Investing in emerging markets has become de rigeur for equity investors in recent years. If you like stocks, goes the argument, how could you not like stocks in countries where growth is fastest? It’s probably fair to say that investing today with the objective of avoiding emerging markets is a more controversial approach than including them.
No doubt GDP growth and other measures of economic output are favorable in the BRIC (Brazil, Russia, India and China) countries than in the developed world. Frontier markets (for those who find mere Emerging Markets boring) are more loosely defined but include Argentina, Bangladesh and Croatia. Of course not every country gets promoted. The implicit promise is that an Emerging country will eventually emerge into the warm sunshine of the developed world. Sadly for Greece, they were recently relegated from developed and back to emerging by MSCI.
The faster growth enjoyed by these more dynamic economies doesn’t necessarily translate into superior returns for investors. China’s growth has moderated in recent quarters, but the central planners are still targeting 7% annual increases in GDP, around three times the sustainable rate in the U.S. However, investors in the iShares FTSE China 25 Index Fund (FXI) have since the end of 2007 endured an annualized return of -6.4% whereas over the same period the S&P 500 has returned +4.2%. The mechanism that translates increased GDP into investor profits isn’t that reliable in China. And why should this be surprising? Public policy objectives regard both real and intellectual property rights as subservient to government policy. Fair treatment of investors is a fairly low priority. John Paulson lost an estimated $500 million in his hedge funds through an investment in Sino Forest, a Chinese lumber company that on closer inspection appeared to be harvesting trees on property it did not own. Running a Ponzi scheme such as this one doesn’t draw the same ire of securities regulators that we see in the U.S.
Several years ago on a trip to India I found myself in a conversation with a senior member of the Securities and Exchange Board of India (SEBI), India’s securities regulator. “Approximately how many insider trading cases are prosecuting annually in India?” I enquired of a man closely involved in maintaining the integrity of India’s capital markets. “Oh none – there is no insider trading in India.” was his breezy response.
Intrepid buyers of securities in countries where substantial segments of the population struggle with basic issues of human survival should leave their pre-conceived ideas of fair markets behind.
That doesn’t mean you shouldn’t invest in emerging markets – that is, after all, where the growth is. But it’s far more sensible to do so through large multi-national corporations who are infinitely more able to assess each opportunity, control their risk and wind up with a fair return. P&G (PG) is heavily focused on growing its already substantial sales in developing markets (currently $33-34 billion). Mondelez (MDLZ) reports that 40% of its sales are in emerging markets. IBM (IBM) is targeting 30% of its sales in Growth markets by 2015. We are invested in these companies and others like them, because their brands of products and services continue to have globally attractive growth prospects.
Investors can obtain exposure to the faster growth of the developing world through companies whose brands are sought throughout the world. In addition, they’ll be protected by U.S. standards of governance and accounting. It turns out that you don’t need to go abroad to invest there. Although we don’t invest directly in emerging markets, we profit from their growth through the expertise of global companies like these and others that do business there. Why do it any other way?