Robert Koenigsberger isn’t rattled by uncertainty, at least when it comes to markets.

He’s had a lot of practice, starting his career in the 1980s when emerging markets were essentially a collection of bank loans in default. He founded Gramercy, the emerging markets alternatives firm, in 1998 when Russia devalued its currency and forced the restructuring of the country’s debt.

That experience comes in handy now as developed markets are facing the kind of uncertainty and volatility once reserved for emerging markets. Wars in the Middle East and Ukraine, shaky global alliances, and rising inflation, debt, and interest rates have all contributed to the turmoil.

When we met to record the podcast, Robert said people will look back at the last three decades as a time of “extraordinary peace,” which translated into an environment that was “extraordinarily friendly to investors.” The tools that investors have come to take for granted, he said, probably won’t work for the next 35 years.

(Listen to the full conversation on Spotify, Apple or wherever you get your podcasts or by scrolling to the end of this article.)

Institutional investors need to make peace with the uncertainty hanging over markets. Koenigsberger said he and Mohamed El-Erian, the chair of Gramercy, agree that “Our highest conviction is you can’t have conviction.”

That isn’t particularly reassuring. But it tells investors that they need to prepare for persistent volatility and construct portfolios that use it rather than “get whipped around by it.”

Which brings me back to investing in emerging markets, which is an object lesson in how not to deal with uncertainty. Institutions have repeatedly allowed risk management techniques, asset allocation rules, benchmarks, and governance policies to prevent them from being flexible and opportunistic when it matters.

In episode 23, Koenigsberger told me that emerging markets performed as he and others expected over the long term. “If you were Rip Van Winkle and you owned the asset class, it did everything it was supposed to do,” including outperforming.

The problem was that many investors failed to earn those returns.

They added emerging markets to their portfolios by buying the index, which includes everything, rather than making bets based on fundamental research and in which they had the highest confidence.

That meant they had substantial exposure to countries like Argentina, whose economy started to slow in 1999 and which suspended payments on its external debt in late 2001. Or they were holding Russian and Ukrainian assets when Russia invaded Ukraine. The pattern repeated itself: investors bought in when markets were exuberant, held on too long, and then sold at the worst time. Koenigsberger said it was easy to blame it all on the instability of emerging markets.

A month before Russia’s invasion of Ukraine in 2022, one of Gramercy’s analysts estimated that there was a 40 percent chance of an invasion after talking to sources, even if all the details weren’t known at the time. Koenigsberger said he didn’t need to hear more. Gramercy sold its exposure and decided to wait.

“How could you go to bed at night thinking” Russian tanks could be in Ukraine by the morning, he said on the podcast.

“Performance doesn’t just come from what you own. It comes from what you don’t own.”

Institutional investors understand these dynamics. But asset allocation and governance frameworks designed to manage risk, such as getting board approval and having pre-defined buckets set up for each asset class, can force investors to work within guidelines that don’t fit what’s actually happening in a market at a specific point in time.

Now, when investors are more concentrated than ever and still want to diversify away from the U.S. dollar, U.S. Treasuries, and U.S. stocks, emerging countries can offer some alternatives as well as exposure to markets that have proved their resilience during multiple crises. In fact, as Koenigsberger said, the gap between the behavior and characteristics of emerging markets and developed markets has narrowed significantly.

“I think you have developed markets and emerging markets and you have submerging markets.”

Other topics of discussion include:

Koenigsberger and El-Erian wrote a piece in late 2019 warning of a coming dislocation in emerging markets. But when it came in March 2020, interested investors said they might get board approval by July or October. “Boing, they missed the entire V-shaped recovery,” he said.
On legal protections and contracts: What’s different about emerging markets is “we have to underwrite the people…. Contracts matter when you get the people wrong.”
On why investors index: “If that’s what everybody else is doing, then I’m not really taking a career risk with this. Hey, we all got smoked from Russia.”

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Podcast: Investors Know What Not to Do in Emerging Markets. They Keep Doing It Anyway.