asset managers, BRICS, closed-end funds, developed markets, dollar-cost averaging, emerging markets, frontier markets, Hong Kong, Howard Marks, NAV discount, NAV premium, portfolio allocation, reductio ad absurdum, Trading Economics
Continued from here. [And most definitely, this is the last post in the series!]
This might actually be the perfect time to write about emerging markets – the developed market douche-bags (DMDs) are out in force again, warning us emerging markets are tanking… It’s a common refrain: a) developed markets are in recession, emerging markets must tank, b) developed markets are showing zero growth, emerging markets must tank, c) developed market growth’s bouncing back & rates are rising, emerging markets must tank, and d) well…emerging markets simply must tank!
2013 may turn out to be even sillier. So far, most of the year’s been spent denigrating – nay, reviling – emerging markets, simply because developed stock markets have done so well. Of course, the sub-text here is ‘why don’t you just forget/sell emerging markets (forever) & just stick to developed markets?!‘ Christ on a rope, that’s like handing out bloody gold medals to whoever took the most steroids… And now developed markets have caught a dose of the colly-wobbles in the past week or two – again, DMDs would have you believe it’s another good reason to sell emerging markets. Yes folks, we’ve finally reached the point of reductio ad absurdum:
i) Developed markets go up – sell emerging markets,
ii) Developed markets go down – sell emerging markets, and
iii) Don’t forget i) & ii).
Of course, the real absurdity is far more obvious – why don’t we all enjoy this chart again:
But when has compelling evidence ever got in the way of belief, no matter how deluded..?! However, I will admit there’s a couple of other (real) issues facing emerging markets right now:
a) The market’s forward-looking (say on a 1-2 yr horizon), and it discounts accordingly. Which often causes it to appear irrationally sensitive to inflection points, or even changes in the rate of change (of GDP growth, corporate earnings, etc.). Right now, the market appears to be reacting to an anticipated narrowing of the growth gap between emerging & developed economies.
This phenomenon’s frustrating – a suddenly less bad economy’s stock market massively out-performs another market whose economy has marvelous fundamentals (why not substitute the words ‘company’ & ‘earnings’ here also!). And all your hard work, research & analysis is simply wasted… But that’s the expectations game for you, and sometimes you just want to throw your hands up & simply join in. But are you really equipped to play the game?
We’re talking about trading vs. investing here, and all the great investors will tell you they don’t even try to time/trade the market. They’re also v conscious of the difference between first & second-level thinking (as Howard Marks so elegantly explains). First-level thinking’s what the media’s all about – the market drops 2%, and they scramble to explain why, quickly followed by a report telling us why we’re entering a new bear market…. Of course, the most plausible (or interesting) explanation quickly gains traction, even snowballs – sadly, this often has precious little to do with the market’s actual underlying driver(s), or direction.
First-level thinking may also yell at investors that growth expectations have shifted a (mere) half percentage point in favour of developed markets…so obviously it’s time to panic & sell emerging markets! Second-level thinking, on the other hand, gently reminds investors most emerging markets will easily rack up double, even triple, the GDP growth of developed markets in the next few years, and you can purchase that superior growth at a cheaper price.
b) On an individual basis, yes, some emerging markets have clearly let investors down in terms of economic growth & slumping stock markets. And increasingly, over-hyped concepts like BRICS & other emerging market investment themes appear to have also misled & disappointed investors.
This really just highlights two big misconceptions: First, emerging/frontier markets are a huge secular growth story…surely no price tag’s too expensive to pay!? Like all growth stories, this exhortation makes compelling sense – but is also incredibly dangerous. Because price always matters… If something’s a secular growth story, obviously you can afford to wait months, even years, for the right time, place & price to come along. And if you over-pay, there’s a fair chance it works out OK in the end, but meanwhile there’s an even better chance you’ll suffer for your mistake! More recently, growth in some of the larger emerging markets was/is slowing down, while their stock markets also became (somewhat) over-priced. Which cues up the second misconception – the actual idea of emerging markets.
This dumping of incredibly disparate markets into a single bucket (the same has now happened with frontier markets) probably made a lot more sense a couple of decades back, but now looks increasingly anachronistic. I mean, what’s an emerging market these days? If I dropped you in the middle of Seoul, you’d quickly see how ludicrous it is to label South Korea as an emerging market. More generally, take a closer look at the airports, roads, subways, bridges & other (often decaying) infrastructure of America (for example), and compare it to what you might find in an increasing number of emerging markets – seriously, which looks more third world to you?
OK, maybe that’s an unfair comparison – it’s easy to have state of the art infrastructure when you only started building it 10 years ago! Good point. But unfortunately it’s an immediate reminder how thread-bare the finances of (pretty much) the entire developed world have become – seems like they can barely afford repairs, let alone new-building! [A terrible missed opportunity – I agree with the deficit dummies for once, that kind of spending still offers huge pay-offs. Actually, now I think about it, I don’t recall them suggesting anything so bloody constructive – ‘shovel-ready’ was just a verbal sop – so, f**k you, Krugman! Erm…again]. [I have to add: How on earth can the greatest capitalist nation on earth still have so much government, and so little PPP?! That’s definitely gonna change…]
It’s time for investors to realize we’re entering a world where thinking in terms of developed & emerging market buckets will probably make far less sense. Instead, there’ll be an ever-changing spectrum of growth, pricing & risk to choose from – while I still think emerging/frontier markets (as we think of them now) will easily out-pace developed markets, country-picking will become the far more logical & lucrative approach to global investing.
[Of course, that will require further research on your part, even if it’s just a checklist review of each country’s main macro indicators. Fortunately, emerging/frontier markets are generally in far better shape than developed markets these days. Inflation rates are obviously higher, but well under control – the only obvious problem is an occasional current a/c deficit which has begun to look excessive (say, 5-7%+ of GDP). You’d be surprised how long countries can comfortably run deficits like that, but suddenly (literally over-night) they end up walking the plank – and investors end up whacked on the stock market, and the currency. I used to reference IMF data, but Trading Economics has now become a bloody amazing resource].
That being said, generalist funds are still a great place to start. After all, many investors just don’t have the time, experience or confidence to start cherry-picking emerging/frontier markets. The grand-daddy of them all (though I’m not sure Mark Mobius could be described as such!) is Templeton Emerging Markets IT (TEM:LN) – actually, it celebrates its 25th birthday next year! Genesis Emerging Markets Fund (GSS:LN), JPMorgan Emerging Markets IT (JMG:LN) & Advance Developing Markets Fund (ADMF:LN) are equally worthy of consideration (plus Murray International Trust (MYI:LN) & Investment AB Kinnevik (KINVB:SS), both with a substantial emerging markets weighting). [I’m usually not a big fan of fund of funds, but ADMF (and its sister fund, AFMF) obviously offer a far greater degree of diversification – which many investors will find reassuring. Also, a major portion of its portfolio is invested in closed-end funds – in times of stress, that may offer an attractive double discount opportunity].
Speaking of (NAV) discounts, these funds have generally traded at an 8-12% discount in the past year or two. In fact, I’d definitely recommend you track discount histories on a long-term basis – nothing too exact, just take a note of the discount levels (of the main trusts) every few months. There’s a simple & compelling benefit to this exercise – to explain, a frequent (emerging markets) lament from investors is ‘How do I know it’s the right time to buy..?!‘:
– Well, first…you don’t! Before you panic, this is actually no different than the situation you face in your home market, and history clearly proves familiarity’s just as much of an enemy as a friend to the investor. So…just get over it!
– Again, you don’t know…and how could you!? Emerging markets are an incredibly disparate collection of countries – how do you expect to consistently evaluate their prospects & attractiveness within a single investment decision? The simple answer – particularly if you’re significantly under-weight emerging markets – is to devise & stick to a regular investment plan. I’m not normally a fan of dollar-cost averaging, but in this situation it might just offer the perfect solution. Adding mechanical rules which prompt you to accelerate or decelerate your purchases, based on market price action, are obviously useful too.
But there’s a couple of far more intelligent rules you can apply:
– First, monitor the P/E ratio of emerging markets vs. the US (for example). Despite their diversity, I believe this ratio generally provides a valuable sentiment index for the emerging markets as a whole. Let’s assume P/E ratios are equal, on average, and this corresponds to your default emerging markets investment plan. You can add more rules obviously, but in my experience if the emerging markets P/E ratio reaches a 20-30%+ premium to the US P/E ratio, you should seriously consider halting your purchases (or even selling some of your holdings). In similar fashion, a 20-30%+ discount should prompt a significant acceleration in your purchases.
– Second, right, we’re finally back to NAV discounts..! [Frankly this advice applies to all investing – I‘m firmly convinced fund discounts are probably the single most valuable & informative indicator(s) you can track]. I’d suggest a similar strategy as above, but now you’ll also monitor the average/range of premiums/discounts on your fund investments. However, I believe tighter limits are generally warranted these days when it comes to funds – I’d recommend using a 5-10%+ premium & a 15-20%+ discount as your upper & lower bounds, respectively.
[If you rely on this approach, and stick with generalist funds, I think you already have a pretty attractive & easy to implement investment strategy for emerging/frontier markets – no need to read much further, or consider some of the more exotic funds I’ll mention! ;-)]
Now, let’s continue – there’s also a reasonable selection of closed-end funds listed in NY which focus on emerging markets -although there’s a clear preference for regional (or even single-country) funds. [The CEF Connect site is a good reference tool also]. Unless there’s a specific exposure you can’t access elsewhere, I’ve never found closed-end funds to be that exciting. While their NAV discounts are now reaching double digit levels, almost inevitably you’ll find better discounts in London. And their tax/distribution situation’s a headache, even if you’re US resident (excepting tax-exempt accounts). If you consider emerging markets as a long-term investment, UK investment trusts are a great way to compound gains on a ‘tax-free‘ basis, at least ’til you finally cash out – a favourite Warren Buffett strategy, if you recall! [The fact a large percentage of UK trusts focus on capital appreciation for their investors, rather than dividends, obviously helps].
Of course, we can’t forget emerging market debt funds – there’s been a rash of them in the past couple of years – in the US, not London, now there’s a surprise..! Like most fixed income, especially bond funds, I just don’t get it – these funds obviously have the potential to punish investors with substantial downside, with v little upside to compensate. As usual, the greedy (& fearful) income investor ends up avoiding equities, and ends up in something else that’s perhaps just as/more dangerous. [I haven’t even checked, surely these funds aren’t stupid enough to pile on the usual US closed-end bond fund leverage?!] Oh please, not for me, thank you…
As for ETFs, I can’t even be bothered… Sure, they offer cheaper fees (hmmm, that’s somewhat debatable), but active management would still appear to enjoy a clear advantage (vs. passive strategies) in emerging/frontier markets. Plus the allocation approach of most ETFs leaves a lot to be desired – there’s a world of markets to choose from, yet there’s plenty of ETFs which sport a bizarre 50%+ of their assets concentrated in just a couple of countries. The handful of frontier market ETFs are far worse… Just take a look at Guggenheim Frontier Markets ETF (FRN:US) – 74% of the fund’s concentrated in Chile (51%!?!), Colombia & Argentina. What ass-clown came up with that allocation & then called it a frontier markets ETF? Can you tell if he’s a liar, or simply an idiot..?
Then there’s the sadly misguided world of emerging/frontier market open-ended funds. I can’t think of a more inappropriate investment structure… Even if you’re a stand-firm long-term investor, do you really trust your fellow shareholders not to all dash for the exit like mindless sheep at some point? How do you think that would savage your investment & peace of mind? It may be academic anyway – if that’s what’s happening, what do you think’s happening with liquidity? You might just end up locked up in a dying fund.
More specialized (global) funds would include Ashmore Global Opportunities (AGOL:LN) & Utilico Emerging Markets (UEM:LN). Craven House Capital (CRV:LN) is a tiny fund focused on emerging (& frontier) markets. [Though its latest deal is Irish – an investment in the debt of the Green Isle Hotel, which actually looks like an extraordinary bargain. It’s worth noting they also have a stake in a newly listed African farmland company, Farm Lands of Africa (FLAF:US)]. After a recent investment by Fortress Investment Group (FIG:US) & GP Investments (GPIV11:BZ), Apen (APEN:SW) will re-focus on private equity fund & direct emerging market investments.
Of course, the ultimate generalists are perhaps the asset managers themselves – obviously they offer a more leveraged exposure, as long as you’re comfortable with that risk. Argo Group (ARGO:LN) (my fave, of course!) & Ashmore Group (ASHM:LN) focus more on debt, while Charlemagne Capital (CCAP:LN) focuses on equities. A substantial portion of Aberdeen Asset Management’s (ADN:LN) AUM is also focused on emerging markets/Asia. I recently published an interesting UK asset manager peer analysis (vs. ARGO) here. [And let’s not forget: Value Partners Group (806:HK) – always looked a little pricey to me, but could be an intriguing China play at some point (some good VP interviews here). And also City of London Investment Group (CLIG:LN) – going through some difficulties right now, but perhaps a great long-term emerging/frontier markets holding (which I’ve owned in the past)].
Unfortunately, there’s not too many listed frontier markets funds, though I suspect we’ll have a slew of them in the next few years. For the moment, you can choose from Advance Frontier Markets Fund (AFMF:LN) (a fund of funds, as I mentioned above) & Blackrock Frontiers IT (BRFI:LN). There’s actually a new frontier markets fund that listed fairly recently, in a round-about manner, but so far it seems to be flying below the radar for most investors – might be worth saving for a closer look some day… 😉
Now, let’s traverse the globe:
In Asia, first as a region, let’s choose to ignore those (perfectly respectable) funds which include a Japan allocation. Of the ex-Japan funds, the real winners are a surprising duo – income & small company funds – including Aberdeen Asian Income Fund (AAIF:LN), Aberdeen Asian Smaller Companies IT (AAS:LN), Schroder Oriental Income Fund (SOI:LN), Scottish Oriental Smaller Companies Trust (SST:LN) (again with the ‘Oriental‘ – gentlemen, the opium wars are over, now it’s ‘Asian‘!), and Edinburgh Dragon Trust (EFM:LN) deserves an honourable mention. Establishment IT (ET/:LN) & Pacific Alliance Asia Opportunity Fund (PAX:LN) are more absolute-return oriented funds. The US also has a reasonably good selection of ex-Japan closed-end funds – they were quite the rage a decade or two ago – again, they’re mostly focused on single countries.
Second, let’s look at individual countries: China exposure can be accessed via JPMorgan Chinese IT (JMC:LN), trailed by Fidelity China Special Situations (FCSS:LN) (where Anthony Bolton has finally given up the ghost). More exotic (private equity) options include ARC Capital Holdings (ARCH:LN), China Growth Opportunities (CGOP:LN) (which looks like it’s being re-focused on retail/real estate businesses) & Origo Partners (OPP:LN). Since I’ve mentioned it before, let’s throw Prosperity Mineral Holdings (PMHL:LN) into the mix as a quasi-investment company (and some say ultimate value trap…). Once you count the value of its 33.1% stake in Anhui Chaodong Cement Co (600318:CH), everything else is pretty much thrown in for free.
For India, we have India Capital Growth Fund (IGC:LN), JPMorgan Indian IT (JII:LN) & New India IT (NII:LN). We also have private equity funds, like Infrastructure India (IIP:LN), Kubera Cross-Border Fund (KUBC:LN), Elephant Capital (ECAP:LN) & EIH (EIH:LN). Thailand: Aberdeen New Thai IT (ANW:LN), and also Symphony International Holdings (SIHL:LN) – whose primary focus was originally Thailand (the excellent Minor International (MINT:TB) is a core holding), but now they’re expanding rapidly in Asia, Turkey & China. Last, and certainly not least, we have Vietnam – and funds like Vietnam Holding (VNH:LN), PXP Vietnam Fund (VNF:LN), Vietnam Infrastructure (VNI:LN) & VinaCapital Vietnam Opportunity Fund (VOF:LN).
Next we have the Middle East – or, more broadly, the GCC & MENA markets. Exposure includes Qatar Investment Fund (QIF:LN) & Qannas Investments (QIL:LN). Of course, the best exposure to the region (in my opinion) is offered by European Islamic Investment Bank (EIIB:LN) – and here’s my latest EIIB post.
Moving down the continent, we next have the frontier markets of Africa. We’ve obviously seen many false dawns in Africa for the past 50 years, but I do believe we’ve finally reached/even passed a decisive inflection point for the continent. This time is different because of the ever-increasing access to the internet, to cellphones & to micro-finance (which is easily enabled via both technologies). Funds on offer here are certainly more exotic: Africa Opportunity Fund (AOF:LN), PME African Infrastructure Opportunities (PMEA:LN), ADC African Development Corp (AZC:GR), Cambria Africa (CMB:LN), Masawara (MASA:LN), Peregrine Holdings (PGR:SJ) & Blackstar Group (BLCK:LN). And Market Vectors Africa Index ETF (AFK:US) is one of the few decent emerging/frontier market ETFs I’ve come across – i.e. I’ve actually owned it in the past!
Latin America’s probably the least favourite (at least outside the US) emerging market region for many investors (including me). Which probably explains the lack of generalist fund exposure – pretty much all that’s on offer is Blackrock Latin American IT (BRLA:LN) & JPMorgan Brazil IT (JPB:LN). Then you have GP Investments (GPIV11:BZ), a Latin American private equity firm I’ve already mentioned above. But I guess we can also still include Clean Energy Brazil (CEB:LN), while Hansa Trust (HAN:LN) & Ocean Wilsons Holdings (OCN:LN) also both offer significant exposure to Brazil. However, Brazil’s had a tough time of it recently – personally in Latin America, considering past & future, I’d prefer to stick with investing on the left-hand side of the map! But that exposure’s more difficult to access…
Right, we’re only getting started! I haven’t even touched emerging/frontier market:
– Property companies: I provide some commentary here, but don’t reference specific stocks.
– Agri-businesses: I find most listed exposure to biological growth/assets (which is what really interests me) is now concentrated in emerging/frontier markets, while listed companies in the developed markets now focus on ‘picks & shovels‘. I detail Russia/Ukraine farmland/agri-business companies here & here – plus Avangardco Investments Public (AVGR:LI), of course – and pretty much cover the rest of the world here.
– Natural resource stocks: I comment a little here. Frankly, the idea of fund managers investing in resource stocks simply based on the fact they’re located in emerging/frontier markets is a little silly. At the end of the day, they’re mostly taking on commodity/resource stock exposure – while their emerging/frontier market risk is unfortunately asymmetric (i.e. increased taxes, regulation, confiscation, etc. – natural resources still brings out the xenophobia in governments & politicians!). However, investing in domestic emerging/frontier market resource stocks can make a lot more sense.
And what about the great undifferentiated mass of hundreds, nay thousands, of other emerging/frontier market companies..? OK, I’m just kidding – let’s not go there, at least right now – I mean, do you really want us to be here all day & all night?!
But in all seriousness, my main investment priority for the next decade – as I’ve done with the rest of my investing, in the past decade – is to gradually migrate from investment funds into a well researched & diversified portfolio of individual emerging/frontier market companies. Unfortunately, when I survey the prospects for much of the developed world, this seems like the only sensible strategy to pursue. I would definitely recommend you at least contemplate such a challenge also – otherwise (presuming you live in the US, Europe or Japan, for example), you may end up shocked at the potential risks to your general economic prosperity (let alone your portfolio) in the years ahead.
But let’s finish up on an encouraging note: This week, I was somewhat randomly hunting around for an interesting emerging market company or two. For example (and avoiding the local property bubble), I was astonished to discover how cheap many large & small Hong Kong stocks are at the moment! Not what you might expect, eh?! Literally in the space of an afternoon, I discovered two holding companies which appear to be stunningly cheap:
– Company A: No property exposure, no real China exposure, a decent investment record, no significant underlying run-rate losses, and the majority of the balance sheet now converted to cash – a Price/Book of 0.4!
– Company B: No property exposure, no real China exposure, an admittedly mediocre investment record, no significant underlying run-rate losses, and net cash on the balance sheet – a Price/Book of less than 0.1!?
You know, if I can find two HK stocks like that in a single afternoon – imagine how many other cheap & interesting emerging/frontier market stocks are out there..?! 🙂