Emerging Markets Conference: Experts Bullish on Africa, Lukewarm on China
I came into the Investing in Emerging Markets conference fearing that there would not be an adequate discussion of global trade imbalances and the global debt crisis. Because many emerging markets are either commodity producers or exporters, it seemed likely to me that emerging markets would be beholden to the health of the developed (importing) world — which of course has massive excess debt. While this is certainly true for some markets, I was pleasantly surprised to learn that the scope of opportunity in emerging markets is much larger than I had expected.
George Hoguet, CFA, managing director at State Street Global Advisors, began the conference by identifying three major challenges presented by the debt crisis of 2008:
- The causal relationship between financial markets and the real economy;
- The insufficient price stability objectives of central banks; and
- The changing role of the finance industry in a zero-interest rate world.
As Eliott Kalter, president of EM Strategies highlighted, many emerging markets learned their lessons about debt in the 1980s and 1990s. So, when the market collapsed in 2008, a very interesting thing happened: Investors sold off emerging market securities, even though many of these countries were generally sound. With additional insight from Lupin Rahman, an executive vice president on the emerging markets portfolio management team at PIMCO, we learned that policy response from central banks in emerging markets played a key role in stabilizing these markets. Once the policy responses were implemented, spreads compressed, and emerging economies were then healthy enough to resume growth.
Of course, in the field of investing, there is an ever-present struggle between the mind and the stomach. Luis Pereiro, professor of international finance at the Universidad Torcuato Di Tella, in Argentina, reminded us that it’s okay to adjust your discount rates until you are comfortable that they meet your analytical requirements as well as your peace of mind. And when it comes to analysis, Arjun Divecha, chairman of the board of directors at GMO, cautioned that there is a major difference between linear and nonlinear returns. He demonstrated that as GDP per capita passes from $3,000 to $10,000 savings rates taper off and consumption begins to explode. For example, as GDP per capita in China increased fourfold over the past 10 years, automobile consumption increased seventeenfold. Not one auto analyst covering China in 2000 had come even close to forecasting China’s actual automobile demand in 2010.
Bias in investing is an ever-present risk. A commonly held belief today is that China’s growth will continue unabated. Fraser Howie, managing director of CLSA Singapore, demonstrated that there is an enormous difference between what China presents and reality. At the core of the problem is China’s fragile banking system, which is wildly misallocating capital and hiding nonperforming loans. Howie then encouraged investors to resist the temptation to say that China is too large to ignore; he views Chinese securities as trading opportunities and not investing opportunities. Another word of caution was offered by Stephen Jen, managing partner of SLJ Macro Partners, who said that in 2010 China passed the “Lewis turning point,” in which wage inflation should begin to accelerate and strip away their labor-cost advantage.
Turning to Brazil, Luis Stuhlberger, chief investment officer of Credit Suisse Hedging-Griffo, highlighted some common misconceptions about Latin America’s largest economy, noting that many investors feel bullish on the country as an emerging market play. Nonetheless, Brazil has a long list of growing problems that have yet to come to a head: excessive pension benefits, declining productivity, poor tax policy, and massive growth in household debt. Donald W. Lindsey, CFA, chief investment officer at George Washington University, then suggested we look for emerging market opportunities outside of the so-called BRICs. He emphasized how important it is for investors to do their own homework and kick the tires before making bottom-up investments.
Outside of the BRICs we find that there is nevertheless a wealth of emerging opportunities. Runa Alam, CEO of Development Partners International, discussed her role as a private equity investor in the frontier markets of Africa. Surprisingly, Africa has gone through a metamorphosis of sorts. Over the past 30 years, African countries have increasingly embraced democracy and free markets. While these markets are indeed immature, the risks of political instability, disease, war, and other crises are now much overblown. Many of these countries are able to leapfrog the infrastructure and development timelines experienced in developed markets. Clarifying these developments in Africa was Nick Padgett, CFA, cofounder of Frontaura Capital, who shared his discovery that many of the companies in Africa are run by Western-educated leaders who understand cash flow management and the importance of good accounting and controls, and also possess an understanding of capital allocation.
Finally, the conference was wrapped up by Kristin Forbes, professor of global economics at the MIT Sloan School of Management, who discussed the challenges of capital flows into and out of emerging markets. We are now embarking on a period of experimentation in which numerous countries are trying to establish various forms of capital controls. She suspects that these policies will eventually fail, but as these markets mature, they will discover the value of open policies along with some macro-prudential regulations.
On the whole, the most interesting opportunities appear to be in the frontier markets of Africa, which have banking systems that are less connected to the markets of the world and possess a compelling domestic-consumption story built on the transition from dictatorships to democracies over the past 20 years — making Africa a high return, low correlation opportunity for portfolio allocation.