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The Billion Dollar Interview:
Jerome Booth, Head of Research
at Ashmore Investment Management

Eurekahedge
September 2011
 

Dr Booth is Head of Research at Ashmore Investment Management and a Member of the Investment Committee.  He joined ANZ in 1994 and was Head of Research for the Emerging Markets Group, then Capital Markets and then Head of Markets Research for ANZ Investment Bank with global responsibility for fixed income and foreign exchange research.  Prior to joining ANZ Dr Booth was Senior Strategic Planning Officer at the Inter-American Development Bank in Washington DC.  Until 1991, he ran a consultancy business advising on aid and trade-related issues for four years.  From 1985-7 he worked in Her Majesty’s Department of Trade with responsibility for multi-lateral development banks.  Dr Booth holds four degrees, including a doctorate in economics from Oxford and an honorary doctorate from Anglia Ruskin University.  He was also a lecturer in economics at Christ Church, Oxford.

 

Eurekahedge: The markets have been very volatile in 2011 so far, how has the performance of your funds been? What are some of the key themes that have worked for you in this year?

Booth: Well, emerging debt has not been very volatile; that is the first point. In fact for emerging debt, both dollar debt and local currency debt have been significantly less volatile than US treasuries but they have performed well and are increasingly seen as a better risk than a developed market equivalent. Emerging markets are the beneficiaries of a global reassessment of risk, and basically the driving factor of this is the combination of the workout after three decades of increasing leverage in the developed world. Increasingly, there will be a global rebalancing which has barely started, and will be driven by the policy action of central banks in the emerging markets via the big first world countries. It will be their action which is largely driven by the need to control inflation – that is what is motivating them. It is their action which will drive global currency as we are in an environment which is extremely healthy for emerging market, fixed income, currencies; and equities of course have been more volatile mirroring the S&P etc. but on the fixed income side it has really been a very successful year.

EH: What sort of fundamental/technical analyses do you put into your pre-investment research? Could you tell us a little about your investment philosophy and strategy?

Booth: First of all, we have 90 portfolio managers so we have a huge amount of input while analysing the structure of our investor base. I think the markets generally, or financial theory, have a simplistic shorthand function about what risk is. Risk is of course much more complicated, as is liquidity and both these things can change suddenly in ways that have not been experienced in the past. Simple extrapolation that while helpful in many environments can be extremely misleading if you get structural shifts. To understand structural shifts, you have to understand the structure of an investor base in great detail, and understand not just its structure but also its liabilities, its behaviour patterns and think how particular investor types may behave in specific future scenarios.

Our investment process starts with a huge amount of contact with emerging markets, policymakers, investors as well as analysing the structured markets. We then have a weekly meeting discussing global scenarios in different countries and we build the portfolios on the back of that with a huge focus on risk – very risk focused, liquidity obsessed, top-down structural approach. The research we use is holistic – we use macroeconomic models, technical analysis where appropriate but we do not see those as alternatives, we see them as additions to the basic understanding in a more comparative sense of market dynamic.

EH: You spoke about having a global meeting with different fund managers, how do you drive synergy between the different fund platforms? You mentioned that you use similar ideas to drive your research, are the same research and risk methodologies used across the different funds and strategies?

Booth: Yes and no. Obviously we are active in a number of different asset classes. All we do is emerging markets but within emerging markets there are lots and lots of asset classes. Our emerging equity which is now managed by AshmoreEMM; EMM which merged with Ashmore earlier this year, have their own investment process from their headquarters in Washington. We have for our alternatives, special situations, distressed debt, private equity, infrastructure, real estate funds, and we tend to have separate monthly meetings which are very bottom-up driven and informed by our macro view. The other portfolios; dollar denominated sovereign debt, local currencies, local currency debt, currency overlay and corporate debt – both local currency and dollar denominated are managed starting with a weekly meeting to discuss macro. We will have the senior guys from those various teams involved in that macro meeting then we will split out in the same day to have a further session with the local currency teams which will cover not just the currency, but the currency debt and the overlay, and then with the dollar debt, the dollar external debt and finally with the corporate debt team. What we are doing in that way is everybody is on the same page. We also manage in teams, we have no portfolios managed by individuals; everything is team based so we are trying to get everybody’s ideas where appropriate into every portfolio and we do not have key-man risk.

EH: You mentioned different fund platforms, to what extent do you diversify your fund’s investments across these different fund platforms and the emerging markets space?

Booth: We have lots of funds and most of them are global emerging markets within an asset class. We do have a global dollar denominated sovereign debt fund and versions of that which are US retailable, SICAV versions or Guernsey versions etc. We have funds which are global, local currency, short end, long end or a combination global dollar denominated, corporate debt, global local currency debt, global inflation linkers, global investment grade only dollar debt, all sorts of combinations and all sorts of multi-strategy ones or blended ones. Most of these funds are global but there are exceptions because we also house some single country and regional products, some of which are managed in-country. As an example of country-specific funds, we have Ashmore Brazil where a team of people in Brazil manage both Brazilian debt and Brazilian equity portfolios from Brazil for the Brazilian market as well as for offshore investors. Likewise we have the same in Turkey, China; we also have a Russian real estate fund and Colombia infrastructure fund. For region-specific, we have an Asian fund for example. In terms of assets under management, the bulk of the money overwhelmingly is actually global. We do have an equity frontier fund which is very large, but most of them are quite small.

EH: Can you tell us a bit more about the frontier equity fund?

Booth: Yes, that is an AshmoreEMM product – it is by far the most successful with the best performance and it has a lot of assets in the portfolio which have been there a long time which is very difficult for someone new to acquire. It is a very strong portfolio. On the equity side, AshmoreEMM has a very long track record since 1987; it has a very strong global portfolio that is also probably very well-known as having the best product for a frontier and having the best product for a small cap in emerging markets equity.

EH: What sort of risk control structures do you have in place in your funds? How have your risk management protocols changed over the last few years?

Booth: Our philosophy is very risk based. When you, as we did in the management buyout, ensure that you build the brand yourself, you care about your own money, your own investment and we have been extremely focused on risk. I would say we have a very strong risk culture throughout the entire company. In terms of the portfolios, there is risk after the event which we can talk about but the first thing is that our entire investment approach is based on risk. In the sense that we do not view risk as additive, we do not take bets and assume there is some risk budget which we can add up. We know full well that correlations can change rapidly so what we look at is the overall risk of a portfolio and how that might be stressed in very specific future scenarios. We are constantly doing that so it is very top-down and very risk and liquidity focused. In addition to that, we have a very strong risk department which looks at a whole range of risk measures and does some quantitative scenario planning. The risk measures provided are available for the portfolio managers and we have a front office system which ensures 100% pre-compliance in every trade. We have a very strong institutional system ingrained in that.

No it has not changed. Our risk systems have been very strong for years so while it was a stressed period when Lehman collapsed, we did not have any major risk problems nor did we  have to change any policies or have any counterparty problems at all. We flagged counterparties with potential stress way ahead and first discussed the subprime problem at a formal level in our investment committee meeting in March 2006. We are macroeconomic investors. We are aware of the holistic approach. Our focus on the big risk is very strong. 

EH: How do you foresee the amount of stress laid on tightening regulations across the hedge fund industry to affect your funds? Are there any requirements that could potentially affect your funds’ performance?

Booth: It does not affect us at all really a) we have got very strong systems b) we do not have any hedge funds. We are already fully regulated. Our biggest client base is government. We manage huge amounts of money for central banks, some wealth funds, pension funds; we are a fully compliant asset management company. New regulations affecting hedge funds are actually not a problem or relevant to us because we are an organisation with over-compliance and fully regulated in US, Japan, Europe, pretty much everywhere.

EH: Did you face any significant redemption pressure in 2008 – 2009? How has asset raising been over the past two years – do you see a lot of interest in emerging market debt strategies?

Booth: Yes we did, and our assets went down but I do not know of any cases where investors took money out because they were dissatisfied with our performance. Basically, we were the ATM machine and there was obviously a need for liquidity. We had a lot of investors who were very apologetic but they really needed the money and we met those in all our major main global emerging market funds; we met all those liquidity needs. The assets under management therefore did fall – they were at a peak at just over US$37 billion, they then fell to about US$26.5 billion and it has gone up again to US$65 billion. Yes there was a period but we did not have any major needs to change risk policies, we did not have any major liquidity problems; a lot of what we invest in is very liquid as you are aware. The local currencies effectively are US$9 trillion dollar money market. It is extremely liquid if a central bank comes to us and says “We want to invest US$10 billion dollars with you;” We can get it all invested in a couple of days, in a good market, maybe a week and that is the liquidity we have. We are not driven by esoteric market theories, we do invest in distressed debt, but most of the open-ended high frequency daily trading funds have a strong dose of the really liquid stuff in them.

EH: Have you seen a lot of allocation activity over the past two years?

Booth: Absolutely, in particular from emerging market investors and the government sector, so it’s the central banks and sovereign wealth funds from emerging markets i.e. the ones with the money. That has probably been the biggest allocators. We have also seen an increase in institutional investors and retail investors.

EH: Which strategies are they most interested in?

Booth: We have an extremely varied heterogeneous investor base. We have built up this investor base; our first fund was in 1992 and when we started we had US$19 million dollars. Since then, we have had organic growth pretty much the whole time apart from the merger with EMM earlier this year – they brought US$10 billion dollars. The result is thousands of different investors and historically most of them have been institutional. We now have more retail investors and retail funds. The investor base is very broad. If you are a central bank, you will be interested in sovereign products, sovereign dollar denominated debt or sovereign currency denominated debt primarily. I would say we have seen most interest in local currency debt. We have also seen a huge increase of interest in corporate debt – our corporate debt exposure, we are by far the dominant player in corporate debt. We have had inflows into dollar denominated sovereign debt but the biggest increase would be local currency debt, corporate debt and also overlay which we have launched. We have several billion dollars in currency overlay as well.

EH: Would you have any advice for new launches; small or medium sized funds which are still finding it tough to raise assets?

Booth: What I would say really goes back to when we were small, which is 20 years ago. 20 years ago and 15 years ago when we did our management buyout in 1998, 1999, what we spent a lot of efforts on was all about performance. We wanted our funds over the cycle to perform well and to be completely consistent in the messages. We are ‘benchmark-aware’ rather than benchmark tracking indices – our view is that ‘benchmark risk’ is an inappropriate term due to benchmark being much riskier. The first job of an active manager is to reduce risk and with emerging markets, that is actually not that difficult. By taking active risk, you are actually reducing risk and that is your first responsibility as someone charging fees for managing money.

We found that by being consistent over the cycle rather than in shorter periods as we have done, being one of the top performers over time, being very consistent in our messages, not having style drift and being very clear about keeping our philosophy; all that has been very important. The brand that we have built – a lot of the work in the early years was building the case for the asset classes because when we started, institutional investors and other investors honestly did not think about emerging debt. Whereas now it is not just a question of that being fairly accepted asset class but it is the fact that there is sovereign debt, and there is corporate debt and there is local currency and within those there are different components.

For new start ups I would be saying, “What is it you are offering that others are not?” Obviously it depends on what market segment you are going for. If you are trying to attract institutional investors then you obviously need to be able to persuade them that you have the transparency and the systems and everything else. We are not in a world where black boxes are appreciated and not least because we know, the basic reality of econometrics and other data-reliant quantitative techniques is that it tries to find patterns in past data and try to extrapolate. That actually prevents you from picking up structural shifts.

As a macroeconomist, there has been some research on how you predict macroeconomic structural shifts and the consensus is you need about 240 years of data – about 200 years more than we have got. You cannot just rely on quantitative techniques to manage macro risk or indeed arguably to manage pretty much any asset class in the current developed world environment where you have  serious structural shifts ahead, serious global imbalances, serious leveraging. Quantitative techniques are increasingly under pressure because investors understand this as well and they are naturally wary of model-based approaches. That does not say model-based approaches have not got their place – one needs to clearly understand and of course if you do not have transparency, that is obviously another issue.

Then you have key-man risk if you are small. People are looking for a different level of comfort than perhaps they did in the past and particularly after Madoff and some of the performances of some of the bigger funds, people are less willing to take things on trust, they want to see long track records, they want to see clear transparency, they want to see process, they want to see very strong risk management and if you have all those it is obviously a huge advantage. If you are a start up it is going to be difficult to convince people that you have them all.

EH: The Fed has stated that interest rates will remain at virtually zero for the next two years which means that most other major western currencies will also be close to zero. Are we looking at a ‘cut and paste’ of Japan from 20 years ago?

Booth: No. There is an economist called Richard Koo who has written a couple of books and he has had experience with the Fed. He describes something called ‘Balance Sheet Recession’. After the big property crashes in Japan in the late 1980s, a lot of companies in Japan had massive losses but they did not tell anybody. They did not go out of business but they turned from being profit maximisers which microeconomics assumes every company is, to being debt reducers. Because they were still reducing, they were still profitable and they managed over a period of 15 years to get rid of their debt.

We now know the truth that that was the problem all along but we did not know for years. From this situation, there was massive fiscal stimulus, no apparent growth, no inflation, and lots of observers not understanding what was going on; that this was a very inefficient fiscal expenditure. What Richard Koo says is no, the counterfactual was a massive depression because without our fiscal stimulus, banks are unable to lend to companies, without simply facing a massive negative multiplier and their balance and entire credit in the economy would have shrunk and it would have been in a slump.

By creating fiscal expansion the banks had the JGB bonds to buy. After 15 years of these companies slowly paying off their debt, they are now in a regular normal recession and their problems are solved. Japan is not healthy exactly but it does have a normal recession. That is what we call Balance Sheet Recession. What Richard Koo then says is because the US and Europe also has some of the similarities of low interest rate, no apparent inflation, low growth, therefore this is Balance Sheet Recession and that is in my view, quite incorrect. In the US a) it is all transparent, they cannot hide the losses for 15 years b) the losses are not primarily on a corporate level as in Japan but they are on a household level and the banking sector level which is actually much more difficult to deal with. Also, the Japanese had a nationalistic and moral suasion such that the big institutional investors are obliged to keep buying JGBs whereas in the US, at least the dollar, is completely dependent on foreign purchases of their assets.

We have a completely different scenario, and then the scale is different. There have been a number of studies of past financial crises; the IMF World Economic Outlook in 2008 identified 113 of them, the book by Reinhardt and Rogoff studied 250 different financial crises over the last 800 years, but mostly 200 in terms of the data. What we discover from that analysis by Reinhardt and Rogoff is that on average it takes growth 4.4 years to recover. On average debt to GDP rises an astounding 86%, real estate takes six years to recover. We also learn from the leading indicators up to this crisis; they are very consistent with past crises but in this case it involves more than one country and this is much larger than the problem in Japan.

We have to go back to the Great Depression to give us similar analogies. My response to your question is you have to look at what happened in the Depression, not in Japan. What happened in the Depression was really frightening - unemployment in the US went from 3% to almost 25% in three years; urban areas hit 50%. Growth did not recover until 1941 and of course equities 1954. We now have a Fed with very unorthodox policies, totally focused on avoiding a depression and a lot of people not fully understanding the depth of that and the tools the central bank has are necessarily less adequate than what Bank of Japan had. I do not think Japan proves a useful model because the dangers are much greater and also frankly the problem is different because the debt lies in different places and the behaviour of the investor bases are very different.

EH: Lastly, could you share with us your near term and medium term outlook of the global markets and emerging markets. Is there any specific or particular sector in the emerging market space that you are bullish on?

Booth: Yes, I think there used to be one principal argument why people look to emerging markets based on equity. That was because it was assumed you would get higher returns than the developed market equivalent but with higher risk. A higher return argument is still there but there is a new argument, and it is in the very worst scenario globally, emerging markets are getting to be safer than investing in the US and Europe. In Western Europe and United States, we have three decades of financial markets deepening, and these countries are now addicted to debt. While the build-up of leverage for maybe the first two decades was extremely valuable, and actually created capital.

We now have a very painful period of years ahead of us of deleveraging and there’s no way of getting around that. This is the analogy with the Depression. And we can do that in a really unpleasant way like Depression which goes on far too long, or we can manage it in a more gradual way. Either way, we are going to have low growth in US and Europe, we are going to have major deleveraging, it is going to be painful. Emerging markets simply do not have that problem. They are 30 years behind in terms of their financial sector development, they do not have enough leverage and they have puny capital markets compared to their economic weight. We are talking about the bulk of economic activity on the planet in emerging markets, not something peripheral. In due course, their capital markets will be the bulk of capital markets globally, and the growth of their capital markets is actually much faster than the growth of their economy – already much healthier and will continue to be much healthier than the developed world.

We have some big changes ahead. The two major problems that the developed world will face are firstly stabilising the banks and that is still not over. Secondly, global rebalancing which is primarily a currency movement within a huge build-up in reserves – the vast bulk of central bank reserves today are owned by emerging markets central banks and it is what they do with those reserves which will drive global currencies, in turn that will drive most other asset classes in the world. We are now in a world where (and I have been saying for years, one needs to understand the developed world to understand emerging markets) in order to understand developed markets, we have to understand emerging markets because actually it is the decisions of those central banks in particular which will drive pretty much everything else. Their decisions are going to be based not on conditions in the US but on their own domestic conditions so we have interest rate and also exchange rate movements, which are driven by central banks.

To answer your question, we are going to have significant currency appreciation in emerging markets against deficit currencies, the euro, the dollar, the sterling etc. That can happen gradually over three to five years or it can happen if there is a sudden dollar crash. We obviously hope it is more gradual. The other thing that is happening is that asset classes are growing. Dollar denominated sovereign debt is looking very attractive largely because there is not a lot of issuance, and capitals look extremely strong. Corporate debt and local currency debt are going to expand massively; I strongly believe that the size of emerging market debt and currency markets is determined entirely in everything but the very short term by the demand for paper. If there’s a trillion dollars more demand for corporate debt in the next year, there will be a trillion dollars more paper, it is as simple as that.

If you think about an asset class like corporate debt, it is so different to say US high yield, it is much better quality apart from anything else, but it is also that average leverage levels have actually been going down. These companies are taking on debt but they are actually expanding even faster. These are companies taking global market share and increasingly pricing these global markets. Which means if you are a pensioner in the UK, your pension fund liabilities fundamentally are in the emerging markets because if I have to retire in 20 years, when I get my pension, half the goods I am going to buy are going to be priced in emerging markets. If we get away from money illusion and think about the purchasing power of the pension, the liabilities in emerging markets – pensions in the developed world have miniscule allocations in the emerging markets so there are big technicalities that are going to happen which will include equities.

There’s a place for equity, there’s a place for real estate, there’s a place for all the emerging markets asset class, but what is driving this today is a huge change in global risk perception, there is no such thing as a risk-free investment. It is a complete myth and as people understand that the US and Western Europe are the major centres in a tectonic type risk; they are going to be reassessing allocations. We are right at the beginning of this process so there is a huge growth in these asset classes ahead and Ashmore is well placed as the only sizeable institutional manager managing across the emerging markets, but dedicated only to emerging markets. We are in a very good position to benefit from all that and we certainly will be trying to continue to grow into that space.  I am sure lots of other people will be joining us as they have done over the last 15 years and in particular, 10 years ago we were practically the only people offering local currency debt product, now there are loads and loads.

That is what will happen with corporate debt, it will happen with real estate and with other asset classes. Over the longer period, we are going to see massive growths and in the very short period, local currency markets will be driven primarily by the central bank action of emerging markets, primarily using exchange rates to help control inflation. Their rates markets are a function obviously of interest rate policy. Again, that is a function of global slowdown as well as inflation. Dollar denominated sovereign debt will be rallying in a short term because the treasuries of course have rallied strongly emerging markets have been going up a little bit but it has to catch up. Likewise corporate debt in dollars, local currency corporate debt will also be rallying simply because of massive demand from liquidity particularly in emerging markets.

Generally corporate issuers, what is happening with companies; hundreds of thousands of companies in emerging markets, is similar to what happened in Europe and the US 30 years ago when banks started to be dis-intermediated by the bond market. If you are a regulator, what is a bank? A bank is a highly levered vehicle at the centre of your capitalist economy with liability mismatches and financial crises always have banks at the centre. A bond market on the other hand takes long term institutional and other investors, and translates that money without leverage, directly into long term investment projects. Every country wants a stronger bond market and what is happening with emerging markets is that you are going to see enormous growth in corporate debt markets over the next decade.

 

 
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