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  • Mark Zanders

Why invest in Emerging Markets?

"I skate to where the puck will be, not where it has been" - Wayne Gretzky

Similarly, we feel this analogy applies very well as we consider emerging markets, as

they may offer the combination of strong growth and under discovered opportunities

providing larger upside than developed markets, making them an investment

opportunity well worth considering. 


Our timing is fortuitous here, as just one example of the potential in emerging markets,

David Hunt, the CEO of $1T+ asset manager PGIM was featured on Bloomberg TV

stating that while they are currently over weighted in U.S. assets for the short-term, they

are concurrently invested in emerging markets, and in fact if he was looking at the next

5-10 years, growth opportunities will come predominantly from the latter (interview on Bloomberg Markets; The Close, 18 October 2019)


With that said, there is no free lunch in investing, and we must thus weigh some of the

relevant benefits and risks associated with emerging markets. Our prior article covered

the risks in great detail, but as a quick summary of some key points:


  • Emerging markets often require substantial external investment in both physical and human capital

  • Emerging markets are often dominated by one major sector, for example energy or mining, rather than being diversified, and thus may be vulnerable to broader market trends outside of their control

  • While not exclusive to emerging markets, there can be a level of political & social uncertainty that creates risk

  • Similarly, not exclusive to emerging markets, but another concern is the political and structure reforms to fully unlock growth potential

  • Financial metrics such as fiscal & monetary policy, debt, currency competitiveness, and liquidity may also be concerns

  • Liquidity: Perhaps best viewed as the flip side of the information asymmetry benefit accruing to emerging markets, the relative lack of interest (in dollar terms rather than any judgment on underlying value) often means a lack of liquidity compared to more developed markets. For public equities, particularly those which do not have an ADR traded on a more liquid exchange, this can mean having  a high bid-ask spread when trying to enter or exit a position; for private investments, this may mean being able to enter a position on advantageous terms due to the relative scarcity of capital, but perhaps lacking the M&A or IPO exit opportunities more available in larger markets

  • Government: This topic could merit its own lengthy article, but a few high-level points worth considering include, but by no means are limited to:  

• Ability of foreign investors to own EM assets, whether IP, (majority) ownership in a business, or land

• Taxation and any repatriation on profits

• The potential for forced partnerships as a condition of market entry


Of course, we would not be here if there were not also many positive factors, which we

believe make emerging markets worthy of consideration at the very least, if not actual

investment when appropriate. 


Growth rates: In line with Mr. Gretzky's  and Mr. Hunt's quotes in our overview,

emerging markets appear to be "where the puck will be", and thus a very positive factor

in favor of emerging markets that is really at the heart of our analysis, as we want to be

where the best opportunities are and in areas that offer outsized growth potential. 


The most recent IMF data further validates this, with emerging market growth at 4.5%

(2018) and forecasted growth of 4.1% and 4.7%, compared to a world growth rate of

3.8% and forecasted growth of 3.2% and 3.5%, and advanced economies growth rate of

2.2% and forecasted growth of 1.9% and 1.7%. Naturally, emerging countries can have

faster growth as they catch up with more developed countries, but with their growth

slowing as they develop (as an analogy, a company with $1MM in revenue needs an

incremental $1MM to double revenue, but one with $5MM needs an incremental $5MM

to accomplish the same) Countries can rapidly transition from the "next big thing" to

being firmly established as leading economies, and the IMF data shows that emerging

markets have been a major driver of overall world economic growth given that advanced

economies have lagged overall growth. 


https://www.imf.org/en/Publications/WEO/Issues/2019/07/18/WEOupdateJuly2019  


Diversification: One underrated aspect of emerging markets is the diversification

opportunity in a portfolio context, especially for readers in more developed countries.

These readers typically have both their human capital (education, jobs) and financial

capital (investment portfolios, homes, etc.) heavily based in their own country, allowing

investments in emerging markets to provide an attractive diversification opportunity.

Swedrow & Kizer have found a correlation between 0.22-0.29 between emerging

markets and the S&P, and this lack of correlation can help to mitigate risk, as the

different markets will often have different risk factors and growth rates -in fact, they

recommend investors should consider allocating at least 30% to international (both

emerging and developed) markets to better mitigate economic and political risks within the broader portfolio . MSCI estimates that emerging markets currently comprise

approximately 10% of world equity value, creating an interesting opportunity where the

markets are very investable yet with room to grow.


Information asymmetry: As a direct follow up to the MSCI example and similar to

small-cap and micro-cap stocks compared to mid-cap and large-cap stocks, emerging

markets are very investable yet also typically not covered by Wall Street to the depths

that emerging markets are, creating an opportunity for the savvy investor who is able to

appropriately analyze these markets. Another analogy may be the Efficient Markets

Hypothesis (https://www.investopedia.com/articles/basics/04/022004.asp), where large

markets like the S&P or stocks like Apple are analyzed in great depth and approach

strong-form efficiency with fewer arbitrage opportunities, but an emerging market index

or stock not being analyzed much if at all and having signification inefficiency (& thus

higher potential profits even after adjusting for risk). This admittedly will likely take more

upfront work to both become familiar with new markets and gain the right investment

approach for a specific market (I highly recommend Jim Rogers' works as excellent yet

easy-to-read firsthand accounts of an American investor who saw the growth

opportunities abroad and was able to capitalize), but can be very lucrative by finding

opportunities that others do not yet see in markets poised for strong growth. 


Broader macroeconomic and social trends: Closely related to the GDP growth rates,

emerging markets tend to have favorable population growth rates. Consumer demand

makes up the largest driver of GDP growth in both developed & emerging economies,

and strong growth rates in emerging markets offer the potential for a larger workforce

and consumer base that can drive outsized GDP growth. From a brief look at the World

Bank data (https://data.worldbank.org/indicator/sp.pop.grow), the world has a

cumulative 1.1% population growth, but with OECD nations, North America, and Asia

Pacific all below 1% (with some regions facing negative growth), and growth instead

coming from Africa, highly indebted countries, and least developed (UN definition)

regions, all with growth over 2%. 


In addition to the strong population and GDP growth trends, another major potential

value driver is natural resources. For example, Africa has over 30% of the world's

natural mineral resources, six of the world's fastest growing economies, and major

holdings of oil/natural gas, cotton, gold, and copper. While there is the potential concern

about concentrated economies, especially with 57% of current exports from

hydrocarbons, the sheer size of the proven oil reserves combined with great

demographic trends makes Africa an area of high interest, and one we will examine in

more detail in our next article.  (https://www.aljazeera.com/indepth/interactive/2016/10/mapping-africa-natural-

resources-161020075811145.html)


In summary, we believe emerging markets provide a compelling opportunity for

investors to at least consider as part of their portfolios. While there are certainly risks

and concerns perhaps more prevalent than in markets like the S&P 500 or FTSE,


emerging markets offer a blend of strong GDP and population growth, rich natural

resources, and information asymmetry that can add value to a developed market

investor's portfolio, not just from a return perspective but also with reduced risk via

diversification,  especially once the investor becomes more knowledgeable about the

emerging market.


The views in this Global Market Outlook report are subject to change at any time based upon market or other conditions and are current as of October 21, 2019. While all material is deemed to be reliable, accuracy and completeness cannot be guaranteed.


Special source/reference credit to the CFA Institute's "Capital Market Expectations"

"Managing Investment Portfolios: A Dynamic Process", and "Asset Allocation and

Related Decisions in Portfolio Management" along with :Larry Swedrow and Jared

Kizer's "The Only Guide to Alternative investments You'll Ever Need" (Chapter 4) for

broad reference points within, and which I strongly recommend for a more detailed

analysis than this overview; analysis author's own.


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