Axel Christensen (Blackrock) on a new investing paradigm, asset prices, inflation and implications for emerging economies

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*This episode is not investment advice. Axel Christensen expresses his own opinion on the capital markets.

Tl, dr

• Volatility means opportunity: Due to a much higher degree of dispersion, the security-providing relationship between equity and bonds is not given anymore - which calls for alternative investments. 
• Experience with inflation cycles: Emerging economies have been able to leverage their close experience to inflation and therefore withstand much better the current global economic slowdown.
• Not the traditional way: Over the past years, Latin America has attracted a lot of interest and money, but rather through investments in infrastructure, direct investments or foreign funded start-ups than through their traditional financial markets. 
• Advantages of lacking liquidity: For venture capitalists, alternative investments also carry benefits; 1. More thinking: You have put a lot of thought into the process when you must invest in alternatives as there is no space for mistakes; 2. More discipline: The vintage type diversification – spreading the investment in an asset class over time – helps avoiding bubbles growing too large and thereby stop investors from panicking. There is a discipline in the roll-out of the investment process.
• From private to publicly listed: There are fresh opportunities in the PE space, as the competition has shifted towards publicly listed companies due to high-growth technology companies becoming cheap

The Evil twin 

Have we hit rock bottom? Axel kicks of the conversation by answering probably the biggest question of them all. Blackrock believes that we are currently leaving behind what has been called “The Era of Great Moderation”, thereby describing the time from the late 80s until just before the pandemic hit the globe. 

“We’re still discovering a new regime that has yet to find a name – and probably more important also terms of investment that meet these.”

However, as we now believe that this new era is starting to become more familiar to us, it is presenting us with a lot more uncertainty, and volatility - but also opportunity. 

“Volatility is the evil twin of opportunity. Or, in other words, a much higher degree of dispersion of result which means that choosing winners and avoiding losers is becoming much more important in terms of investment.”

Altogether this means, that a new playbook is at stake. What has worked in the past is not going to work the same in the future. This shows, for instance, the basic relationship between equities and bonds. A typical benchmark portfolio for many investors was 60% equity since it had more exposure to growth. Bonds usually were part of portfolios, because they provide income but – more importantly – provide security. 

“And if we look at what happened last year – that didn’t work out. At certain points, if you look at global fixed income benchmark indices, they were underperforming, they were doing worse than equities.”

For common investors, that implies that to find more secure asset classes during times of turmoil, alternative investments become more relevant.  

Inflation-experienced 

Inflation is touching the markets from many different angles:

1. Consumers are becoming more sensitive to prices,
2. Policymakers, which must build around targeting inflation rates, need to revisit their objectives. 

“The trade-off between controlling inflation and allowing for economic activity to find its path is going to be much more of a dilemma.”

From an investor’s perspective, in the developed markets inflation has not been a relevant issue for years. Just some years ago papers and magazines were calling the death of inflation. However, whereas for some regions, such as Latam, it was always a theme in the background. In the US and parts of Europe there has been a whole generation with zero experience in terms of dealing with inflation, the effect it is having on our day-to-day living and the way we invest. 

Being asked about how emerging economies are manoeuvring through the current environment, Axel points out that it’s important to look at inflation cycles. When the US central bank, the Federal Reserve, started to react, it increased rates to adjust for higher inflation. This usually meant that Latin America was doomed to go through a crisis – but not this time. On the one side, when the Fed started to increase rates, rates were already high in most emerging markets. But also, they have learned from past mistakes: 

“Flexible exchange rate regimes, a higher degree of reserves and much more developed local capital markets. That has meant that if you look at some of the currencies that typically take a beating when you have a rate cycle. In the US currencies, like the Brazilian real or the Mexican peso have withstood quite well, a lot better than supposedly safe haven type of currencies like the euro, the British pound, or the Japanese Yen. “

This shows that emerging markets have been able to leverage their close experience to inflation and act accordingly, which means that overall, they will not feel as much the pain of the global economic slowdown and come out of these cycles in a much better shape than in the past. 

Not the traditional way 

Historically, Latam has not been a popular place for investment due to currency risks and overall volatility. However, as Axel highlights, today it is important to look at the money flows also from a different perspective. 

“Latin America has attracted a lot of interest and actual money, but not through the traditional channels.”

Investments are rather done through infrastructure projects or direct investments than through financial markets, or startups entering the region are funded directly from the US or Europe rather than at the local market level. 

Altogether, if all channels are included, the overall growth has been significant for the region in the past years. 

Vintage diversification

With publicly listed equities and bonds no longer providing secure sources of diversification, investors need to look out for other options as well, as Axel explains. For instance, diversification can result in decoupled price cycles of the assets, that have a delay in finding their way into market prices. Additionally, Blackrock looks for increasing the universe of eligible investments by including sectors that might not be available in public markets in a country or region and investing in different stages of growth and lifecycles. 

The lack of liquidity that those alternatives carry also has some positive aspects as Axel points out: 

1. More thinking: You have put a lot of thought into the process when you must invest in alternatives as there is no space for mistakes, because your investment will be locked up for several years
2. More discipline: The vintage type of diversification – spreading the investment in the asset class – helps avoiding the bubble to grow too large and thereby stop investors from panicking. There is a discipline in the roll-out of the investment process.

Larger fish coming to the pond

In terms of private equity, there is a new wind of opportunity as the competition has shifted towards publicly listed companies due to high-growth technology companies becoming cheap. 

“There are several very well-known companies trading below their IPO price.”

As more risk is priced in, multiples of fair valuation are lower than expected – but it seems that many companies, their stocks, or other types of securities, have overreached in terms of correcting to a more challenging environment. But Axel foresees that times will also change again: 

“[...] Time will come when that window may be closed, and prices recover. And then private equity will provide an increased set of opportunities in terms of consolidation and again, giving exposure to some parts of the market that is hard to find.”

In the past, the private equity universe in Latin America was primarily composed of a few local players. Today there is more interest in companies that come from medium-sized economies such as Chile or Columbia, as they expand their footprint to the overall region, which means that larger fish are also coming into the Latam pond. However, their emphasis is different now as the appetite from investors toward positive cash flow growth has changed: 

“Until recently it was all about growth, and then growth and even more growth, Now, because of what's been going on in terms of public market prices, because of the appetite to continue to put money to work in this space, suddenly, the investors are discovering the importance of being profitable and of having the opportunity to have a much more financially sustainable growth going forward.”

Finding a balance between regulation and innovation

If Axel had to change one part of the financial infrastructure in emerging economies, it would be allowing regulation to open more towards competition. He understands that regulation needs to be concerned about financial stability and the health of the banking system. Nevertheless, when looking at the fintech landscape in the region, it has been important to allow for more competition to be able to increase financial inclusion.

“Newcomers need to be able to find ways to grow and to challenge the incumbents and move things to offer a better service, a better product, or probably both.”

This is just possible if there is enough space in terms of regulation of innovative companies to enter the market. 

Dive into the full episode on:

👉 Spotify

👉 Apple Podcasts

👉 All others

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If you haven’t yet subscribed, join the 1,241 Enthusiasts via Substack, Medium, or LinkedIn and follow the show wherever you are getting your podcasts. If you enjoy the work we are doing, drop us a review or rating on your preferred podcast app.