What do China, Poland, Saudi Arabia and Turkey have in common? That’s not a joke, it’s a serious consideration for anyone who has money tracking MSCI’s Emerging Markets Index.
Investment market taxonomies like developed, emerging and frontier are stupid by design. Risk and reward is lopsided whenever the category is too narrow — the R in Brics has given Jim O’Neill’s remaining followers a tricky couple of years, for example — whereas a broad selection guarantees mediocrity. And while guaranteed mediocrity gives fund managers an easy benchmark to (fail to) beat, it’s clumsy to the point of uselessness when trying to express a view.
Here’s a fun report from Actis, an emerging markets-focused infrastructure investor, that proposes a better way.
Our “relentless march in liquid markets towards indexation” has “obliterated incentives to differentiate,” write Actis Macro Forum editor-in-chief Ewen Cameron Watt and investment principal Joonas Taras. “Homogeneity has suffocated opportunity, with a handful of countries representing over 80 per cent of most indices”.
Broad labels have also encouraged casual stereotyping:
Across 80-plus countries, wide differences of opportunity are obvious. Yet common and lazy investment and media shorthand ignores this point. The weakest countries frequently dominate the dialogue. The case of Sri Lanka — a wonderful country with woeful macroeconomics — overwhelms the attractions of India just to the north in the mantra that EM is too risky, too corrupt and unable to deliver returns.
Here’s what they suggest instead:
The Global Influencers — the US, China and Japan — are important to trade, so are price fixers and the suppliers rather than receivers of investment. These are the nations that “will continue to drive risks, rather than be dictated to.”
Big Middles — Brazil, India, Mexico, etc — are big and stable G20 countries with significant foreign reserves and domestic savings institutions. Big Middles “are natural destinations [for investment] provided inappropriate policy does not dilute investment opportunity.” (Mainstream Europe and the UK would probably be included in the category; their absence is because they’re not within the Actis investment universe.)
Supply Chain Heroes — Malaysia, Philippines, Thailand, etc — are places that attract significant foreign direct investment beyond natural resources, but have volatile currencies and funky monetary policies so can’t entirely be trusted. Some will succeed long-term but generally, their attractiveness will wax and wane with the global economic cycle.
Stable But Small — Bulgaria, Romania, Uruguay, etc — are like Big Middles but are just too wee to be price and policy setters. What matters most is what’s going on with their neighbours.
Natural Resource Winners — Chile, Colombia, South Africa, etc — is the self-explanatory basket of commodities-reliant economies. Energy transition makes them long-term works in progress.
Structurally Challenged — Egypt, Ghana, Kenya, etc — are places where “financial and/or macroeconomic volatility seem to be a way of life”. Turkey is in this category because of its unorthodox leadership, even though it’s problems with tax collection and debt repayments are atypical to the group. There be dragons, basically.
The idea here is not replace DM and EM in the investment lexicon. Neither is it to tell you which places are best to invest. It’s just a clearer lens through which to look at the world. “This is not a framework for rejection or selection, rather a series of working titles to allow effective investment and portfolio management,” Actis says. “[U]nderstanding and differentiating the risks being taken and pricing thereof is vital. That above all is the point of this exercise.”
The full report’s available for download here.
Further reading:
Investors should be cautious of simplistic indices (FT)
Source: Economy - ft.com
