The Emerging Markets Handbook. Pran Tiku
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Dr. Mark Mobius, is still actively traded today. In the early days, this was one of the few emerging market opportunities for ordinary investors.
In 1999, the first index of emerging markets (later acquired by Standard & Poor’s) was developed. As investing in these markets became more profitable, investors became interested – slowly at first, but with greater enthusiasm as years progressed. Firms such as Morgan Stanley and Goldman Sachs began using their vast market influence to secure investments for new funds dedicated to emerging markets, and Goldman Sachs garnered further interest by publishing their well-known papers: ‘Dreaming With BRICs’ in 1999 and ‘Building Better Global Economic BRICs’ in 2001.
This catchy acronym, BRIC, referred to four countries: Brazil, Russia, India and China. The overall theory was that these countries represented above average opportunities based on demographics, growing consumption, technological innovation and rising living standards. The timing for emerging market investing and the idea of BRICs was perfect as the recession and technology burst of 2000 had just ended.
Investors’ animal spirits were rising again. China, India and Brazil in particular were in the news for spectacular growth that exceeded that of the US and Europe by two-to-three times. At the time, Japan was still stumbling through its decades-long recession. Goldman Sachs created a special BRIC fund and BRIC50 fund, both of which became major hits with investors. The influx of capital to all four BRIC countries multiplied.
The great recession
This wave of economic growth and the stock market and real estate boom continued around most of the world (including the emerging countries) until late 2007. It all came crashing down in late 2008 and early 2009. The crash and the great recession that followed destroyed a large slice of wealth created during the boom years from 2003 to 2007. This recession created large tidal waves beyond the shores of America and Europe and in fact it hit the emerging markets even harder. Even though many of these emerging countries did not suffer economically or even record a recession, their stock markets lost substantial value.
However, stock markets also recovered faster in emerging markets. As an example, the stock markets in Brazil, India and China lost 41%, 52% and 65% respectively in 2008, and all of them gained over 80% in 2009. Russia was an outlier with a loss of 67% in 2008 and a gain of 121% in 2009.
Many people who had theorised that the emerging markets would continue to march to their own beat, unaffected by the developed markets, had egg on their faces. Despite good economic conditions and no recession, the shadow of the sluggish economies of the West (particularly in the US) loomed large over emerging markets. The theory of lack of correlation between developed world and emerging world (particularly in relation to stock markets), came under attack by investors.
If we move beyond the short-term performance of the stock markets, particularly at the time of global financial stress, there is a strong long-term case to be made for growth and opportunity in emerging markets. Long-term fundamentals of growth are in play for most of these countries – even though these will not be consistently reflected in the stock market gains.
The exhibit below presents a timeline of significant events in the recent history of emerging markets.
Exhibit – Timeline
How institutions perceive emerging markets
The semantic arguments for what constitutes an emerging market are not likely to end anytime soon. While investors should be mindful of this, it is far more beneficial to look at emerging markets the way that large institutions perceive them.
The following table covers almost every nation that is considered to fall into the category of emerging markets and shows which institutions regard these countries as emerging markets. A shaded cell indicates that the institution given at the column head regards the country in that row as an emerging market. As you can see, there is still some disagreement, but at least it provides investors with something approaching a concrete definition.
Exhibit – How financial institutions define emerging markets
Criteria for selection of the 18 markets
As of 2013 there were 193 countries recognized as members of the United Nations. At any point there are likely to be countries that represent a better case for investment than the rest. What criteria should define countries that can be considered to be ranked above average in investment terms?
The starting point for choosing the markets studied in this book was to take a framework of recognised market indexes such as MSCI Emerging Market Index. This index encompasses more countries than other indexes such as the Financial Times, S&P, and other lesser-known indexes. This index is populated by large, mid-sized and small nations.
A note on the MSCI Emerging Markets Index
The MSCI Emerging Markets Indices cover over 2700 securities in 21 markets that are currently classified as EM countries. The EM equity universe spans large, mid and small cap securities and can be segmented across styles and sectors. MSCI regularly reviews the market classification of all countries included (or under consideration for inclusion) in its global equity universe based on extensive discussions with the investment community. Using the MSCI Market Classification Framework, MSCI examines each country’s economic development, size, liquidity and market accessibility in order to be classified in a given investment universe. Each June, MSCI communicates its conclusions on the list of countries under review and announces the new list of countries, if any, under review for potential market reclassification in the upcoming cycle.
Although many of the countries in the MSCI Index will be covered in detail, some were excluded based on concerns over their geopolitical situation, serious internal conflicts, small market, lack of transparency, or lack of access to investors.
For example, Saudi Arabia and Morocco were excluded because of their small market size and lack of reasonable access to foreign investors. Other countries that appear in some indexes but which have been excluded are: Argentina, Israel, Nigeria, Egypt, Pakistan, Vietnam and Myanmar, among others. In these cases these markets were excluded because of concerns about access or size, or political challenges. Broadly, all countries that are sometimes considered to be frontier markets were excluded (which includes some of the countries listed in the charts above).
Early-stage markets
In the first stage of development, investors discover the emerging market opportunity – be it a specific country, theme or sector. This stage is liquidity-driven and money flows are strong. In many cases, there is much promise and hype that in the end remains unfulfilled.
For example, from 2009 to 2010 many companies moved their manufacturing away from China to Vietnam based on its competitive wages. But Vietnam’s weak institutions, lack of skilled workers and crumbling infrastructure meant most shuffled their manufacturing back to China in the end.
There is potential for big profits investing in early-stage markets, but the timing for entry and exit must be impeccable. We will not be studying such early-phase markets in this book.
Mature-stage markets
Mature-stage markets are evaluated based on financial criteria such as:
Earnings and valuation
Cash flows
Return on investment
Debt levels
Longer-term