Zaks Investment Advisory Service

A Few Comments About Emerging Markets

Last time, we tried to assess the prospects of BRIC nations’ economic and financial growth. But why did we focus on these four countries? Are there any others out there where investments would be just as attractive? Goldman Sachs had certain grounds for setting aside China, India, Russia, and Brazil into a separate group. Their economies are the largest of all the emerging market nations. Yet this might be just about the only thing that unites these four countries. In all other respects, both political and economic ones, they are completely different from each other. Moreover, they are not the ones enjoying the fastest growth, either in terms of their economies or stock exchange price levels. The World Bank believes that there are currently 93 emerging nations in the world. It is quite obvious that if we are thinking about investing in emerging markets, our choice should not be limited to the BRIC nations alone.

Let us begin with a curious fact. Take the world’s 100 largest countries according to their gross domestic product and pick out the ones with actually functioning exchanges. Out of these, which nation’s markets enjoyed the fastest growth over the past five years? The answer may surprise you: Ukraine. Over the past five years, prices on the Ukrainian stock exchange shot up by 1,700 percent! I mention this not only because it is an interesting little piece of information. This example also points to certain difficulties facing US investors: far from every nation’s market is accessible to them. For instance, even if we did want to invest some money on the Kiev stock exchange, this would be a very difficult thing to do. For this reason, we will begin our overview with the more developed nations whose markets are open to average investors, and then move on to the more exotic ones.

I must make one clarification: when I am talking about investments in emerging markets, what I mean are the US financial instruments like exchange-traded funds, mutual funds, and closed-end funds, ADRs and so on, which all fall under the jurisdiction of US organizations such as the Securities and Exchange Commission. These instruments are traded on US financial markets. In one way or another, they are all linked to emerging nation stocks or bonds. In many ways, these financial instruments are riskier than, for example, a diversified fund of US stocks. Nevertheless, they may still be suitable to many investors – but, of course, in different proportions respective to the size of their investment portfolios. Besides strong potential growth, these instruments have another appealing characteristic: often, they are poorly correlated with the performance of US stocks. As a result, even though they are riskier on an individual basis, a portfolio that contains them as one of its components may end up being less risky overall. In either case, you would be wise to discuss all of these issues with your investment advisor before making any investments.

And one other comment: We are talking about making investments in securities of developing nations. Many of them have political, ethical, and moral standards that differ quite greatly from our own. Imagine a fund that is partially composed of investments in Middle Eastern nations. Some people may decide that it is simply beyond them to invest in companies of such undemocratic and corruption nations, with their ambivalent attitudes toward the West. This is each investor’s individual right. Some people, for example, refuse to invest in tobacco or arms manufacturing companies. This is also their choice. I would only like to remind you that we purchase Chinese goods without devoting much thought to freedom of speech, religion or the plight of ethnic minorities in that country. On a fundamental level, investments made in funds differ little from the purchase of a shirt or gasoline. Nevertheless, this may pose a problem to some investors. Each investor must be aware of where his or her money is going, and then make decisions according to their own code of ethics.

However, let us get back to specific countries. Several nations are fairly obvious candidates for the more developed list: Mexico, South Africa, Turkey, and South Korea. Mexico’s economy is about one-and-a-half times smaller than Brazil’s or Russia’s. Turkey’s economy is about half the size of Mexico’s. South Africa’s is slightly smaller than Turkey’s. On the other hand, South Korea’s economy is about the size of Mexico’s. I have previously mentioned that assessing the size of a nation’s economy – in other words, its gross domestic product – is a fairly difficult task. The main problem rests in which exchange rate to use when converting the GDP from local currencies into dollar terms. One method involves using the market exchange rate. This is a simple process, but market exchange rate conversions often distort the real size of the economy. Exchange rates never stay the same; for example, the dollar has lost nearly 40 percent of its value against the Euro over the past five years. But few would claim that this means that the size of the European economy grew by 40 percent relative to that of the United States. It is much better to use purchasing power parity. But while this method is preferable, it too is far from being precise. Two respected agencies, the World Bank and the CIA, publish statistic about every nation in the world. If one believes the Word Bank, than the Swiss per capita GDP is higher than that of Ireland. But if one trusts the CIA, things are the other way around. The World Bank believes that Britain is richer than Canada, but the CIA says no, Canada is ahead. There are many such examples. I mention these only to highlight the fact that when we talk about the global economy, and emerging markets in particular, the data we rely on is quite approximate.

Unfortunately, we will have to wait until our next program before analyzing specific emerging market cases. This was Sergey Zaks. Thank you for your attention and until next time.