The Emerging Markets

Although the article below deals exclusively with Emerging Markets investment opportunities via listed securities, it lays out a strong case, which could easily be extrapolated into a decision-making framework for those involved in the tangible areas of international business – exports and foreign direct investment (FDI).  Although the latter two areas of participation require more diligence and risk mitigation, and some of the decision analysis is counterintuitive to that of investment money manager.

The main difference between investors in listed securities and direct investors, of course is liquidity and ability to divest one’s holdings rapidly.  Listed investors will be well served to diligently study the markets and to follow the path recommended in the article below. Direct investors, in addition to the analysis presented in the article,  would also look at risk mitigation through political risk insurance, which covers expropriation, political violence, currency inconvertibility and loss of income.  They would consider putting in place contingency procedures for evacuation of personnel and their families, adequate security and various business exit scenarios.  Thus by definition, taking on this type of risk would dictate selection of  only those investment opportunities, which adequately compensate those contemplating such an investment. Sounds simple?  Well, it isn’t.  Headlines, crowd euphoria, and lack of in-depth understanding of target countries’ risk profile often skew direct investment decision-making and prevent companies from taking advantage of solid, financially rewarding direct investment opportunities.

For those wishing to export, the country buy/sell analysis below offers a good starting point to see most attractive markets, yet it should be viewed from a different angle.  For instance, India is marked as a Sell country for investment, since as the net energy importer it will be negatively affected by the high oil prices.  Yet for the U.S. exporters of alternative energy goods and services, this represents a terrific opportunity to serve already rapidly growing Indian alternative energy industry. Thus for the exporters analysis of the Sell markets in general has to be performed in the Judo fashion of using the negative economic factors to one’s advantage.  Remember, every negative event, has numerous positive implications and brings with it export opportunities.

I fully agree and have written extensively, that despite the challenging landscape, Emerging Markets represent one of the most attractive investment and trade opportunities available today.  To participate one has to be well informed, risk averse, nimble and FluentInForeign™.

Despite the Gloomy Headlines, Opportunities Are Cropping Up in Unexpected Places

By BEN LEVISOHN as seen in The Wall Street Journal, Saturday March 12, 2011

DANGER SIGNALS are flashing all over the emerging markets. Growth is slowing. Inflation is heating up. And political instability is upending governments in the Middle East and North Africa and could spread further.

In the past, a trifecta like this would prompt investors to dump all emerging-market holdings and hide out in safer countries until conditions improve.

But those who bail now could miss out on big opportunities. For the first time since the financial crisis, the emerging markets aren’t trading in lockstep. Some countries look strong despite—or because of—the recent turmoil, with solid growth prospects, little inflation pressure and the ability to capitalize on rising oil prices. Among them, say money managers and market strategists: Russia, Mexico, Thailand, Taiwan, Turkey and the Czech Republic.

The overall statistics are gloomy, but they tell only part of the story. Since the start of the year, the MSCI Emerging Markets Index has dropped 2.2%—compared with a 5.7% rise for the Dow Jones Industrial Average and a 3.5% gain in the broader MSCI World Index. Investors have pulled money from emerging-market mutual funds for six of the past seven weeks, according to EPFR Global, a financial firm that tracks global fund flows.

“Most emerging markets are past the recovery stage,” says Ousmene Mandeng, head of public sector advisory at Ashmore Investment Management in London.

But emerging markets aren’t the monolith they used to be. Russian stocks, for example, are up 6.4% since Dec. 31. Hungary isn’t far behind, jumping 5% so far this year. Morocco has gained 3%, the Czech Republic is up 2%, and Thailand has edged up 0.8%.

In fact, the average “correlation” between the MSCI index and its component nations has dropped to 0.53 on March 2 from 0.8 on Dec. 31, according to financial-data firm FactSet. (A correlation of 1.0 means two assets move in lockstep; a correlation of minus-1.0 means they move in opposition. The closer the figure is to zero, the less correlation.)

By another measure, the emerging markets are less connected than they have been since at least 1995. Goldman Sachs Group Inc. recently measured the difference between actual economic activity in 24 emerging-market nations and the historical trend, a spread known as the output gap. It found that there is more divergence now than at any point since at least 1995.

Markets were almost as differentiated during the debt crisis of the late 1990s as they are now. Investors who bet smartly back then were rewarded for their courage. For the 12 months beginning July 1, 1997, the MSCI Emerging Markets Index lost 28.4%. But Turkey soared 108%, while Hungary and Morocco gained 38% and 29%, respectively.

The battle now brewing is between economic growth and inflation, says Dominic Wilson, co-head of global macro and markets research in the economics group at Goldman Sachs. “Good growth and low inflation is better than the opposite.”

So far in 2011, a portfolio of the five emerging-market countries with the most industrial-production growth beat those with the least by 4.7 percentage points, according to FactSet. The nations with the smallest month-over-month rise in inflation have outperformed ones with the largest by 0.75 percentage point.

Solid economic fundamentals are meaningless, of course, amid political chaos. Egypt’s stock market dropped 20.4% this year before trading was halted on Jan. 27, despite an economy that grew 5.5% during the third quarter or 2010, the most recent data available. Markets throughout the Middle East and North Africa remain on edge—but the goings on there have little to do with what is happening in Southeast Asia or South America.

“The increase in political turmoil is making investors look more at the idiosyncratic risks of each emerging market,” says Alex Bellefleur, a financial economist at investment bank Brockhouse & Cooper Inc. in Montreal.

Another big wild card is oil prices. From June 2009 to the end of 2010, oil and emerging markets largely moved higher in tandem, on expectations of stronger global growth. The 26-week correlation of the two asset classes, measured on a weekly basis, averaged about 0.88, according to Thomson Reuters Corp.

This year, however, the correlation has declined from 0.83 on Dec. 31 to 0.49 this week. The difference: Oil prices now are rising not on growth expectations but on supply fears. That has hurt oil importers such as India but helped exporters like Indonesia, where stocks have risen more than 10% since Jan. 28, as protests in Egypt erupted.

Where to Buy—and Sell

Given all of these factors—growth, inflation, political stability and oil—many money managers and strategists cite Russia, Thailand, Taiwan, Turkey and the Czech Republic as the best plays now.

Russia is the most sensitive to oil-price swings, with about three-quarters of its public companies in oil and energy. The correlation between oil and stock prices there is 0.92, the highest among emerging markets. Yet despite the recent run-up, Russia’s price/earnings ratio based on 12-months of analyst earnings forecasts is just 6.8, well below its historical average of 8.1.

“Russia is one of the cheapest markets in the world,” says Louis P. Stanasolovich, president and chief executive at Legend Financial Advisors Inc. in Pittsburgh.

It is cheap largely because earnings are projected to soar from rising oil prices. The trend could reverse—but few analysts expect that scenario. In the near term the main question is whether prices will rise to $120 a barrel or more, or remain near the current $100, says Jason Press, an emerging-markets strategist at Citigroup Inc.

Taiwan is another favorite among money managers and strategists. The HSBC Taiwan Purchasing Managers’ Index, a growth measure, jumped by 9.3% in January from a 5.4% rise in November, signaling a strengthening economy. Yet its consumer-price index, the main inflation gauge, rose just 1.33% year over year in February.

Mexico, too, looks attractive. Its central bank recently raised the range of its growth forecast to 3.8% to 4.8% from 3.2% to 4.2%. And like Indonesia, Mexico is a net oil exporter. It also should get a boost from a recovering U.S. economy, since exports to its northern neighbor make up nearly a quarter of its GDP.

Thailand, Turkey and the Czech Republic also seem like good bets based on their solid growth prospects and moderate inflation, say strategists and fund managers.

Where should investors tread most carefully? Start with India, a major energy importer. Inflation is running high and growth is expected to drop to 6% this year from 8% in 2010, according to Lombard Street Research. Yet despite the recent selloff, India’s stocks aren’t cheap, with a P/E of 14.6, compared with a long-term average of 13.8.

“The impact of oil prices and a sticky inflationary environment overshadow the long-term domestic consumption and growth story in India,” says Joel Wells, co-portfolio manager of theAlpine Emerging Markets Real Estate Equity Fund.

China is facing many of the same problems, and it isn’t clear whether policy makers, who have boosted interest rates three times since October, will be able to engineer a soft economic landing while controlling prices.

“Long term, China looks good; short-term there are headwinds,” says Jose Morales, a portfolio manager at South Korea-based Mirae Asset Global Investments.

Funds and ETFs

The best way to play individual countries is through exchange-traded mutual funds. You can track Russia via the Market Vectors Russia exchange-traded fund, Mexico via the iShares MSCI Mexico Index ETF and Taiwan via the iShares MSCI Taiwan Index ETF, among others.

Placing individual country bets isn’t for the timid, however. Emerging markets are notoriously volatile, and single-country ETFs are susceptible to big swings. “These ETFs can have enormous years on the upside and enormous years on the downside,” says Howard Sontag, chief executive of Sontag Advisory LLC in New York.

With correlations breaking down, the safest way to play emerging markets is to invest in a broad range of nations. You might assume that diversified index funds or ETFs would be a good vehicle. But those tend to be dominated by the biggest companies in the biggest markets—China and India among them.

“You can’t just invest in the aggregate index,” says Nuno Fernandes, a professor of finance at the International Institute for Management Development in Lausanne, Switzerland. “You have to do a better job of choosing where to invest.”

An actively managed mutual fund might be a better alternative, because the manager, in theory, has the expertise to make the difficult strategy calls that most individual investors can’t. To find the most experienced, scour fund websites for information about managers, and look for tenures of five years or longer or other emerging-markets experience.

The top performer during the past three years has been the Aberdeen Emerging Markets Institutional Fund, which gained 11% annually, according to investment-research firm Morningstar Inc. As of the end of January, it had 17% of its portfolio in Brazil, about one percentage point more than the MSCI Emerging Market Index—and just 5% in South Korea, versus 7% for the index.

The best performer on a five-year basis is the Wells Fargo Advantage Emerging Markets Fund, returning 13% annually. As of the end of February, Korea made up just 10% of the portfolio versus 15% for its benchmark, while Mexico accounted for 5.6%, more than the benchmark’s 4.5%. The fund focuses on companies more than countries, says portfolio manager Jerry Zhang.

The menu of actively managed portfolios is growing. Firms have rolled out 23 new diversified emerging-market funds during the past 12 months, according to Morningstar, compared with six in the year-earlier period. There are 135 actively-managed emerging-market funds overall, according to Morningstar.

A caveat: Most actively managed funds lag the index over time. And for some of the firms rolling out new funds, this will be their first emerging-markets product. Among them: Marsico Funds, Baron Funds and Fred Alger Management Inc.’s Alger Funds.

Michael Kass, manager of the Baron Emerging Market Fund, says the firm will apply the same investing discipline it has used in its other funds. Alger Funds says it has hired managers with extensive emerging-markets experience. Marsico says it launched its fund because it had been finding many emerging-market companies it liked but that didn’t fit its existing portfolios.

Other new funds, however, are established portfolios being made available to U.S. retail investors for the first time. The Brandes Institutional Emerging Markets Fund, for instance, is a new U.S. version of a long-running Canadian fund. The new fund is down 2.27% for the past month, but the Canadian version has gained 8.62% a year during the past three years, placing it in the top 3% of funds in its category, according to Morningstar.

The strategy has been in place since 1994, says Gerardo Zamorano, director of investments at Brandes. The fund has large positions in South Korea and Brazil.

“A good emerging-market fund covers the bases on all the countries,” says Karin Anderson, a mutual-fund analyst at Morningstar. The key, she says: “You have to be comfortable with the individual managers.””


About Alexander Gordin
An international merchant banking professional with over twenty years of business operating and advisory experience in the areas of export finance, international project finance, risk mitigation and cross-border business development. Clients include foreign governments, municipalities and state enterprises as well as Fortune 500 and small/medium enterprises. Strong entrepreneurial instincts, combined with leadership and strategic skills. Transactional and negotiations experience in over thirty five countries. Author of the highly acclaimed "Fluent in Foreign Business" book and creator of the "Fluent in OPIC", "Fluent in EXIM","Fluent In Foreign Franchising", "Fluent in FCPA",and "Fluent in USTDA" seminar/webinar series. Currently developing "Fluent In ......" seminars and publications. Co-author of the Fi3 Country Business Appeal Indices. Extensive international business development and project finance transaction experience in healthcare, aerospace, ICT, conventional and alternative energy infrastructure, distribution and hospitality industries. Experience managing international public and private corporations. Co-Founded three companies abroad. Strong Emerging and Frontier Market expertise. Published and featured in numerous publications including: The Wall Street Journal, Knowledge@Wharton,, The Chicago Tribune, Industry Week, Industry Today, Business Finance, Wharton Magazine Blog, NY Enterprise Report, Success magazine, Kyiv Post and on a number of radio and television programs including: Voice of America, CNBC, CNNfn, and Bloomberg. Frequent speaker on strategy, cross-border finance and international business development. Executive MBA from the Wharton School at the University of Pennsylvania. B.S. in Management of Information Systems from the Polytechnic Institute of NYU. Specialties Strategic Management Advisory, Export Finance, International Project Finance & Risk Management, Cross-border Negotiations, Structured Finance transactions, Senior Government and Corporate officials liason

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