Episode #300: Best Idea Show – Geoffrey Batt, Euphrates Advisors, “You Get Used To The Terrorism Problem And You Just Start To Focus On The Companies”

April 7, 2021

Episode #300: Best Idea Show – Geoffrey Batt, Euphrates Advisors, “You Get Used To The Terrorism Problem And You Just Start To Focus On The Companies”

Guest: Geoffrey Batt has been investing on the Iraq Stock Exchange since January 2008. In October 2010, Mr. Batt launched the Euphrates Iraq Fund. Prior to his Iraq investments, Mr. Batt was an analyst at Quantrarian Capital Management. He is a Senior Advisor to the Atlantic Council’s Task Force on the Future of Iraq. Mr. Batt studied philosophy at Columbia University.

Date Recorded: 3/17/2021 | Run-Time: 1:27:11

Summary: In today’s episode, we’re covering Geoffrey’s best idea: investing in the Iraqi stock market.

Geoffrey begins by telling us how learning about Daniel Cloud’s post-Soviet Union Russia fund led him to look around the world to find somewhere he could earn huge returns, which led him to Iraq. He gives us an overview of the market and economy and how it’s rebounded since Saddam Hussein died. Then he walks us through everything he’s had to deal with since he first invested there in 2010 – political instability, a 20% currency devaluation, negative oil prices, and an Iraqi stock market that closed in response to COVID. We talk about the tailwinds for Iraq, including the growth of the banking sector and ESG, which Geoffrey believes is bullish for oil.

Be sure you stick around until the end to hear about Geoffrey’s first trip to Iraq, when he was driving to visit with a company and was forced to turn around because of a car bomb.

Comments or suggestions? Email us Feedback@TheMebFaberShow.com or call us to leave a voicemail at 323 834 9159

Interested in sponsoring an episode? Email Justin at jb@cambriainvestments.com

Links from the Episode:

0:39 – Intro
1:43 – Welcome to our guest, Geoffrey Batt
3:11 – How a philosophy major like Geoffrey ended up an investor
9:25 – Adventure Capitalist: The Ultimate Road Trip (Rogers); Investment Biker: Around the World with Jim Rogers (Rogers); An Empire of Wealth: The Epic History of American Economic Power (Gordon)
10:12 – Parallels between investing, philosophy, and leadership
11:57 – Losing interest in philosophy and pursuing a career in finance
14:28 – Russian insight and settings his sights on Iraq
19:33 – The end of civil war and the restoration of stability
22:58 – Size of the Iraqi stock market
23:46 – Early days of the fund and a macro analysis of Iraq’s market
28:03 – Lessons learned from a frontier market’s entrepreneurial class
31:15 – Baghdad Soft Drinks
33:27 – Persevering through an informational asymmetry in 2010
37:23 – Investors fortifying their market positions amidst the rise of ISIS
39:52 – COVID-19 and its effects on Iraq in 2020
41:54 – Sending monthly newsletters to clients about internal Iraqi affairs
44:44 – What distinguishes this frontier market from other markets in the world
46:08 – Finding opportunity in the devaluation of their native currency Dinar
52:22 – The future for the Iraqi market and what it will take for global acceptance
56:09 – Dallas Fed Quarterly Energy Survey
1:01:51 – The Meb Faber Show – Episode #294: Dan Rasmussen, Verdad Advisers, “A Lot Of These Regime Changes Happen Around Recessions And Crises”
1:02:14 – What’s on the horizon for the Iraqi stock exchange and how to invest in it
1:07:18 – The emergence of an early-stage tech scene in frontier markets
1:10:05 – Regional exposure to companies operating inside of Iraq’s borders
1:13:42 – Local equity and investment culture among the locals
1:15:23 – Geoffrey’s most memorable moments investing in Iraq
1:22:51 – The media’s portrayal of Iraq versus how it is when you’re there
1:24:17 – Learn more about Geoffrey; euph.com; Twitter @geoffreysbatt

Transcript of Episode 300:

Welcome Message: Welcome to the “Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Meb: What’s up, everybody? Another awesome show today in our “Best Ideas” series. Our guest is the managing partner and founder of Euphrates Advisors where he invests in and his best idea is Iraqi stocks. In today’s episode, our guest begins by telling us how learning about Daniel Cloud’s post-Soviet Union Russia fund led him to look around the world to find somewhere he could try to earn huge returns, which led him to Iraq. He gives us an overview of the market, the economy, how it’s rebounded since Saddam Hussein died. Then he walks us through everything he’s had to deal with since he first invested there in 2010, political instability, currency devaluations negative futures oil prices, and an Iraqi stock market that closed in response to COVID. We talk about the tailwinds for Iraq, including the growth of the banking sector and the ESG, which he believes is bullish for oil. Be sure to stick around to the end to hear about our guest’s first trip there where he was driving to visit a company and its first turnaround because of it exploding car bomb. Please enjoy this episode with Euphrates Advisors’ Geoffrey Batt. Geoffrey, welcome to the show.

Geoffrey: Thanks for having me.

Meb: Last time we tried to connect, you didn’t have any Internet, and I just figured you might be in Iraq but you just didn’t have any Internet in Philadelphia. Is that the case?

Geoffrey: Meb, COVID has made this area not that different from Iraq. We have low power lines in this area. And they’re all…you know, well, many of them are, you know, running through giant trees and you get snow, and ice, and cold weather, and wind, and branches fall, and lines come down. And before you know it, you know, you just cut off. And we have a generator. So, like, you know, we still get electricity but when your phone line goes out and your Internet goes out, your generator doesn’t matter. Everything is slowed down. It takes a week to get Verizon out here to fix things. Yeah.

Meb: You’re making the bull case for Starlink it sounds like, Musk’s project. It’s funny because when I was an engineer undergrad, I remember writing a paper about Iridium, which was 20 years ago. And living here in L.A, I’d sympathize because when one of the most populous places in the planet, we literally don’t have cell phone service in my house, which is actually kind of nice. But all right, well, glad to connect, glad we both have Internet. Wes Gray was the common friend that introduced us. Shout out, Wes. You live not too far away from the crazy folks at Alpha Architect. You need to go over to his office aka his house. It’s a unique place. This is almost the beginning of a joke. It’s like a philosophy major walks into a hedge fund or something. Let’s rewind to the origin story. Listeners, we’re going to talk about investing in Iraqi securities in a little bit but first I want to hear how does a philosophy major end up in that part of the world interested in investing?

Geoffrey: I studied philosophy as an undergrad and wanted to go on and do a Ph.D. if I could and try and teach philosophy. Obviously, very ambitious. While I was there, I was taking…while I was studying philosophy I was taking a graduate seminar on this, like, obscure 17th-century philosopher.

Meb: Who? We need to know the name.

Geoffrey: Leibniz, disputed inventor of calculus, father of the phrase. This is the best of all possible worlds, which Voltaire famously marked in “Candide.” So I met this older guy in the class. He was maybe in his early 40s. I’m in my early 20s. In my opinion, he was the smartest guy in class, by far. He even looked more disheveled than, like, your average philosophy graduate student, if you can even imagine that. He was brilliant but very unpretentious, unconventional. I’m immediately attracted to people like that. I just like to be around people who are different and have different ways of thinking about the world because they tend to be the ones who have the best ideas and the most interesting things to say. And so we became friends over the course of that year.

And at the end of that year, I didn’t have money to…I run out of money to go to school. And I didn’t have a cosigner for my student loans. So, I couldn’t get a student loan. And I told him I had to take a leave of absence to get a job to save up money to pay for tuition. And he was like, “Well, you know, I’m starting a new family office that’s going to invest in Asia.” And I’m like, “What’s a family office?” “Oh, well, before I came here to do my Ph.D., I started the first hedge fund to invest in post-Soviet Russia. We invested in Russian equities in 1994, and we were one of the best-performing emerging markets fund in the world. And then I decided to leave. You know, I made my fortune and I decided to leave and do a Ph.D. in philosophy. Anyway, I’m starting a new family office, why don’t you work for me? And you’re looking for work…looking for a job, you philosophers tend to be pretty good in markets.”

And, of course, I didn’t believe him. I thought he was crazy. He did not fit my ill-informed description, you know, image of what a high net worth, ultra high net worth person looked like. I’ve never met an ultra high net worth person before. In my mind, they looked a certain way. And he certainly didn’t look like the stereotypic rich guy. So, I told him I’d think about it. And then I, you know, went off to the library and looked them up and saw that it was true. And like, I think he’s on the cover of “Barron’s,” maybe, or I found like, maybe there was a feature article in “Barron’s” about him and his fund. And it was all true. So, talked to my parents, they were like, “Yeah, why not? Give it a try.” And I went to work for him for a year in his family office that was focusing on East Asian emerging markets.

I had no background whatsoever in finance. About the only thing I knew was that the New York Stock Exchange was in New York City. Other than that, I was utterly clueless. You know, there was this three-month period where I felt useless, and totally lost, and was, like, questioning whether or not I made the right decision. But then I would say halfway into it, I started to pick up the basic concepts. It helped that we went to Asia and we travelled to all these different countries in Asia and met with companies. And by the end of that year, I just had fallen in love with markets because what I’d learned was that, in some ways, investing, it’s like applied philosophy, that philosophy teaches you to be…what you learn from studying philosophy is that, you know, one should be extremely skeptical of the claims that are made in the everyday world because even the most, sort of, simple things in the world, like define what a table is, or define what a human being is defined what life is, is a virus a living thing? Technically, you know, according to standard biological definition, no. So, it seems to have all the characteristics of life, but yet it’s not life.

And we can’t even define these basic concepts. How on earth can people tell me who’s going to win the Super Bowl next year or who’s going to win the NBA Finals this year? What stock is going to be the best performer over the next 12 months? Nobody really knows. And yet people make these claims all the time with great confidence. And what I learned in that year was that if you’re skeptical of the conventional wisdom, if you’re skeptical of the prevailing narratives that are out there in finance, and politics, and so on, and you, sort of, search for the truth on your own, that oftentimes you can find errors in conventional wisdom and poke holes in these prevailing narratives, and invest in a way that would benefit from those views being wrong.

And what I loved about it was that…What I learned quickly was, markets are very much a meritocracy, that me being some young, inexperienced investor in my, you know, early 20s, could have a view on oil and oil stocks, or think that a particular oil stock was deeply undervalued and that the market was totally getting its valuation wrong, Warren Buffett, or George Soros, you know, could take the completely opposite view. They could be sellers and I would be the buyer. It didn’t matter that they were Warren Buffett or George Soros. It didn’t matter that I was nobody. All that mattered was who was right. It’s something that I never found in the philosophy classroom. In the philosophy classroom, it’s very much like a power dynamic that was hierarchical…You know, the professor, even if you could be very great deal of conviction that your view about some issue in philosophy is the right view, or at least is a compelling view, a professor can just shoot it down and there’s really nothing you can do about it. There’s no real way to determine who’s actually right on these issues. In markets, there will be a winner and there will be a loser. And who you are makes no difference. And I love that.

Meb: In many ways, it’s talk about a dream job, fantasy of getting to travel and it being high compensation and involved in an incredibly dynamic world. It takes me back to the old Jim Rogers books, like “The Adventure Capitalist” and “Investment Biker.” I was actually thinking as you were talking, some of the most interesting reads in the world of investing to me are actually the economic history. There was a great one called “Americana” this past year, with things like “Empire of Wealth,” “The Scent of Money,” “Birth of Plenty,” all the bubble ones by McKay, and others. And this is coming…The reason I was asking you who the philosophy was, my wife was a Ph.D. philosophy grad. So, I’ve been exposed a lot to that side of the world. I think she was more Kafka, Niche…

Geoffrey: You know, what I learned as I’ve gotten older is that really what matters in markets is not so much your intelligence, but it’s, sort of, your character, and not just your moral character. But, like, how are you under fire? How do you respond in stress situations? And that’s not something that you can really know until you’re in this situation. You find a lot of interesting things in philosophy about just this, the average person, this is, sort of, what separates people who are capable of achieving…the difference between a leader and a follower, I guess, is really, that the leader is cool under fire. And what you find in markets often is that, you know, even people who have gone to the best business schools, have tons of experience can really become quite unsettled and error-prone when the stakes go up, and the cost of an error is very high.

That’s something I think is useful philosophy, too, is that not that reading philosophers will give you that, but it just helped me better understand, how was it that when ISIS took control of a third of Iraq and took its second-largest city in June of 2014, how was it that, like, I survived that? How was it that we were able, my team and I were able to figure out in two weeks what was going on and actually get it right, make the right decision and not have that destroy us? I mean, I think really was that we were cool and rational in a very stressed situation. And that enabled us to, sort of, see clearly what was happening. And that’s a trait I think a lot of people don’t have in markets and I don’t think it can be taught. I just think you either have it or you don’t. And I’ve come to reflect on that a lot more, especially lately, given what’s going on with COVID and everything.

Meb: Well, under fire probably has a little bit more of a literal meaning for your part of the world than it does necessarily for what we do. Tell me a little bit…So, all right, so you started to get some stamps on your passport. How’s the timeline workout? Do you end up finishing school? Do you just hop over and go full investor? What was the on-ramp?

Geoffrey: So, I went back to school, I got a bonus, which at the time seemed like a ton of money. But in retrospect, wasn’t. But it was more money than, you know, I never imagined I would get a lump sum at that point in my life. I went back to school and started investing on my own with that money, and I paid my tuition and, and had money left over to invest and it was all great. But I just didn’t have the same passion for philosophy that I did before. Instead, I would be in class thinking about markets. I would be on my laptop following the market or looking at a reading for a 10Q. I remember reading through Apple’s…One of the great regrets of my life was that in 2003, I was back in school, and I’ve seen people with iPods and just seemed so obvious that that was an amazing device and thinking that…You know, so I was reading through Apple’s, like, latest quarterly and so impressed by the whole thing. And the numbers were great, but the stock had, like, doubled, maybe. I’m like, “Oh, I missed it.” Little did I know.

But before I went to go work in finance, I was just completely focused on philosophy. After a year in finance, I was completely focused on finance. I just lost whatever passion and focus I had. Whatever focus I had on philosophy had switched to finance and markets. And after a year of being back in school, I just realized…I mean, I was struggling with one class. It was like Latin, the last Latin class, Latin for whatever. I was like, “To hell with this. I’m just going to go out on my own. I have enough money to go out on my own.” And again, in retrospect, that was a very, very, very foolish decision. And I think 99 times out of 100, you know, the probabilities might not even be that favorable and that probably ends badly. But I had this guy, his name’s Dan Cloud, was a partner of mine. Now, he, sort of, became a mentor and said, “Okay, if you’re going to do this, you need somebody to mentor you while you do it. You can’t just do it. And you need to, sort of, work with someone.”

I did that for the next few years. And it went well, but, you know, I made enough money to support myself in New York, barely. But it was more of, sort of, an education for me. And this was in 2006 or 2007. What Dan said to me was, “Look, what you’re doing now is fine. But, like, really, if you’re really going to ever make money, you need to have a fund. To get a fund, like, yes, you have to be credible, you have to be skilled, but you have to have an idea that distinguishes you from everyone else. Everyone else is doing long-short, and everyone’s in private equity and doing all this other stuff, and they all have business degrees from Harvard and Stanford, and you don’t. So, what’s going to distinguish you is your idea. And so, I went looking for, like, the next big thing.

And what Dan found was Russia. And what was fascinating about Russia, after the collapse of the Soviet Union, was it was a total basket case. And it was being compared in, like, leading foreign policy journals, like foreign affairs, was saying, I think the headline was, like, “Russia, the next Weimar Republic.” They were forecasting a hyperinflation, which did occur, but they were also forecasting, like, a, sort of, Hitler-like figure taking over, and however nefarious Putin is, he’s no Hitler. And of course, they got the economy completely wrong. And the fact of the matter is that there were extraordinary opportunities. You could buy a company, you know, with the voucher option, you could buy a company that had the same reserves as, I guess it wasn’t Exxon Mobil, then which is Mobil, so a Russian oil company that had oil reserves in production similar to Mobil’s but it was trading at one cent on the dollar. And we actually ended up making I think 100 times your money on that.

But the idea was, you look for these transitional situations where a country that has some kind of flawed ideology, flawed political system, something dramatic happens, there was a revolutionary change, the old order was done away with and a new order that, sort of, was more rational and more consistent with economic growth, replaced it, during that transitional period, it’s going to be very chaotic. There’s going to be a lot of violence, it’s going to be political instability. The macroeconomic environment will be unfavorable at first. But as the saying goes, you know, “You buy when there’s blood in the streets.”

And that’s what Dan saw in Russia was that there was this country with enormous human capital, enormous natural…a huge natural resource base that was inefficiently run for half a century, longer, more than a half a century. It was transitioning and embracing capitalism. And that would unleash that transition and that new model would help it unleash its economic potential. Everyone was saying he was crazy. But the reality was, there were good companies that were really, really cheap. And I guess the key insight he had was that it was a terribly screwed up place, but not quite as screwed up as everyone thought it was. And that if it just got a little bit better, that would be all it took for there to be this giant bull market. And he was right. It got a little bit better. There were many gut-wrenching moments, of course, and there was a huge crisis in 1998. But from 1994 to 2007, I think that fund returned 50x net of fees. And it came from, again, a country and a market that was considered uninvestable when it was actually the best time to invest.

So I was looking for something like that. And the most screwed up place I could think of was Iraq. I didn’t know anything about it, except what I read in the newspapers. I had a bullish view on oil, so I was drawn to its enormous resource base. And I remember that what really caught my attention was an article, I can’t remember if it was in the Times or the Journal, it was something like one of those publications, and it was about how oil production was rising in the country. And to my mind, Iraq is a failed state fighting civil war. So, this is where, like, it’s the philosophy comes in or maybe it’s not even philosophy. It’s just common sense, really. But I asked myself, “How on earth is oil production rising in a failed state that’s fighting a civil war? That seems…How do you reconcile that?” And it seemed you couldn’t.

One of those claims had to be incorrect. You could not…either it wasn’t a failed state or oil production wasn’t rising. Both of those statements could not be true at the same time. That was my view. And I think it’s true. It’s very hard to imagine how a failed state could actually increase oil production because that presupposes some level of functionality and competence to get oil production to rise, and some level of stability, and that just isn’t consistent with the idea of a failed state. So, that really got me interested because there was this apparent incongruity between the perception that I had of Iraq, and I imagined pretty much everyone had of Iraq, and what could be the reality of the country.

So I spent the next six months looking into it pretty closely. And I found that, yeah, the perception was off that while, you know, they were fighting a civil war, and it was awful, it was coming to an end. And that the surge, if you recall that term, the surge in 2006 and 2007 worked. And, you know, there are many facets to it. It wasn’t just an increase in the number of troops. It was actually very much result of great diplomacy on our part. But it ended the civil war. Violence from terrorism was down 90%. Oil production was up. The country had, at that point, a 17-year period of hyperinflation that was just crippling economically. And suddenly, that ended. Inflation was at, I think, 70% or 80% year-over-year the year before, and then suddenly, it was at 10%. I mean, that just doesn’t happen by chance. That’s another indication that there was an institution, namely a central bank that had managed somehow to impose macro-stability on the system.

And so, the more I looked at these just, sort of, basic macro-level indicators, the more it seemed to me that the narrative that I had accepted as reality was just off. Again, it was a terribly screwed up place. It was by no means a healthy country, but it was not a failed state. And it looked to me like they had reached a turning point. And so, I got really excited about it and went to talk to Dan Cloud, and mentioned it to him. And, you know, I had gone to him maybe with dozens and dozens of ideas before this one. And every time, you know, within a matter of seconds, he would tear it apart. And I’d just, sort of, give up and go away, you know, dejected. And this one was different.

I mentioned it to him and he, like, perked up and he said, “That’s interesting.” And I had not heard that from him before. And then, you know, he’s like, “You know, this is interesting, really interesting because the first idea I had in my mind when you said this to me was, ‘How can I steal it from you?'” Not that he was going to do that. He’s like, “That’s a really good sign because, like, my first instinct was greed, and that’s usually good. I guess the next question is, what’s their market like? Do they have a stock market? And can you get money in there and invest? Can you do that?” So, that, you know, took a couple of weeks to figure out and wired some money…you know, emailed a million brokers, and only a few of them spoke English. The one spoke English fluently, and I went with that broker, wired $5,000 or something, placed a trade, bought a stock, sold it the next day, and wired the money out of the country, just to see if I could do it. I completed the cycle. I could wire money in, buy a stock, sell a stock, get the money out.

So, it seemed like it was viable in that regard and we decided to put some money there. And before I knew it, I was pitching it to his two old partners at Firebird, and they gave me managed accounts. This was in early 2008. And in 2010, I decided, you know, I had enough experience there. I understood the situation there well enough to credibly market a fund. And that’s how Euphrates’ Iraq fund was born. I went to Dan and said, “I want to start a fund and do this.” And I sold to him a small stake of my management company. We put money into the fund and we were off and running.

Meb: Tell me a little bit about what the early days were like and give us some context. What’s the ballpark total investable market?

Geoffrey: Ten billion.

Meb: Smaller than GameStop, currently. You could have the entire Iraqi stock market, listeners, or GameStop, take your choice. Probably the same volatility, maybe not. Better racks, less…

Geoffrey: But no, racks a little bit less volatile, actually. Well, though, I’ll tell you in January, this is unaudited, but we were down like 22% in January and then we were up 27% in February. That’s not normal. It was kind of a crazy period. But you have months where you have 20% swings in either direction. It’s pretty volatile. Not GameStop volatility, definitely not.

Meb: So let’s go back to 2010, sort of, vintage and maybe walk us through some of the general macro cases of the country, you know, in general, and then we can probably hop over to the investment side a little bit. But curious also what the early days were like. You know, is it a scenario where a frontier market 10 years ago, was it easy to access management, to even talk to management? Is it something where you just buy the market cap index and move on? Is that a total disaster? Because I don’t know any other Iraqi funds other than ones that happen as a portion or a sleeve. And so, give us a little color on what the early days, in general, macro picture looked like.

Geoffrey: So the macro picture is very interesting in 2010. So the central bank had achieved macroeconomic stability. The currency had appreciated pretty significantly against the dollar and then they put a defective peg in place. And they had growing forest reserves, rising oil production, the price of oil was very favorable. So the currency…the macro picture was excellent. You still had a terrorism problem. You still had major car bombs going off maybe every two to four weeks in Baghdad and other cities. And maybe the monthly fatalities from terrorism were, at the peak of the civil war, between 3,500 and 4,000 a month. At that point, they were maybe down to 200. So it was a huge improvement but it was still a problem. You know, they had a terrorism problem.

The economy was growing very rapidly. You had…I think that was maybe the first or second year that they had this nice run where they had several consecutive years of double-digit or near double-digit GDP growth. And assets in the banking sector were growing very rapidly, everything that you wanted to see. So the macro picture was pretty bullish. The one problem was politically, and to this day, it’s still a problem. They’re sort of like the United States before the Constitution. They’re the United States under the Articles of Confederation. That’s the best way I can explain their political system to people who aren’t familiar with it. It’s a very decentralized, becoming…After Saddam, nobody had an appetite for establishing a political system with a strong central government. They were very fearful of the rise of another dictator.

So they did the opposite. They went in the opposite direction and created a very, sort of, loose confederation of provinces and states. And the result was that you had all these different, sort of, factions fighting against each other for control. You have Kurds and First Arabs. And then within the Arab community and the Kurdish community, you had Shia or Sunni. And it was just unstable in that regard. And a lot of the terrorism was really political violence. It was an outgrowth, or it was an expression rather of this political conflict. It became violent. It was low level, but just it was a nagging problem.

But it became, sort of, normal. It got to the point where you almost looked at car bombs clinically. The shock value goes away pretty quickly…When you’re focused on a country where bombs car bombs are going off regularly, the only way you can cope with it, I guess it’s, sort of, like medicine, you kind of can’t get too close to the…you can’t have like an emotional attachment to the patient because it, sort of, clouds…at least that’s the consensus view, I guess, that it will cloud your judgment. It’s the same thing in a frontier market with a terrorism problem. You have to look at it clinically and not get emotionally attached to it. And then you start to figure out, okay, a horrible car bomb goes off. The people who did that, they’ve made at least three or four mistakes when they…every time there’s a major car bomb, the people who did it left three or four mistakes behind for somebody to find. They’re going to have to go into hiding now for a while, so there’s not going to be another one. It’s very unusual for there to be multiple ones in a short period of time because the people who did it have to hide and recruit, otherwise, they risk getting caught.

So, you can figure out, okay, it’s not going to get that much worse unless there’s some kind of major shock or reason for it to escalate, things could stay at this tempo for a while. You get used to the terrorism problem and you just start to focus on the companies. What I learned in the entrepreneurial class in Iraq was really no different than an entrepreneurial class anywhere else in the world, that they were living in an environment that presented a unique set of challenges and they had to adapt to those challenges to thrive and prosper, and they did. So I quickly learned that to operate effectively in a market like this, you have to filter out a lot of that stuff. You have to be able to filter out the noise pretty well efficiently and focus on just whatever the signals are.

And the signal to me was companies are growing, despite the tourism, companies are growing. Despite the tourism, the economy is growing. You know, despite the terrorism, oil production is steadily increasing if not destabilizing consumer price index. The macro situation is fine. So, clearly, this is noise. At least that’s how I looked at it then. And that allowed me just to, sort of, focus on the companies. And the companies then, I mean they were much smaller, I mean they’re … but yet they’re much smaller than they are now. Very, very wary of foreigners, particularly Westerners, not out of any kind of animosity towards us, it was just that lack of…they were unfamiliar with us. And so, initially, I had a very difficult time contacting, you know, getting in touch with management of any of these companies. Usually, the guys who would talk to you were the guys who had the worst companies because they were desperate for money and capital.

So, what I found was that the best companies were the ones who were, like, the most tight-lipped because they felt that their stocks are undervalued and they didn’t want some foreigner to come in and take a huge stake in it and steal their companies from them. So, initially, because I didn’t know the companies that well, it was hard to get access. I took a sort of…I didn’t do…definitely not do an index approach because they’re just…many of the stocks listed on the exchange were uninvestable, like, sort of, parasternal companies that just weren’t making any money and there was nothing compelling about them. I think being diversified in this small market, you maybe own 20 stocks and, sort of, equally weight them. And that’s what I did initially.

And over time, I start going to the country, when you’re there, it’s a lot easier to meet people. You get to know them. Over a period of years, it becomes clear who real winners are, who the really smart people are who have the best businesses that you can trust, and which companies look good on the surface but have a lot of dead bodies hidden in or are untrustworthy. And you start to figure that out, you get more access, you start to build a relationship, you start to trust each other. And over time, I was able to regain the confidence that was necessary to start really stock picking and becoming much more discriminating.

And right now, we hold 11 names in our portfolio. So it’s a super-concentrated, long-only book. But that’s where we have the most conviction. We went from not having any access to being on the boards of these companies, very politely and suddenly agitating for change over time. One of our largest positions is a company called Baghdad Soft Drinks, which is a Pepsi bottling and distribution business in Iraq. Iraq is one of the few countries in the world where Pepsi is the dominant soft drink. In Baghdad, it has 80% of the market. In the entire country, that’s about 60%. And they doubled their dividend in the last two years and we had a lot to do with that.

Meb: By the way, everyone knows Pepsi’s gross compared to Coke. But that notwithstanding, give me like a ballpark, like, market cap. So when we’re talking about these names, the whole stock market’s $10 billion.

Geoffrey: This is like a $500 million company. Back then, it was probably like a $70 million or $80 million company, very cash-rich, no debt, no leverage at all. But I think they were producing about 20 million unit cases a year 10 years ago or so, and now they’re well over 100 million. They only had Pepsi, and Mountain Dew, and one other product to sell in 2010. And now they have a lot of others. They have Aquafina water. They’re going to get Tropicana juice this year. And they were originally just in Baghdad and central part of the country, now they’re nationwide. I think in the last 12 years, sales are up 10x or more. It’s just a wonderfully run company. You know, there were major governance issues when we first invested. The governance in a frontier market is never going to be anything close to what you find in the developed world.

Not that the developed world doesn’t have its issues with governance, but it’s a different universe, a different mindset, and we’ve got them to come a long way in the last 10 years, to the point where we’re on the board and, you know, we can say, “Look, you generate so much cash flow, free cash flow this year that you really can afford to increase the dividend. And after your capex requirements, you’re going to spend to grow in a very rational way. And there’s still plenty left over for you to increase the dividends. Let’s do it and reward shareholders.” It has been a brutal year. And they did it. It’s night and day really. It’s almost an unrecognizable…If you look at Iraq today compared to what it was like when I first invested, it’s almost unrecognizable in that regard and other important regards.

But yeah, going back to 2010, the best way to put it is that there was this, sort of, information asymmetry where it was really, really hard to figure out, like, which companies were worth investing in. It was really hard to figure out where you should put your money. But once you got on the other side of that asymmetry, you had this huge edge. Now, like, you know which companies are good companies and which ones should be avoided. They can be tricky because some of them look like they’re growing very rapidly, but their numbers just don’t add up. It’s just they flat-out lie in their financial statements, or the growth is unsustainable, or they’re doing it in some kind of way that’s going to, like, end up destroying the company. And it’s hard to tell initially because back then, disclosures were weak disclosures. Financial disclosures have gotten much better. The market was, like, only trading three days a week and they were trading on whiteboards. It was like open outcry for two hours a day, three days a week. Now, it’s five days a week, and everything’s automated or electronic. It was, like, slow going and painstaking.

But once you put in the time, you go to the country, you meet these people, get to know them well, and then suddenly, you have this huge edge over everyone else that wants to invest there that isn’t really that familiar with it. That’s kind of the environment that I was in for those first few years. Things started off wonderfully. But then, I guess, in 2013…2013 was a really good year for us, but you could see that the political situation was becoming much more unstable. Terrorism, which, you know, had been very low, collapsed from its peak in 2007 and stayed low until 2013, started to pick up again. And it was a pretty steady rise. And, you know, in 2014, early 2014, there were some really disturbing things happening in the Sunni parts of the country.

The middle of 2014, everything just blew up and created a situation where not only was the country facing an existential risk because of the Islamic State and the threat that that posed to the territorial integrity of the country and the end of the post-Saddam political order, but the price of oil also peaked a week or two after ISIS took control of Mosul. And then I think it was, like, maybe $100 to $110 a barrel and then it collapsed. That was the high. And then over the next 6 to 12 months, it just completely collapsed. So, they faced the situation where they’re fighting a war against ISIS to try and reclaim this territory. They lost. The political system is a total basket case and the economy is in a depression.

It wasn’t that different, I guess, economically, from what the United States looked like in the early 1930s. They really had an extreme, painful economic depression. And what we’ve been experiencing from that period of, say, 2015 when they reconstituted the army, the U.S. stepped up its effort and NATO stepped up its effort to help them, they gradually took back reclaimed their territory and eventually won the war against ISIS. It was a process from, say, 2015 to 2018, of, sort of, slowly crawling out of this giant hole that they dug for themselves. Baghdad Soft Drinks actually miraculously grew throughout this period. It was the only company that we owned that managed to grow continuously. But we had investments in banks, in banking stocks, in real estate. They just, of course, got killed. You know, they fell 80%, 90% from their highs, their balance sheets were a disaster, their income statements were awful. It was just a real challenging period.

But to my complete and utter surprise, what I seem to have unwittingly created was something that’s highly desirable and rarely found in the fund management business, which is I had what appeared to be a countercyclical fund that…Normally, when you’re managing a fund, when you’re doing well, you get more inflows and when you’re doing poorly, you get more outflows, net outflows, and that exacerbates. The upside is better and the downside is worse. You’re a for-seller. When you have outflows in a downturn, that’s vicious. In my case, I had investors who weren’t…I had some investors that ran for the hills, but most of the people who invested with us stayed with us and are still with us today. And in fact, many of them, you know, added to their investments over that period. I mean, we added to our investment.

We figured out pretty quickly that ISIS was not going to…even though it was a disaster, they were not going to…like, the oil wasn’t threatened. And all the oil, 90% of oil is in the south and there was no way that we’re going to get to it. There was no way that they were going to take Baghdad. We had figured that out two weeks or so. In two weeks of Mosul falling, we had figured out that this wasn’t the nightmare that it could have been. It could have been ISIS taking over the country. And we pretty quickly realized that that wasn’t going to happen. And that proved to be right. The fact that I think we got that right gave our investors confidence that we understood well what was happening and we doubled down in our personal investments in the fund. And I guess that gave our investors confidence to come in with us. And we ended up being in this enviable position of being able to buy a market that was crashing. And so, we picked up fantastic bargains and, sort of, rode out to recovery.

But things didn’t really start to get better until 2018, 2019, then the bank started to grow. You know, they were working through bad loans and balance sheet issues. Credit quality generally was a mess for a good three years. But once that it was all behind them, it was like their balance sheets were fresh again. It was like they were like brand new banks in a way. And you started to see significant growth. And whatever growth trajectory they were on, the company was on prior to that shock in 2014, they resumed that growth trajectory in 2018, and especially in 2019.

Meb: So, 2019, getting things kind of feels like trajectory getting back to normal, how did the pandemic have an effect, continuing to have effect? What was the situation last year? I feel like there was devaluation somewhere in the last year or so with currency too mixed in. What was the last year like?Geoffrey: Really picking up in 2019, and then in 2020, COVID happened. And Iraq took it very seriously. I mean, they instituted a national curfew. Very much like I guess, like, a Western European country, they just went into full lockdown mode. But unlike European countries, the market was closed. So from I think it was sometime in mid-March 2020, so about a year ago, right about a year ago, to this day, they went on full lockdown and the market was closed. And we had no idea when it was going to reopen. And for fund like mine, that’s a big problem because people can come into the fund every month. And we couldn’t establish NAV, or net asset value, for the fund. We couldn’t value our assets because the stocks weren’t trading. The price of oil proceeded to go negative or was in the process of going negative. And we were certain that the last quoted prices on the exchange did not reflect market value.

So, we had to suspend redemptions, which is the last thing…like, really the last resort that you never want to do. But in this case, we went to all of our investors and ran it by them. And they were totally comfortable with it and said it was, in fact, the desirable thing to do. There’s no other option, really. So we had to really suspend operations in the fund until the market reopened and the market was closed until the last week of April. It reopened, we reopened the fund. And the next thing you know, a month later, we were down 40% from where we were. But once again, you know, we had inflows, luckily and unfortunately, and we opportunistically bought the crash in the panic. And we write very lengthy monthly newsletters. I mean, I think that’s also one of the reasons why we have such a durable and sticky investor base is that we go out of our way to keep them informed about what’s going on in the country. I guess if you’re just doing like, you know, a regular plain vanilla fund, you write a quarterly letter and it’s not all that insightful. Your investors really don’t care. They just want to see how you’re performing.

But here are investors who really want to know what the hell’s going on. So we go into great detail every month explaining what’s happening. And there’s really never a shortage of things to write about. We kept them very well informed. And what we forecasted in May, we were forecasting about 20% earnings growth for our companies before COVID and we were like, “Look, this changes everything. We don’t know what their earnings are going to look like with precision. But we can say with confidence that there’s not going to be growth this year. In fact, there’s going to be probably significant contraction.” And in fact, that turned out to be completely wrong. To our complete, utter surprise, the banks, Baghdad Soft Drinks, our real estate company that we owned, they all had extraordinary years. I mean, in fact, the banks had the best years they had in a decade.

Baghdad Soft Drinks…and keep in mind, it’s a very seasonal business because the fourth quarter with the winter in Iraq, it actually snows in Baghdad. So, the appeal of Pepsi and Aquafina in a place like Iraq is when it’s very hot, it’s 120 degrees, the product sells itself. But they were in lockdown just when seasonal demand really picks up. So, they lost about a good month to month-and-a-half of the second quarter when sales started to pick up. So they said they lost about the last half of the second quarter. Even with that, they still managed to grow the top line by 12.5% and the bottom line by 20%. If you X out the second quarter and just look at the first, third, and fourth quarters of 2020 compared to 2019, that was even better. I don’t have the numbers off the top of my head, but it was closer to 20% sales growth and 30% to 35% I think earnings growth.

So, the balance sheets were growing by 30% or 40%, top-line is growing by 50%. That’s the great thing about a market that really distinguishes it from just about every other market in the world is that in the very early stages of its development, the Ba’ath Party under Saddam was, sort of, socialist, just a couple state-owned banks, no one really banked. It wasn’t a modern banking system at all. The people there just had no expectation, no real desire to bank. And if you wanted to bank, there weren’t really any viable options. In a country like Iraq, what you’re seeing is a country slowly transforming from being unbanked to banked.

And that’s like a very powerful secular trend that, it turns out, continues even during a pandemic that people still have…prior to COVID, they wanted to get their first bank account. And before that, they had their money under their mattress. They have an iPhone now or, like, a Samsung smartphone with Wi-Fi Internet. And there are actually e-commerce companies in Iraq now that they can shop on. They can use their phone, do all kinds of stuff. They want to maybe start to mobile bank. COVID isn’t going to change that. As long as they still have the money to put into a bank, they’re going to open up a bank account. And that’s what we saw in one of our banks, the stocks that we own, just from one segment of the market, they opened 45,000 new accounts last year. That’s huge. And it’s like the net additions were 45,000 in a year for a pretty small bank. And it just experienced this, sort of, tremendous growth as a result.

So, 2020 actually turned out to be…We were expecting for the worst and it turned out to be much better than we ever imagined. You know, we had a good year, our performance was very good. And the companies were great. Their operational performance was unbelievable. I mean, that continues to this year. There was devaluation. The dinar, the Iraqi dinar, the local currency had a defective peg in place that more or less held for 12 or 13 years. But this decline in the price of oil just killed them. Not only did 90% of the economy of their state, not the economy but 90% of the state’s revenues are coming from oil and the fiscal situation just completely collapsed, it wasn’t just the price of oil declined, the OPEC cuts really hurt them too. So they had to drastically cut exports. You know, exports went from like 4 million barrels of oil a day to 3 million, at one point even below 3 million. And their price realizations were, at one point, in the late 20s.

So, you know, they just blew through their Forex reserves and the pay was just untenable at that point. They consulted with the IMF. IMF totally gave them the green light to do it. And they devalued by 20%. And we were bracing for more like, this isn’t going to be good, this is going to lead to…We thought there’d be rioting in the streets. And we’re imagining pretty horrible scenarios and reactions to this, and it was the exact opposite. People were just like, you know, shrug their shoulders and went on with their lives. It actually has created…So, I mean, that’s why the fund is so volatile. In a place like Iraq, in frontier markets, generally, stocks become a store of value and an inflation hedge, a way to, sort of, maintain your purchasing power in a period of instability like this.

So, the devaluation led to, like, a flood of buy-in in the stock market. We had this huge surge in December, followed by a huge correction in January, followed by another big move higher in February. But it’s actually created a very interesting opportunity that Iraq hasn’t had inflation. I mentioned they got inflation under control in 2007 and they haven’t had inflation really at all for over a decade. And now they’re going to have inflation because they import just about everything. So, the weaker dinar is going to raise the import costs for whatever it is that they’re bringing into the country. You could expect…I think the forecasts are for CPI inflation to be…the official CPI rate will probably be around 10% to 15%. I think the IMF has it at like 11% or 12%. That’s going to force the central bank to raise its policy rate, and the policy rate’s very low. Right now, it’s about 1.5%. The policy rate is, like, very much in negative real territory and has to go up quite significantly to even approach being neutral.

The fascinating thing about it is the banks that we own are very liquid. They’re very cautious about lending. Many of them have loan-to-deposit ratios of, like, 20% to 30%. And most of them, what they do is they just make their money from fees, a little bit from lending, but mostly from fees, and the interest they earn on their cash assets. Right now they’re not earning much. And similar to three or four years ago, I guess maybe it was like 2016, whenever it was that the Fed in the U.S. started tightening again. And people started to get pretty optimistic and bullish on companies like Bank of New York, Mellon, and Charles Schwab because they had these huge cash balances. They were very levered to short rates.

And if the short rate was going to go up, the Fed was going to raise a risk-free rate, eventually, get it to like 3%, it meant that these companies that were sitting on like trillions of dollars of cash were going to make billions and billions more than they were in the investments, in risk-free way too. And something very similar is unfolding in Iraq now, that except the scope for rate increases is much higher. And the impact that will have on the bottom line at these banks is much more significant. So, we found ourselves in a situation like a month ago or a month-and-a-half ago where we’re like, “Wow, some of these banks, if the rate goes up to 1.5% to 6% over the next like 18, or 12 to 18 months, and the cost of funding goes up a little bit, maybe they’re going to earn like a risk-free 300 or 350 basis point spread, they’re going to earn…just from their interest on their cash at the central bank deposit, they’re going to earn close to their market cap just from this.

And so, we saw, like, all of a sudden, this extraordinary opportunity open up for certain banks, and we just went in and aggressively…We actually went to some our largest investors and pitched the idea to them, and raised a pretty substantial amount of money, and have become, within the last 6 weeks or so, very close to 10% shareholders in some of these names. So, the devaluation in that little brief period of instability that it caused actually created a wonderful opportunity for us that we hadn’t seen in a decade. So, we’ll see if it works. But we like it so far. And it seems to be moving in the right direction.

But yeah, so 2020 was difficult, but it seemed like it was difficult for everyone. Just living in this world was extremely unpleasant. But people figured out how to move on with their lives and how to survive. And as you saw in the United States, it was like feast or famine. Some companies…if you’re a company like Aramark or something, you’re doing all the concessions at, like, sports arenas, you were in real trouble or, like, an airline company, you know, like a Delta Airline was in real trouble. If you’re Netflix, business, you know, was never better. And it was like that in Iraq. There are companies that benefited immensely from this. And we didn’t expect it initially and then it turned out to be a big tailwind that’s still in force right now, still, sort of, exerting its influence as we speak.

Meb: I was looking through y’all’s deck. You have a really great deck. I’m not sure if it’s publicly available. But listeners, if you’re accredited, hit up Geoffrey and crew. And there are a lot of charts. I mean, look, you got a chart that shows the Iraqi PE ratio last year of like 5. A lot of the macro factors are totally reasonable as far as government debt, as far as the market cap to GDP is one of the smallest in the world. And now it seems, and you can correct me, that some of the headwinds seem to look like tailwinds. Oil prices are up, the devaluation is out of the way, the world’s reopening. What does, sort of, thing s look like today? We find ourselves the end of Q1 2021. Are things looking bright? And what needs to happen for this story to reach, like, broad acceptance, maturity growth, and multiples expand, and institutional investors? Is it simply performance or is it a lot of these macro factors need to continue? What are your thoughts now?

Geoffrey: We’re very positive on what’s happening right now. If you look at…I know this is controversial and, you know, feel free to disagree with me. I could be completely wrong about this. But my view is that the ESG craze and phenomenon, or however you want to label it, the fact that it’s become just so popular and widespread is quite possibly one of the most bullish developments for the oil market in the last…maybe ever. And I say that because the last time the oil market maybe was this bullish was maybe you had to go back to like 2003 when China was, sort of, emerging as a global power in its oil consumption, which is growing by double digits every year. And nobody had seen that coming and it just caused a major imbalance in the oil market and led to the super cycle. I don’t know if we’re going to get a super cycle in oil. And I don’t even really know how anyone can predict something like that with accuracy. I’m not even going to try.

But I just look at, sort of, very simple, basic data and try and apply logic to that and see where it gets me. And when I look at it in a simple way, I’ve just come to the conclusion that the sudden and, like, complete revulsion of everything having to do with hydrocarbon in the West means that the outlook for capital expenditures in the oil industry has never been bleaker. And it shows in the data that, I mean, last year was an anomaly clearly, but globally, capex was about $320 billion. And to give you some perspective, I think in 2014 when oil was above $100 a barrel, it was almost $800 billion. But 2019, it was maybe $450 billion. So capex fell off a cliff in 2020. And it’s, sort of, interesting to look at what CapEx looked like before COVID because what Shell did to the oil market was really destroy the returns that you got. Your IRR in, sort of, a Shell oil investment started to collapse in 2017, 2018, and 2019.

And it got to the point where, you know, these Shell companies were just pumping all kinds of money into…The only thing they cared about was oil production growth. That’s all they cared about. They didn’t care whether it was economical, whether they were going to actually generate any kind of free cash flow, whether they were going to be able to just fund their operations from the cash that they generated from their business or they were going to keep having to issue shares and tap the debt market. And they were able to do that for a while, tap the capital markets for capital to keep increasing production. But the returns went down significantly. And the supply crushed the price of oil, which made returns even worse.

They got to the point in late 2019 where the cost of capital for shell companies had gone up significantly. It’s funny, if you look at the Dallas Fed, if you ever want to know what’s like going on in the Shell industry, you go to the Dallas Fed website, and they have a quarterly energy survey for the Texas area. And it’s all about Shell. And they have these very colorful quotes from people who are operating in that area. And several of those guys compared…they called Shell Oil Ponzi. They said it’s a Ponzi scheme, that is not a self-sustaining process. Just you need a greater fool to come in with more capital to bail out the last guy who came in. But they were saying that in the fourth quarter of 2019 before COVID hit. So the outlook for CapEx was very negative before COVID.

Then, like, COVID hit and it seemed like the whole ESG phenomenon just went into overdrive, that governments in the West became more determined than ever to focus on green revolution in energy. And that oil was looked at like tobacco. And Biden has now banned drilling in federal land. And you look at oil majors in Western Europe and they’re like turning into renewable energy companies. They’re promising that, like, they can basically be carbon neutral, and some huge percentage of their output will be green. It won’t be hydrocarbon-based in 10 or 15 years. Well, that’s a huge problem because if you look at the scenarios that are contemplated in the Paris Accord agreement, there’s a 2 degree Celsius scenario they call it. It’s called 2 degrees C.

And the idea is, like, what do we need to do…? What kind of green transition needs to take place to limit the increase in the atmosphere temperature by to just 2 degrees Celsius over a certain period of time? And it contemplates a dramatic reduction in oil consumption and a huge transition to green energy. Even in that scenario that’s outlined in the Paris accord, the world will still need another, I think, 370 billion barrels of oil and requires another $14 trillion or $15 trillion of CapEx from between now and 2040 just for the oil market to be in equilibrium. And we’re not getting anywhere near that. So if you look, you’d have to spend about $580 billion to $600 billion a year, every year until 2040 to get to about $11 trillion, which is not even $14 trillion.

And if you assume that demand is going to be impacted permanently to some extent by COVID…and so that the CapEx requirements come down 20%. So if you lower from, say, $14 trillion to $11 trillion, or somewhere in that area, you’re still going to get nowhere near that level of CapEx to get the oil out of the ground that’s required to keep the market equilibrium. With the amount of money we’re spending, even pre-COVID, we were still falling about $100 billion a year short. So over a 20-year period, pre-COVID, that’s $2 trillion short of this reduced estimate. And now with ESG taking hold in the way it is, I think the outlook for that is even more dismal. So, I just don’t know where the CapEx is going to come from.

You have major endowment funds that are…I mean, just look at BlackRock and Larry Fink, they’re throwing their weight around. They’re demanding that the companies that they invest in outline how they’re going to be more ESG compliant. And a big focus is going to be on the E part of the equation. And I just don’t see them 10 years from now financing Shell oil companies. I think it’s going to become very unattractive to anyone with an ESG orientation to put money into a company like this, to a hydrocarbon company. But that creates a real problem because the fact of the matter is we need oil between now and 2040 to prevent the price from skyrocketing. And I just don’t think we’re going to get it. I think that the aversion to hydrocarbon has become so strong, demand is proven to be pretty resilient as we now see.

It looks to me like the outlook for oil is extraordinarily bullish. And that has wonderful implications for a place like Iraq because they’re a low-cost producer. China, and South Korea, and Russia are the countries that are, sort of, most active in helping Iraq develop its oil fields, could care less about any of this stuff. And they’re just looking to make money and looking to secure their share. They just want to make sure they have access to oil resources in coming years. And Iraq has one of the lowest costs of production anywhere in the world. For the conventional fields, it’s about $5 a barrel. So, it’s very cheap. And they’ll benefit from this because they actually have the ability to increase production significantly over the next 10 or 15 years. So, they could be a huge beneficiary of what could be a rising oil price environment, and the fact that they can increase production and exports could really result in a windfall for them, which if spent wisely, that’s a big if, but if it is spent wisely, could really transform their economy.

Meb: As we kind of look at the opportunity set today, forget emerging markets, frontier markets, in general, you’re going to have this opportunity where these markets are…We just did a podcast with Dan Rasmussen talking about buying emerging markets when they’re down. And we’ve done a lot of research too that shows that buying markets when they’re down 60%, 80%, 90%, which often just coincides with low PE ratios, it’s kind of the same thing but a different name, usually is a pretty good idea. And ditto reviewing some of the opportunities in your stocks. For someone who’s been at it for 10 years, how would you counsel investors, professional as well as individual, listening to this podcast…? I know they could invest in your fund is one choice. How hard is it for someone to actually transact in Iraqi stocks today? Is it still really hard? Is it something you could do with an interactive brokers account? What’s the lay of the land?

Geoffrey: You’re being charitable even describing it as frontier because you can find the ETF for Nigeria, and you can find ADRs or GDRs for, you know, Georgian companies in London. Iraq, you’re not going to find anything like that and certainly not on the interactive brokers. They don’t even have a third-party custodian right now. This stock exchange is the custodian. So they’re still in the stone age’s actually in that regard. But that’s actually one of the most…Another, like, really bullish development is that they have this new, really capable, impressive guy running their version of the Securities Exchange Commission. And he reached out to us in January and said, you know, he wanted to have a Zoom meeting to discuss ways to develop their capital markets and to make it more attractive to foreign investors.

And this is the first time in 10 years that anyone had ever expressed any interest in that at all. I mean, we had constantly had gone to…met with the ambassadors, Iraqi ambassador to the United States. We’ve talked to people at the state department who were focused on economic development in Iraqi Treasury and, you know, even met with national security adviser, the head of the Iraq desk and the National Security Council in Trump’s administration to talk about this. Like, how do you develop their capital markets? And there was no traction. And then suddenly, this guy gets put in, a technocrat, gets put in charge of the Securities and Exchange Commission there, and we had this meeting with him, and the first thing we tell him is, “You need to work on custody right now. Even if foreigners want to invest, it’s like almost impossible because a foreign fund is going to have a difficult time investing without a third-party custodian. It’s just the way things work these days.”

In the early days of Firebird, there were no custodians, it wasn’t even a market. They were, like, buying stocks at, like, fish markets and coffeehouses. But things have changed radically since then and you just have to have, like, a reputable international bank act as a custodian for your exchange. So, we discussed that at length. And he said, “Okay, let’s talk a month later.” So, a few weeks ago, I got an email saying, “Let’s have another Zoom call.” And he started off the call telling us what he did about custody since our first meeting. And I won’t go into details, but I can say generally that he took action. He started a process that he believes will lead to Iraq having a third-party custodian. He said, “One, this won’t be fast, but could happen later this year.” And that would be a game-changing event for that market.

The RFP global funds that definitely, you know, that have exposure to Iraqi equities, but most won’t go near it just because of the custody issue. So, now, suddenly, if Iraq…If people have a bullish view on oil and may want to get exposure to a very cheap bank with a very high dividend yield that’s growing rapidly and that’s exposed to oil in a big way, in a frontier market, suddenly their screens will start showing Iraqi banks or Iraqi telecoms or Baghdad Soft Drinks as attractive opportunities. And if they want to invest, they’ll be able to invest.

So, the last 10 years or so, we’ve pretty methodically sucked up much of the free float, like, in the most attractive companies. At least from our point of view, we are the most attractive companies on the exchange today. And, you know, it’s a $10 billion market. And if foreign money comes in, like, I think if $100 million came in to the Iraqi market from foreign funds, that alone could lead to a doubling. I mean, I’m not saying that that’s going to happen with certainty. This is a guess, I could be completely wrong. I’m not promising the best, like, performance, that’s going to happen. But it wouldn’t surprise me if something like that happened because it’s just hard to find stock at this level right now. It’s so illiquid right now because nobody really wants to sell with valuations this low. The prices are going to have to go up for supply to come onto the market. And it won’t take much money to push prices up significantly.

And something else that’s happening that’s very bullish too is we never imagined doing this, and I guess some could call it style drift. We don’t think it is at all. I mean, we built it into our mandate so I guess we did imagine it in some way. But we have the ability to put 5% of NAD into unlisted companies that are doing business in Iraq. In other words, private equity. We never did it, just because we don’t have a background in it and there’s never really anything appealing. Never anything that we thought was super attractive that make us want to go in that direction. But starting a few years ago, there was the emergence of this tech scene in Iraq. And consistent with, like, a broader trend in the region, that I would say in the MENA region, generally, actually, what’s happening in technology in many of these countries is extraordinary. And most people are completely unaware of it.

But what you’re finding is that, you know, these people who were, like, past generations of Iraqis, or Nigerians, or Egyptians, or whatever, you know, whatever country you’re thinking of in that area, they were pretty much cut off from the outside world. And I think in Saudi Arabia, like, when the second king they had wanted to put in…The TVs were illegal. The religious authorities said that, you know, in, like 1963, maybe, or ’64, so the TVs were illegal at that point. And the king had this, like, radical decree that you could have televisions. And that created rioting in the streets in Saudi Arabia. Right? There were, like, real riots and it was like a big problem, just because they introduced television. So, like, that part of the world was really cut off from everything else that was going on in the rest of the world, and particularly what was going on in the West.

Now, I think 5% of the population had a smartphone in Iraq in 2010. And that’s 70% of the population in Iraq has a smartphone. Very few people had Internet connections 10 years ago. A significant, like, majority of the country has an Internet connection now. We’re just upgrading to 5G, they just upgraded to 4G, but that’s a big deal for them. So, you have this whole, like, group of 20-somethings, like the millennials in Iraq, who don’t have the same background, and experiences, and prejudices that their parents and grandparents had. So, like, instead of going to the mosque on the weekend, they’re, like, going to an incubator and trying to, like, build their fledgling…they have, like, an idea for a tech company and they’re trying to actually write the code for whatever it is they’re doing.

And, you know, so you’ve seen these incubators pop up and this whole new class of tech entrepreneurs that are creating essentially clones of what’s worked in the West, in the developed world. There’s never going to be an Intel in Iraq, or anything like that. That requires significant manufacturing ability. But there’s a company that’s a major e-commerce company…I can’t say it’s a major e-commerce company, but it’s “the” e-commerce company. It’s still very small but it’s trying to become the equivalent of Amazon, you know, Web Services with Amazon e-commerce in Iraq. There are companies trying to become the Zillow or Redfin of Iraq, companies trying to become the micro blogging social media sites of Iraq.

Meb: What is the scene for the region, in general, as far as investing? Are most of these companies…Do they have broad exposure to just Iraq? Is it to the region, in general? Do they have revenue exposure ever to, say, Europe, America, Asia?

Geoffrey: Just Iraq. But I mean, that’s the thing is that Iraq is so far below its potential. I mean, just to put it in perspective, in the early ’60s, Iraq’s GDP per capita was about $500. In the late ’70s, ’79, Saddam came into power, it was $3,500. And Iraq had the most developed industrial infrastructure in the Middle East, had the best system of higher education in the Middle East. And its economy, in terms of GDP per capita at least, was on par with South Korea and Malaysia. Saddam destroyed that over…It was like one of the single greatest episodes of wealth destruction in modern history outside of, like, Myanmar and North Korea. I would say Saddam’s Iraq ranks third. From ’79 to 2003, it was just a series of disastrous decisions and sanctions. And by the time he’s overthrown, GDP per capita is back to $500 in 2003. So, it’s the same level in 2003 that it was at in 1963, 40 years earlier. Now, you know, it’s back to, like, say, $5,500, $6,000, but it should be more like $15,000. And in 5 or 10 years, more like $20,000.

They don’t really have to sell into other markets. Potential for growth in Iraq itself is extraordinary. And a country going from not having a banking system to having a banking system means that, like, you know, banks tend toward oligopoly, right? It tends to be, like, three or four banks in every country that dominate. And for whatever reason, that’s just the way banking seems to work. And that’s happening in Iraq. There are two or three private banks that have the best chance of becoming the dominant banks in the country. And a decade from now…right now, 15% of the population uses the banking system. But in 10 years, 60% or 70% are using the banking system. That kind of growth is like once in a lifetime. It’s once…not even, it happens once, period. You go from unbanked to banked once, by definition. And in Russia, what you saw when that happened…something very similar happened in Russia in the ’90s. And there were banks that had, you know, balance sheets of $300 million in the early ’90s that 10, 15 years later had $25 billion balance sheets. So something like that similar, you know, it’s possible rather in Iraq over the next decade.

The same is true with the tech sector. So, the e-commerce companies and the web portals that are doing, you know, real estate, the food delivery services, the, sort of, last-mile logistics company that’s very much tech-based, they’re going to go from…If e-commerce takes off, it’s going to be a country that didn’t have e-commerce to suddenly having e-commerce. And it’s a $30 billion market right now. And currently, only a few million of it is on e-commerce. You know, 10% of that is e-commerce in 10 years. This one company will have $3 billion in sales. And that assumes that there’s no growth in the overall size of that market. So, if it really takes off, they have 50% of the market. It could be $15 billion in sales. This is a company that has, right now, the company that we invested in, you know, a few million. And that’s the beauty of this is they don’t really need to look elsewhere for growth. They can get all the growth they need and more in their own country.

Meb: What’s the, sort of, boots on the ground Iraqi individual institutional investor appetite for stocks in Iraq? Is it like no one is an investor, or is it growing, or is it established sovereign?

Geoffrey: There’s not much of an equity culture in the country yet. It’s starting to change a bit. But historically, they’ve gone to…You know, what’s worked for them, everyone just invests in real estate. It’s like, they own land and real estate. It’s worked for centuries and so why change a good thing? But we’ve seen more interest in the region, especially in the last year or so, we’ve been getting calls from local funds that are in the MENA region that are starting to explore Iraq. And, you know, our broker is seeing more interest from locals, especially, again, from the younger…The same group that in the United States would be on Reddit, using Robinhood, and speculating on GameStop or something is starting to take an interest in stocks in Iraq, not to the same, sort of, frenzy and extent, but it’s happening.

So, again, there’s this, sort of, generational shifts in attitude that we see taking place, where the older generations feel like the stock market is just a casino, it’s gambling, you never make money, to just put your money in land, God isn’t making any more of it, etc., etc., to the younger generation wants to just own stocks and be involved in tech in one way or another. So that’s like a new tailwind that we haven’t seen before. And we hope that it develops and gets stronger over time. It could be another encouraging thing about the market right now.

Meb: I imagine that we could do an entire second episode just on stories of investing in Iraqi companies. Is there any one particular memorable investment that stands out over the past 10 years?

Geoffrey: Here’s what I can tell you, I’ll tell you about my first trip there. The period had just ended where things were so bad. Planes that landed at Baghdad International Airport had to do these corkscrew landings where you just don’t land. You actually have to start, like, going down in a corkscrew pattern in circles so that you’re a harder target to hit surface to air missiles. So, like, that period had just ended and planes were allowed to land normally. And so that’s when I came in. And intellectually, I realized there was a huge difference between what was actually happening in the country and what was reported. Narratives are powerful things. For most people, narrative is reality. That’s all they know. And even though I had been exposed to data that showed me the narrative was flawed in many ways, the narrative still had a very powerful influence on my psychology when I was approaching Baghdad.

I got real nervous and I was, like, expecting it to be this, like, wild, chaotic place, which shocked me as you get to land and, like, get out of the plane, and go through the airport, and get into a taxi and drive to your hotel. And it’s completely normal. There are definitely signs, like, you can see parts of it maybe resemble Detroit. Like, you see, like, certain city blocks that are, like, leveled to the ground. But then you also see parts that are affluent. And you see, like, women window shopping, pushing their kids around in strollers, like, carrying, like, expensive handbags. And I never forget this one scene where we’re driving to the airport, and they had grass tennis courts. Who has grass tennis courts, like, regular public tennis courts? It’s not even, like, a hard court. It was like a lawn tennis court like in Wimbledon. And there’s these two guys playing recreational tennis in the middle of the afternoon. And that was about, like, as far away from what I was imagining.

Meb: You just hopped out and said, “Canadian doubles, anyone?”

Geoffrey: Yeah, exactly. I was shocked by how normal it seemed. But what I realized was that it had a lot of the chaos of normal, emerging frontier markets. It was tons of traffic. It was very loud. It wasn’t particularly clean. But there weren’t bullets flying everywhere. There weren’t bombs going off. It was, you know, just functional and people were…It wasn’t like people were so scared they weren’t going outside. There were people everywhere. And it looked like just the place was booming economically. It was unbelievable. And I just couldn’t understand, like, all this is happening, why aren’t there any stories about this? Why isn’t, like, mainstream media writing about this? It was just so eye-opening to me. Like, long before anyone ever said the word “fake news,” we were writing in our newsletters, like, “Wow, the mainstream media is, like, just utterly unreliable.” And their coverage of Iraq was so clearly driven by a desire to…Like, they realized what will sell.

The only thing people are interested about when it comes to Iraq is tragedy, and bombs blasting, and how us going to war there was a disaster. We’re never going to tell a good story because if we do, it’ll confuse our readers. And if you confuse your readers, that just go somewhere else. So, we’re going to stick to this narrative, come with me. And they do. And if you want to find a negative story in Iraq, you’re going to find it. Pretty much, you’ll find it anywhere. If you want to write about something negative, there’s always something horrible happening somewhere. And in Iraq, there happens to be more of it happening. So, there’s plenty of stuff to write about. But there’s a juxtaposition that they just ignore of, yes, it’s dangerous, there are terrible things happening, but at the same time, it’s gotten a lot better. And there are people, sort of, living normal lives and doing normal things that you wouldn’t expect.

So, that was my first day there. It was just the shock of seeing that and really experiencing the country as somewhat normal. But then I had this wake-up call. So, I was going visit Baghdad Soft Drinks, which requires you to drive through a pretty dangerous part of Baghdad. And at the time…now, you don’t need security. Then, we were strongly advised to get security. And security means it’s like a bunch of South African mercenaries working for a U.S. company. And they have their Kalashnikovs and their body armor and they pick you up in, like, a 1988 Nissan Sentra that’s reinforced to handle an IED and all kinds of blasts and it’s bulletproof. It looks like a regular car. You don’t want to drive around in, like, black SUV. So you drive around in, like, this nondescript piece of crap that just could survive a bomb blast. And you’re in a convoy of, like, three cars. It’s you in your car with a driver and the guy sitting in the front passenger seat with his AK47, another car behind you, and then a scout car, like, a mile ahead, just making sure everything’s okay.

And we’re going to meet management of Baghdad Soft Drinks for the first time actually. And I’m with one of my analysts, this Iraqi woman, she was an ex-pat. So it was her first time back to Baghdad in a while. And we’re sitting in the back of this car, and the scout car in front was like, “I don’t know, we see some weird…something weird is going on up here. I think we might want to turn around.” And then the next thing you know, we just heard this giant explosion. And it was, like, maybe a quarter or half a mile in front of us. Just this, like, massive car bomb went off. And my analyst understandably threw up. I was like, “Oh, my God.” They’re like, “What do you want to do?” We can still get you there. Like, our job is to get you there. So do you want us to get you there or do you want to go back to the hotel?” Like, “Let’s go back to the hotel. We can meet these guys tomorrow.” You know, they turned around the car. We, like, sped back.

And as we’re speeding back to the hotel, like, it’s just complete and total chaos. And, like, that’s what I realized Iraq was at that time, that for 23 hours and 45 minutes, every day was normal. And for 15 minutes, there was, like, chaos, something happened. It wasn’t a bomb blast, you know, but there was something that happened that, sort of, destabilized things for 15 minutes. And then things normalized again. But when you see it up close, it’s terrifying and it’s really jarring. But the interesting thing is, it never happened to me again. And I’ve been going there for over a decade and it’s never happened again. I’ve never seen anything remotely like that. And not only that, but all the people I’ve met in my time in Iraq, I’ve never met anyone who’s been injured or killed in an event like that. That’s not, you know, your normal experience when you go for a company meeting.

Meb: And I assume you’ve been back many times since. Have you noticed a difference over the past 10 years?

Geoffrey: Oh, completely. I mean, a car bomb went off a couple of months ago and it was, like, a shock because it hadn’t happened in years. And managers of these companies take you to their social clubs and, you know, you’re outside and it’s like these outdoor, like, dining area with music blasting, and they’re serving Johnnie Walker, and drinking beer, and people are getting pretty hammered, actually.

Meb: Sign me up for the next investor tour. I’ll join you.

Geoffrey: It’s amazing. And, like, you have, like, your belly dancers. And it’s quite the scene. People are, like, smoking their hookahs. And I’ll tell you what, the places that tend to be the most chaotic or most unstable tend to have the best parties because the people really need to let off steam. And, man, the nightlife there is just pretty extraordinary.

Meb: You could certainly point to places like Columbia that turn the corner and economic booms have happened. We could be, who knows, five years away from the Lonely Planet crowd, Conde Nast saying this is the next hot travel destination. We’ll see. But…

Geoffrey: Before COVID, they actually started to be people like that, like, really adventurous people going to Baghdad and, like, posting travel blogs about it. It was pretty cool. Anyway, yeah. So it’s night and day from what it was when I first went there.

Meb: Geoff, we should do this again. This has been a great deep dive. I think a lot about emerging markets, frontier markets, whatever comes after frontier. And to me, it’s one of the most fascinating, interesting, and opportunistic spots in the whole world. If people want to get information on you, your fund, the opportunities, are you guys accredited only? How does it work?

Geoffrey: Yeah, we do accredited only and we have a basic website. You can contact us through the website if you want, euph.com.

Meb: Perfect. And we’ll add that link to the show notes, as well as your Twitter handle. Geoff, it’s been a blast. Thanks so much for joining us today.

Geoffrey: Likewise. Thank you for having me. I had a great time.

Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at feedback@themebfabershow.com. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.

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