Investing in the ‘first world’ could be very risky business
Often SA investors muddle global diversification with fleeing risk, when emerging markets offer a better bet
But, he says, diversification is about managing risk: avoiding or eliminating risks can only be done by downgrading investment goals. He makes a crucial point that moving assets from SA to the UK is not global diversification. SA is not a bad place to invest, but it is a risky place in which to invest everything. Moving assets to the UK is moving into one with lower political and currency risk. It is one of the longest established developed markets, after all.
It is a good idea to remind ourselves why we invest in global assets. In the days before the relaxation of exchange controls the focus was simply on taking money out of the country in case of a national emergency. Few people cared about the returns they would receive, they just squirrelled away the unused portions of their travel allowances in low-yielding bank accounts.
But more sophisticated professional advisers have come onto the market and can offer multi-asset and multijurisdictional portfolios. Credo Wealth, Stonehage Fleming and Citadel offer a much better alternative than sticking your money in a NatWest savings account.
Another player in global portfolios that seems to have raised its head above the parapet is Bellwood Capital, run by former executives at Sasfin, Coronation Capital and BOE. Bellwood’s David Nathanson says all too often SA investors muddle global diversification with fleeing risk. This is no surprise given the old tradition of moving capital overseas in case the country implodes.
It is often argued that only the developed markets offer true diversification – emerging markets just have SA’s problems in different climates. That thinking, popular in the 1970s, divided the planet between the global north and the global south, which was previously known by the unflattering name “Third World”. Not very good geography considering that Russia and China are considered to be in the south and Australia, New Zealand and perhaps one day Chile, are described as part of the north.
But the UK represents only about 4% of global investment opportunities, and Brexit shows it is by no means an investment safe haven. Nathanson isn’t advocating switching from the UK into another market such as Australia. Instead he urges avoiding too much concentration.
There is a lot to be said for the somewhat dull approach of mimicking the global indices such as the MSCI all country world index. Some concentrated portfolios have done well, but even they present risk. The Orbis global equity fund has been an excellent long-term performer, with more than double the return of its peer group over 25 years. But over the past year it has suffered a 21% loss (in dollars), almost double that of its peers.
In Orbis’s case, country selection did not play a big part. It was the style of shares Orbis owns, those on a fat (but in many cases growing) discount to intrinsic value such as XPO Logistics and insurer PG&E, a victim of the high claims from California’s wildfires.
Nathanson says these events encourage people to argue that “other places have risks too”. This is a self-evident statement; diversification isn’t about looking for places without risk, but it is supposed to look for lowly correlated risk.
But emerging markets are nothing like as monolithic as some think. Many emerging markets, such as India, offer a much higher rate of economic growth, and China may still be some way from joining the ranks of the developed countries but it is already a global superpower.
Manraj Sekhon, chief investment officer of Franklin Templeton Emerging Markets, says they are still widely expected to achieve faster economic growth than developed markets, with GDP increasing 4.7% compared with 2.1% for developed markets. He says emerging market company cash flows have remained resilient. And though emerging markets had a poorer year than those of the “north” you would have made money, what with the long emerging markets and short developed markets in the last quarter of 2018. The former fell 7.4% and the latter 13.3%.
Over that time Asia suffered losses led by Pakistan, Taiwan and South Korea. Pakistan, which many consider to be a frontier market, as its financial markets are still unsophisticated, had to secure a bailout from the IMF. It is a good example of an emerging market that is in even more trouble than SA. Its proximity to Afghanistan doesn’t give investors much comfort either.
Taiwan and South Korea are at the other end of the scale. Both have developed economies, but for political reasons none of the index providers want to move Taiwan before mainland China into the developed category and therefore suggest it is a different country. South Korea might take a step back from developed status if and when it reunites with North Korea.
But looking at the economies objectively it is hard to see the homes of Samsung and Taiwan Semiconductors as emerging markets – their markets are becoming much more correlated to tech indices such as New York’s Nasdaq. In contrast, the labour-intensive, more classically Third World economies of India, Indonesia and the Philippines gained from improving local currencies.
Latin America was the only emerging market region to make gains in the last quarter, and this was because of what Franklin Templeton calls the “market friendly” policies of new Brazilian president Jair Bolsonaro. Never mind his reactionary views on the rain forest, the rule of law and homosexuality, the business of business is business. But don’t be surprised if more and more Brazilian equities and bonds don’t pass future environmental, social and governance screens.
The new president of Mexico didn’t get the same reaction from the market, since he is an old-fashioned high-spending leftist. If Bolsonaro is the Trump of the Tropics, Andres Manuel Lopez Obrador must be the Corbyn from Chihuahua. But Brazil is the dominant market in the region so in some ways Mexico is a special case, being so heavily dependent as a workshop for the US.
The emerging European sector also has some different levers. Poland is treated as a developed country in some indices, but Hungary and Czech Republic play a similar supporting role to Germany that Mexico plays to the US. Turkey, huge in emerging market terms, tends to be a hostage of domestic tensions from the conflict between secular and religious forces, as well as an unusually volatile currency. But it made a strong recovery in November.
Anybody who says we should not invest in other emerging markets because they are “just like us” is just ill-informed.