"Market gurus" in Investment Banking are in the business of marketing like everyone else, so much of what they do is more to do with presentation than reality. I have been forcibly reminded of this in recent weeks as yet another "emerging markets" crisis has unfolded on the currency and stock exchanges of the planet.
In a way "Emerging Markets" is itself more a presentational than real idea, because the only thing that the so-called "emerging markets" really have in common is that they are poorer than the so-called "developed markets". About three quarters of the worlds population lives in "emerging markets", and some are growing and some are collapsing. Hence the need for an overpaid "market guru" to try to make some kind of sense of the huge pile of data that comes from 75% of the world. Jim O'Neill, an economist with Goldman Sachs, is usually credited with coining the acronym "BRIC", standing for Brazil, Russia, India, China. Sometimes South Africa is added- BRICS. But BRIC or BRICS, the idea is that investors should allocate money to these markets en bloc as a separate asset class. From the point of view of investment, the idea is that these large, but relatively primitive economies should offer higher growth and therefore better investment returns.
In practice the returns from investing in BRIC states are actually rather questionable. The levels of corruption in India or Russia, or the role of the state in Russia or China or the social unrest in Brazil or Russia implies a higher risk premium. In other words you get a better return, not because of structural growth, but because you are exposing your capital to a higher risk- you SHOULD be getting a better return. In practice, when blending returns over a reasonable time frame, the BRIC states as a whole have not generally outperformed the developed markets. So for higher risk, investors get lower returns. This is the fundamental problem of "emerging markets"- in many cases they are not "emerging" at all, they are often -at best- stagnant. The exception has been China, but as a foreign investor your position is compromised and there is no level playing field for investors in the domestic market- nevertheless the Hong Kong and Shanghai exchanges have provided far better returns than- say- MICEX in Russia. In India, the bureaucracy of the system strangles entrepreneurship and inward investors are at an even bigger disadvantage than they are in China or Russia.
So, as investors have recognised that BRIC states are not the easy ride that was hoped, O'Neill came up with yet another easy acronym: MINT. This one is Mexico, Indonesia, Nigeria and Turkey. As with BRIC, these are economies that are roughly the same sort of size, but otherwise fundamentally uncorrelated. Yet while it took maybe a decade for the market to see that BRICs were not that fundamentally attractive, it has taken less than a year to see that MINT states are significantly weaker than the hype implies. The meltdown- political and economic- of Turkey, which happens every decade or so has returned to haunt investors even more dramatically this time. As Turkey faces yet another collapse is it not time to ask why global finance still insists on a commodity approach to "emerging markets" investment?
The BRICS and MINT hype is built upon the fact that these markets have the capacity to take large inward investment flows- whether or not they do this efficiently or generate adequate returns for investors is not the point- the critical thing is that they have the capacity for investment firms to place big bets. From the point of view of "market guru" marketing, there is no point in selling a brilliant company or indeed country, if it is too small for large capital flows to get in. In other words, the major market players know that the "emerging markets" that they sell are not the best investment returns, but merely the best returns that large capital flows can get into.
In fact, as my use of inverted commas around the term "emerging markets" may have already hinted to you, I do not believe in the concept of "emerging markets" at all- that too is more marketing bullspiel. If one draws an arbitrary line of GNP per capita or industrial development or education level, or any one of a dozen or so data matrices, all you are really doing is measuring relative poverty. If you are an optimist, then poorer people get richer, as they have in China over the past forty years, if you are a historian you can see that this is not always true- as the peoples of Afghanistan, Egypt and Iran can tell you.
So, to invest in poor countries or not?
Firstly it is important not to listen to the fashion led agendas of market gurus. From Jim O'Neill to Mark Mobius, all have their own agenda, which is most definitely not the same as yours. In the end it boils down, not to collective, commodity based, mediocre investment, but to individual economies, sectors and entrepreneurs. Some countries, such as Estonia or Singapore, have the social and scientific capital to make a leap from backwardness to developed world life-styles in a single generation. Other states, such as India or Russia have a huge economic and political inertia that is resistant to that kind of large scale change. Yet even in these slow states it is possible to find entrepreneurs. However in such closed systems, it is very difficult to find such good investments in open markets. So if you are taking the market risk of India, then it would make more sense to invest in private equity than in the relatively thin public markets- the risk between the public and private markets is not that distinct, as it would be where stock exchanges have much higher levels of liquidity relative to GDP. The market gurus won't tell you this, because they have an interest in you buying their funds or the stocks that they already own. Private Equity investments are many orders of magnitude smaller than the stuff they are trying to sell to you.
Of course what is true for emerging markets is true across all of the investment markets- there is no deus ex machina, there are only hucksters of various types attempting to part you from your money. This is the point that Nassim Nicholas Taleb has made repeatedly in his various books, including his latest, Antifragile. Investments in packaged products, such as funds, do not- and in fact probably cannot- out perform the general market over time. The fallibility of the human in charge will sooner or later lead to under performance.
It is now five years since I left my career in the City of London. I worked in JP Morgan, Robert Fleming, UBS, and Lazard over the course of nearly twenty years. I advised several other institutions, from Bank Vontobel to UniCredit. All of these institutions shared the same flawed investment methodology- and this broken risk model is why the financial system will go through yet more turbulence in the coming years. Although dressed up in quantitive models, in the end the flaw in the investment markets is precisely the same hucksterism that we see more obviously in "emerging markets"- it is a human failing, not a structural failing, that is gnawing away at the foundations of global capital.
For me that insight has led me to Estonia and to begin entrepreneurial investment, rather than the market investment that I used to cover. It is a far slower and more intricate process than the preparation of investment strategy reports that I used to do, yet in the end I believe that I can create more value and more wealth for myself and for others than I did as part of the questionable social utility of global investment banking. That remains to be seen, of course, but it is certainly an interesting experiment.
In a way "Emerging Markets" is itself more a presentational than real idea, because the only thing that the so-called "emerging markets" really have in common is that they are poorer than the so-called "developed markets". About three quarters of the worlds population lives in "emerging markets", and some are growing and some are collapsing. Hence the need for an overpaid "market guru" to try to make some kind of sense of the huge pile of data that comes from 75% of the world. Jim O'Neill, an economist with Goldman Sachs, is usually credited with coining the acronym "BRIC", standing for Brazil, Russia, India, China. Sometimes South Africa is added- BRICS. But BRIC or BRICS, the idea is that investors should allocate money to these markets en bloc as a separate asset class. From the point of view of investment, the idea is that these large, but relatively primitive economies should offer higher growth and therefore better investment returns.
In practice the returns from investing in BRIC states are actually rather questionable. The levels of corruption in India or Russia, or the role of the state in Russia or China or the social unrest in Brazil or Russia implies a higher risk premium. In other words you get a better return, not because of structural growth, but because you are exposing your capital to a higher risk- you SHOULD be getting a better return. In practice, when blending returns over a reasonable time frame, the BRIC states as a whole have not generally outperformed the developed markets. So for higher risk, investors get lower returns. This is the fundamental problem of "emerging markets"- in many cases they are not "emerging" at all, they are often -at best- stagnant. The exception has been China, but as a foreign investor your position is compromised and there is no level playing field for investors in the domestic market- nevertheless the Hong Kong and Shanghai exchanges have provided far better returns than- say- MICEX in Russia. In India, the bureaucracy of the system strangles entrepreneurship and inward investors are at an even bigger disadvantage than they are in China or Russia.
So, as investors have recognised that BRIC states are not the easy ride that was hoped, O'Neill came up with yet another easy acronym: MINT. This one is Mexico, Indonesia, Nigeria and Turkey. As with BRIC, these are economies that are roughly the same sort of size, but otherwise fundamentally uncorrelated. Yet while it took maybe a decade for the market to see that BRICs were not that fundamentally attractive, it has taken less than a year to see that MINT states are significantly weaker than the hype implies. The meltdown- political and economic- of Turkey, which happens every decade or so has returned to haunt investors even more dramatically this time. As Turkey faces yet another collapse is it not time to ask why global finance still insists on a commodity approach to "emerging markets" investment?
The BRICS and MINT hype is built upon the fact that these markets have the capacity to take large inward investment flows- whether or not they do this efficiently or generate adequate returns for investors is not the point- the critical thing is that they have the capacity for investment firms to place big bets. From the point of view of "market guru" marketing, there is no point in selling a brilliant company or indeed country, if it is too small for large capital flows to get in. In other words, the major market players know that the "emerging markets" that they sell are not the best investment returns, but merely the best returns that large capital flows can get into.
In fact, as my use of inverted commas around the term "emerging markets" may have already hinted to you, I do not believe in the concept of "emerging markets" at all- that too is more marketing bullspiel. If one draws an arbitrary line of GNP per capita or industrial development or education level, or any one of a dozen or so data matrices, all you are really doing is measuring relative poverty. If you are an optimist, then poorer people get richer, as they have in China over the past forty years, if you are a historian you can see that this is not always true- as the peoples of Afghanistan, Egypt and Iran can tell you.
So, to invest in poor countries or not?
Firstly it is important not to listen to the fashion led agendas of market gurus. From Jim O'Neill to Mark Mobius, all have their own agenda, which is most definitely not the same as yours. In the end it boils down, not to collective, commodity based, mediocre investment, but to individual economies, sectors and entrepreneurs. Some countries, such as Estonia or Singapore, have the social and scientific capital to make a leap from backwardness to developed world life-styles in a single generation. Other states, such as India or Russia have a huge economic and political inertia that is resistant to that kind of large scale change. Yet even in these slow states it is possible to find entrepreneurs. However in such closed systems, it is very difficult to find such good investments in open markets. So if you are taking the market risk of India, then it would make more sense to invest in private equity than in the relatively thin public markets- the risk between the public and private markets is not that distinct, as it would be where stock exchanges have much higher levels of liquidity relative to GDP. The market gurus won't tell you this, because they have an interest in you buying their funds or the stocks that they already own. Private Equity investments are many orders of magnitude smaller than the stuff they are trying to sell to you.
Of course what is true for emerging markets is true across all of the investment markets- there is no deus ex machina, there are only hucksters of various types attempting to part you from your money. This is the point that Nassim Nicholas Taleb has made repeatedly in his various books, including his latest, Antifragile. Investments in packaged products, such as funds, do not- and in fact probably cannot- out perform the general market over time. The fallibility of the human in charge will sooner or later lead to under performance.
It is now five years since I left my career in the City of London. I worked in JP Morgan, Robert Fleming, UBS, and Lazard over the course of nearly twenty years. I advised several other institutions, from Bank Vontobel to UniCredit. All of these institutions shared the same flawed investment methodology- and this broken risk model is why the financial system will go through yet more turbulence in the coming years. Although dressed up in quantitive models, in the end the flaw in the investment markets is precisely the same hucksterism that we see more obviously in "emerging markets"- it is a human failing, not a structural failing, that is gnawing away at the foundations of global capital.
For me that insight has led me to Estonia and to begin entrepreneurial investment, rather than the market investment that I used to cover. It is a far slower and more intricate process than the preparation of investment strategy reports that I used to do, yet in the end I believe that I can create more value and more wealth for myself and for others than I did as part of the questionable social utility of global investment banking. That remains to be seen, of course, but it is certainly an interesting experiment.
Comments