LADISLAS MAURICE: Hello, everyone. Today, we’ll be discussing emerging and frontier markets together with Scott Osheroff, a fund manager. Scott, how are you?
SCOTT: Doing well, Ladislas. Thanks.
LADISLAS MAURICE: Look, as a fellow investor in emerging and frontier markets, when I look at the latest figures in terms of the MSCI Index, I see that almost 74% of the index is composed of US stocks.
Investing in emerging market stocks
LADISLAS MAURICE: In your opinion, how sustainable is this and the strong US dollar, and what will be the impact short term, medium term, long term on emerging markets?
SCOTT: Yeah, well, I guess nothing’s really sustainable, everything goes in cycles. It just is a question of what your time frame is. Of course, the current boom in the US markets could last for a while longer. Markets can remain irrational longer than you and I can remain solvent, but then again, at some point, there’s going to be a tipping point. And next year looks like an interesting one. Not to say that it will happen, but Trump wants both tariffs, which he’s using as a negotiating tactic, of course, a lot of the tariffs that he’s announcing preliminarily won’t actually happen, but equally, he wants a weaker dollar. You really can’t have both, because tariffs is going to drive up investment in the US, it’s going to drive up demand for the US dollar, and it’s going to impact the developing world, the Vietnams, the Chinas, etc.
And then smaller countries, which really are hostage to the broader global monetary system, that don’t have the ability to print money into oblivion are going to be potentially selling treasuries to be able to afford imports, specifically commodities. I don’t think that lasts too much longer. And the question I keep asking myself is, with everyone running into speculative assets, whether it’s crypto, to a degree, or just, again, large cap tech, a lot of it not profitable, and you look at the valuations, from a risk reward standpoint, I’d much rather own things that are cheap that are real assets. We’ve talked about this for a handful of years, actually, and it’s been quite rewarding, but I think that we’re on the verge of potentially another capital rotation out of US assets, or specifically tech into hard assets.
And the question is, you look at a lot of hard assets or commodity businesses that have run up handsomely since 2020 in the US, if you look at similar companies or economies that are heavily commodity dependent, they have received almost no love. And I think that’s a really good opportunity right now to be able to keep an eye on them and really get paid to wait. You recently did a video on Kenya, not a huge commodity country, but again, you’re able to buy real estate for $1,000 per square meter in the city center, that’s pretty juicy. I think there’s a lot of opportunity in the developing world that is really overlooked, and if you can get paid to wait at some point with a bit of capital rotation, you should have some really handsome opportunities at hand.
Dividend stocks in emerging markets
LADISLAS MAURICE: So are you going exclusively for stocks that pay out dividends?
SCOTT: Not necessarily, but, I mean, there’s a handful of really interesting ones that are hard to turn a blind eye to. So yeah, we’ll consider anything, of course, but I guess a broader example is, you look at Brazil, the EWZ Brazil Index is back at the 2008 low. Of course, the economy is being run not that well, with a handful of people calling the President a socialist, but nonetheless, is you have elections in across Latin America over the next few years, you potentially have the opportunity for a turnaround in a lot of these countries’ economies. So not necessarily looking at companies that just pay dividends, but just broadly looking at the opportunity at hand.
LADISLAS MAURICE: Can you give us examples of some specific stocks you’re looking at?
Bank stocks in Central Asia
SCOTT: Sure. I’ll start off with probably one of the more attractive ones, pays a dividend. Again, there’s so much low hanging fruit in the space, a lot of, say, Southeast Asian companies based in Hong Kong, Thailand, Singapore don’t necessarily pay dividends, but you have a lot of really great conglomerates that are growing nicely, that are trading at fractions of book value. But probably one of the more attractive ones for me is Halyk Bank. It’s listed in London and in Kazakhstan. It’s Kazakhstan’s largest bank. It’s growing. It’s equity at, what, 33% per year, pays a 16% dividend, and it trades at 0.84 times book. So, super cheap, great company with great exposure to Central Asia. They’re also in Uzbekistan.
Then you have TBC, which is a Georgian bank. Georgia has its own issues. And keep in mind, of course, we’re talking about the Republic of Georgia, not the state of Georgia. But the company, what’s attractive about that business is their exposure to Uzbekistan, which is the largest population in Central Asia. It’s Uzbekistan is 9% of their profits. The company is growing at 26%, equity wise, it’s got a 7% dividend. You have companies that have basically just been, I don’t want to say left for dead, but that everyone is overlooking due to the fact that you can buy NVIDIA and have it be up 10x in a year.
Latin American oil stocks
SCOTT: And then going down to Latin America again, Brazil, over the next few years, I think will be very interesting, if you just look at the economy and buy some assets and don’t really look at them for a few years, even though the Brazilian real is blown out back to 2020 lows. And then Colombia is an interesting economy. Sorry for the rants, but Colombia is interesting because Petro, who has not done a great job of governing the country, is up for reelection next year. He’s got a 30% approval rating. And then you have SOE like Ecopetrol, which has been absolutely decimated, but again, it has a 13% dividend yield. It’s the hydrocarbon behemoth of the country, doing business also outside of the country a bit. And with Petro on potentially, you have a shift of the company’s focus away from renewables back to pure hydrocarbons. You get reissuance of leases for oil and gas exploration. And again, the world is not going to stop consuming hydrocarbons.
With the first two companies I mentioned, you look at Central Asia, the region is largely under banked. It’s growing, especially as part of the Belt Road Initiative of China. This part of the world is going to do very well for the next 5 or 10 years, easily. So again, you’ve got good growth, relatively stable jurisdictions, there’s perceived risk but as we both know when you travel to these countries, perceived risk is very different than risk on the ground. And again, with the capital rotation, I don’t see why you won’t see money flowing into these parts of the world, because you’ve got companies paying double-digit dividend yields. And keep in mind that yields I mentioned are US dollar yields. The opportunity cost is relatively low to have some exposure to these markets.
LADISLAS MAURICE: Yeah, I agree. I find Kazakhstan particularly interesting. They’ve really managed to play all sides. They’re in with the Chinese, they’re in with the Russians, they’re in with the West, and they’re just dancing in-between and doing a very, very good job at it. So yeah, when you get the country’s biggest bank at such valuations, why not? It’s definitely a way to play the multipolar world.
Risks of investing in Georgia
LADISLAS MAURICE: I would tend to challenge you more on TBC in Georgia, especially seeing everything that’s going on in the country. My fear with Georgia, and I like Georgia, nice country, I mean, nothing wrong with the place, but it’s on the front line. And when you have the West, just this week, the European Union was threatening sanctions. Do I really want to be invested in financial services in Georgia, because we know when there are sanctions, first thing, it’s like a few politicians, and then it just expands, and then it starts to be the banks.
I mean, already we’re hearing reports of people that are struggling with their Georgian banking, in the sense that when they make international transfers in USD, the correspondent banks in New York are now a lot more demanding in terms of paperwork and kickback on transfers, etc. So already, soft pressure is being applied on these financial institutions. And if the West does not get its way, could companies like Bank of Georgia, TBC become collateral damage? And that’s what I’m worried about. I see the attractive valuation. I also saw very attractive valuations in Russia before– [laughs]
SCOTT: As did I.
LADISLAS MAURICE: we both got burned. So are we running the risk of getting burned again here?
SCOTT: I mean, of course, none of these are recommendations, just examples of what I see opportunity wise. But when I look at Georgia, we talked about this a bit earlier, I’m amazed that with two political events over the past 12 months in Georgia, the price of TBC has really done nothing. I think it’s a bit up on the year. I was hoping for a 40%, 50% correction with some of this, as well as the currency, the Lari blowing out. It really hasn’t blown out that much. Obviously, the Lari is very much overvalued. If you look at what’s going on, on the ground, the amount of money that’s come in from Russia and other markets, Central Asia is again, it’s a second tier banking hub. The Lari is very much overvalued. If the Lari went out to five or six and TBC corrected sharply, I think that would be a great opportunity, because my interest in TBC is not really the Georgian economy. The Georgian economy is peanut-sized.
The opportunity there is the Uzbek exposure, which, now that the Uzbek business is profitable, they entered the market in 2019 and started ramping up in 2020, again, profits, or about 9% representative from Uzbekistan, and a year ago it was six. So you’re actually seeing the rate of change in terms of Uzbekistan’s contribution to their bottom line increasing. And that’s the real opportunity. Georgia is just a second tier banking jurisdiction, with a few good banks, TBC being an interesting one with broad Central Asian exposure. Yeah, Georgia, we’ll see what happens. Unfortunately, this is the West doing its job of, I like to say, the US has three main exports, entertainment, fast food, and color revolution. So we do our best, sadly.
LADISLAS MAURICE: Yeah, another way to play Uzbek banking is OTP in Hungary. They have operations as well, they bought a bank in Uzbekistan. I mean, it’s a lot smaller than the TBC operations in Uzbekistan but still, that’s one way of getting cheap exposure, because OTP is also quite cheap.
SCOTT: And you look at a lot of these economies, what’s interesting, of course, is that you’ve got good demographics, relatively low debt to GDPs. Again, you have a lot of commodity exposure, but really, a lot of these places are freer than in the West.
Increasing regulation in the West
SCOTT: I think it was, correct me if I’m wrong, Ladislas, but last week or the week before that France announced that they’re going to start charging capital gains on Bitcoin and crypto. You’re seeing more regulation in the West due to poor budgets, lack of receipts from tax collection, and that’s not going to change anytime soon. I think, at some point in the next decade, you see a handful of Western economies implement some form of capital controls, which, again, is what you’ve seen in a lot of frontier and emerging markets historically. But I think you’re starting to see that reverse.
Not to say that the dollar system is going away anytime soon, because you ask anyone in any developing country, would you rather hold your savings in local currency or dollars, the answer is blindingly obvious, dollars, or gold, or Bitcoin, certainly not local currency. But if you look at the freedoms that are available in these countries and just the growth prospects across the board, again, you’re big in real estate, there’s huge opportunity in these markets, and there’s a variety of ways to play it. Equities is just one way.
Capital outflows during war
LADISLAS MAURICE: Yeah. And I think also a learning that we got from the whole Russian situation was the outflow of Russian money, which went to places such as Antalya in Turkey, in Dubai, in Belgrade, to some extent, even a little bit Montenegro. And it just led to little mini bubbles in some ways, because when money flees, money isn’t prepared for it. So money just goes where it’s the most obvious and where the owners of that capital are familiar with. You suddenly had, like, all this Russian capital, just like bursting into a few places. That was quite interesting.
And we’re seeing this again with regards to what’s happening in the Middle East with Israel and Palestine. We’re seeing a lot of Israeli money just going into the Balkans right now, a lot into Albania, Montenegro, even North Macedonia, Serbia, Cyprus, all these countries, Greece, a whole lot of Israeli money going into Greece. People just feel the need to get out, and they just go where they’re familiar with because they’re not people that were traditionally investing overseas but suddenly reality slaps them in the face, and they feel the need to be diversified, and they just go to the most obvious places.
And again, I’m going to give another example that I saw two ways, which is in Kenya. Well, with Sudan, actually. With the whole civil war going on in Sudan, capital has been fleeing Sudan, obviously, the place is being completely destroyed. A lot of it is going into Egypt, into specifically real estate in Egypt, a lot of it is also ending up in real estate in Kenya, and a lot of it is going into real estate in Dubai. The reality is that when money flees these countries, it can’t flee to the west, because it wouldn’t pass any of the KYCs, AML, blah, blah from Western countries. I mean, especially Sudan that’s under constant US sanctions. Money will just go where it’s familiar and where other jurisdictions allow that money to come.
In a world of heightened geopolitical tensions and with wars being created and provoked all around us, that’s also one very sad play, is to see, okay, if conflict erupts in a certain jurisdiction, where will the capital flee to?
SCOTT: I think that’s, arguably, one of the biggest news events that’s going to be, well, how do I say this, this is probably one of the biggest trends that no one’s talking about. It started a few years ago. It’s happening now, as you said, Russia, the Middle East.
Capital controls returning to the West
SCOTT: And there will definitely, as the world continues to fragment, I imagine that such events, in terms of capital fleeing and being reallocated, is going to only accelerate. And it’s not, as you mentioned, it’s not just going to be Western capital, I think the really big one is Western capital beginning to flee, or trying to flee. And again, once you potentially see capital controls, probably in some European countries first, and in due course, perhaps Central Bank digital currencies, etc., then people start to wake up and realize, wow, I need to start diversifying and have capital and investments in a few different countries, because, God forbid something happens in one country, I have access to savings investments elsewhere.
And again, the big rotation is going to be Western capital that causes that to happen. It’s already beginning to happen, but I think it accelerates. And per what you mentioned in terms of the Balkans and whatnot, a year and a half ago, I was in Serbia, and you and another friend of ours was talking about Serbia for a while to me, and I was blown away at how expensive it was. The developing world is no longer cheap in a lot of ways. You look at Mexico, Mexico, depending on where you’re coming from, was never super-duper cheap, but now in certain areas it’s not cheap at all, in some cases, it’s actually quite expensive. And people have the stigma, or the stigma is attached to the developing world that it’s cheap, it’s poor. The reality is that a lot of it is more developed, it’s more diverse, it’s safer, there’s better investment opportunities, there’s certainly more freedom than in a lot of other countries.
And the more that investors begin to realize this, I think that’s when you start to see real huge step changes, not just in real estate, which you’ve already seen in a lot of markets, because the first thing a lot of people do is, especially in developing markets, when they’re reallocating capitals, they buy real estate, but you’re going to see the financial markets change as well. And I think this is the story for, not the decade, we’re almost halfway through, but probably for the next 15, 20 years. And, yeah, it’s a trend that I expect to accelerate.
LADISLAS MAURICE: Yeah, absolutely. And Westerners have no recollection of capital controls, which we had in Europe in the 70s and the 80s. People have forgotten these days. But the reality is when capital controls show up, it’s too late to get your money out. In emerging markets, generally, you can always find a way, because the banks are a little bit more loose, and you can use crypto, and Hawala, and all that. The government is weaker to enforce capital controls, but in Western countries where just withdrawing $5,000 from the bank will get you a whole bunch of questions, I mean, good luck getting past capital controls. Like, all the crypto onramps will be shut off, and you’ll be stuck with your money in Germany, in France, in Canada, wherever, and you will not be able to get it out. It’ll be extremely hard. You’ll have to resort to random fake invoicing and this and that, and [laughs] that’s complicated. And with AI now they can see these things if you start playing big transfer pricing games.
People just don’t even know what capital controls are. I’m astonished at the amount of people that criticize Bitcoin and that say, “What’s the use case? There’s no use case of Bitcoin.” There is. There is. There’s a huge use case. I do business in emerging markets. I use crypto, like, to get past capital controls, etc., in out. Crypto is great to get past capital controls, that’s really, ultimately, the main reason why people in developing countries have been using crypto, it’s to get past capital controls and to have exposure to another currency than their own, which they don’t trust, and for good reason.
Hypothetical impact of sanctions on China
LADISLAS MAURICE: Let me ask you, let’s just go through a bit of a mental exercise here. We’ve discussed how conflict and sanctions results in very specific capital outflows into some jurisdictions. Let’s say, suddenly, sanctions on China, sanctions on Chinese banks, sanctions on Hong Kong banks, the whole deal, the trade war gets out of control, [laughs] which is not a scenario that would be impossible these days, where would Chinese capital rush to? Because they’ll manage to find some ways to get out. Where is it going to go?
SCOTT: They already have it, yeah.
LADISLAS MAURICE: The already do. I mean, they already have capital controls, and money finds its way out. But suddenly, real sanctions show up, people in China panic, they try to get money out. Where does that money go? How do you position yourself for this?
SCOTT: Well, [laughs] I can tell you with near certainty, it’s not coming to the West. Per what we just discussed, it’s going to go to frontier and emerging markets. And then the question is, again, you look at anyone in the developing world when they make money just because of lack of sophistication when it comes to the financial markets, the first thing people do is buy property because you can touch it, you can always sell it. And I think the Chinese understand this very well. When you look at the property bubbles in North America, Vancouver, Toronto, Silicon Valley, or just California in general, they don’t necessarily care about paying a premium to market because they just want to park their money. If they need the money, they can always liquidate that property at a 15% discount to market and take a little loss, but it’s better than having your money locked away forever, not being able to utilize it. And that’s what people don’t understand.
I think you’d have a huge Chinese wave of capital going into the developing world, let’s say, the world of BRICS, which is friendly to the non-West, say, the global south. And yeah, it would go primarily into real estate. And then I think also you’d have a huge amount of businesses start up. I look at Cambodia and, to a degree, Vietnam, but the money that flooded into Cambodia post-2015 when former Prime Minister Hun Sen vetoed any discussion at the Southeast Asian Summit on the Chinese construction of islands or expansion of islands in the Spratlys, in the South China Sea. The Chinese money started flooding in, and it became a de facto Chinese colony. And you look at something like this. The Sihanoukville Special Economic Zone, when I was there in 2013, it was a dirt road that looked like Mars going by a coal-fired power plant that was under construction. And there was a little Chinatown. Again, you couldn’t even get Cambodian beer. It was all Qingdao. It was all imported stuff.
Now there’s a few hundred factories in the Sihanoukville Special Economic Zone, all Chinese, billions of dollars pumped in, the infrastructure is great. The Chinese will do business where their capital be accepted, but it’s not going to be in the West. And of course, that’ll flood into the property market in a huge way, caused a big property bubble in Cambodia. And that’ll also trickle into the capital markets. Again, the world’s in the process of being bifurcated, both politically, economically, socially. And we’re at the early stages of this, but it’s only going to accelerate. So that’s where I believe the Chinese money would flood. I can’t give you a specific country, because you’re talking about potentially trillions of dollars in due course. So everywhere.
Real estate in Cambodia
LADISLAS MAURICE: Yeah, I agree with you on Cambodia. I mean, I went there in 2018 to look at real estate, and it just felt super bubbly back then. I just walked around, I was like, yeah, no. [laughs] I turned my real estate exploratory trip into just a vacation after three days.
SCOTT: Well, let me give you an example of what happened. I first went there in 2012 and I met a lawyer who was telling me that they were going to expand the border of the capital city, Phnom Penh. I was offered land at, what was it? I think it was $4 US per square meter. It was rice paddy. That’s where, basically, the new ministries are, I believe it’s Sen Sok District, land there is going for about $2,000 per square meter.
LADISLAS MAURICE: That’s insane.
SCOTT: And then in the city center, you’re looking at stuff going for $10,000, $12,000, $15,000 per square meter. Until the real estate bubble deflated a few years ago, you had apartments in the city center going for $4,000, $5,000, $6,000 per square meter in Cambodia. There’s realistically not much yield to be had on this, it was just parking capital, and it was mostly Chinese money. In the early days, it made sense, there was yield and capital appreciation to be had. This was a ploy by Chinese companies to market to people in second and third tier cities that said, I’ll never be able to afford a $10,000 per square meter apartment in my city, or even more, in, say, Shanghai, but I can buy something in Sihanoukville, a luxury apartment for $3,000, $3,500 per square meter. I can move my family there, I’ve got the beach, I can start a business, and you had basically a Chinese colony spring up overnight. Truly fascinating what happened, but again, it’s not exclusive to Cambodia, just one of many, many examples.
LADISLAS MAURICE: Yeah, I’m actually going to Cambodia next month to go check out the real estate market, after a few years of going down, getting hit hard, I want to go sniff around and see if there are any interesting opportunities. Because, yeah, in a world of rising tension and rising conflict, Cambodia could be a major beneficiary if there were to be financial sanctions against China from Western countries. That would be, like you say, money would just flood into Cambodia, and they already have all the mechanisms in place in Cambodia to get money past capital controls in China.
Follow Scott on Telegram
LADISLAS MAURICE: Great. Scott has a very interesting Telegram channel in which he discusses investments, particularly equities and also the macro landscape across emerging and frontier markets. I’ve subscribed for a few years now. I really enjoy reading all of your updates. There is a link below. Scott, thank you very much for your time today.
SCOTT: Thanks, Ladislas.
