Preface
It is foolish to assign any permanence to current economic balances, growth patterns, or trajectories. Very fundamental event risks are systemic. Yet it would be equally foolish to miss early opportunities afforded by the inevitable rebalancing of the global economy.
Investing in developing markets, including emerging and frontier economies as well as some unclassified investment destinations, is a broad subject that cannot be treated adequately in one book. It covers public and private securities (direct investments), debt and equity, large and small investments. They all are very different and all deserve much consideration on their own. We have therefore taken an inductive approach to elaborate on some of the more unusual aspects of developing markets investing to provide the ingredients for a holistic view on the subject.
The objective of this book is that in 5 or 10 years, you may still want to read certain contributions and refer to some market selections. This book is not meant as a short-term perspective or investment guide, but as a long-term view of what will become a necessity for every investor.
If you believe statements of the leading investment bank1 that any economy less than 1 percent of global GDP is frontier and below 0.5 percent of global GDP is not going to influence the world, this book is not for you. This view restricts the universe of meaningful economies to some 20 countries (and including frontiers, to some 30 economies) globally by 2050,2 if at all. This will cause an overinvestment problem and largely miss the current rebalancing of the global economy.
We rather believe the sum of around 50 to 60 economies, each below 0.5 percent of global GDP, with huge endowments in natural and human resources and often adequate financial reserves, will individually and collectively have a very significant impact on global trade, consumer developments, and business activity and therefore are investable markets to consider. Moreover, regionalization will give those economies new impetus to grow and prosper and their political voice will increase. Far from sidelined, they will gradually increase their share of attention and in many cases deservedly so.
This book is for those who agree that it may take another few years, possibly longer, before the true impact of smaller, less-developed economies is fully appreciated. As investors, you do not want to wait until the future is history; now is the time to reflect and act.
On such a broad subject there cannot be only one view. Thus a number of contributors who have experience and insights into the trajectory of developing markets and are not hypnotized by China, India, or some of the other mega-economies are included. Undoubtedly, China will dominate the global economy in size and impact, but they will face as many issues down the road as the United States and Europe are confronting today.
Elephant hunting is not the only solution for the rational investor. Being nimble and alert is often the better play. To adopt a stratagem of The Art of War (Sun Tzu), when all investors target the relatively big markets and they become more expensive, the rational investor will be nimble and fast and target the less popular opportunities. This we argue throughout this book to the extreme of talking about Lao PDR, the Kingdom of Cambodia, or even Haiti as a possible investment destination in a timeframe of a few years to a generation’s lifetime.
Parts of this book are written from the perspective of a private equity investor (direct investments) because private equity investors are less concerned about the initial stock market framework or comparative analytics from a Bloomberg/Reuters screen and more about the specific investment and its value creation. They are more adventurous and find more interesting investment opportunities; they tend to outperform more passive public equity investors. Much can be learned and in developing economies even listed companies often present themselves and behave in way that is better suited to the assessment and approach of private equity investors.
In today’s world, the asset management industry that manages most of anyone’s financial assets faces great challenges. As with listed companies, the focus is on the shorter term when investing should be a horizon beyond five years. It is about capital concentration and the rewards asset managers get for investing other people’s money in line with traditional wisdom even as the world changes fundamentally. It is about sharing accountability with others when markets decline or blaming global economic factors for value destruction. We argue that with respect to the potential of developing economies, the train has left the station. Hard work, flexibility, and significant due diligence will be required but there can be no escape from investing in smaller developing markets.
Most of the growth will come from economies that are still weak in key areas such as the rule of law, governance, and economic freedoms; these economies are dominated by informal structures. We see these bandit economies as no different than where European kingdoms or territories were a few hundred years ago, or the United States maybe 200 years ago. However, at the current rate and catch-up, this time frame has been compressed. Developing economies generate three times marginal GDP compared to developed nations and create three times the population. They all want to become economically independent and prosperous. A hundred years becomes 20 years, and in the case of South China it was only 5 to 7 years. In 5 to 10 years, the discussion about developing economies will be very different than it is today and our arguments will be old hat. Such is the pace ahead of us.
Moreover, in a few years’ time, we may no longer be focused on GDP but on more advanced concepts such as the inclusive wealth3 of an economy, which go beyond the income view of GDP to measure the assets and sustainability of an economy along its produced capital, human capital, and natural capital. Then, the relative importance of some of the smaller developing economies will become clear: They are the main source of growth and resource supply to the rest of the world, which is increasingly depleting its resources and has little opportunity for substitution or augmentation. Since investment success ultimately depends on economic growth, these sustainable economies will continue to outperform more advanced economies and investors will increasingly bet on sustainable growth.
We see developing markets as the upcoming middle class of the world, the necessary driver of all economies. They save, consume, start companies, and create value. Sharing in the growth of this group of economies is imperative. As with the middle-class customer, the individuals may not be attractive as customers, but as a group they are increasingly dominant.
In the end, investing is all about making money and this book offers general and specific, theoretical and practical approaches to this subject. With several contributing authors, this book offers different perspectives, styles, and ideas that reflect the multidimensional nature of investing in emerging markets, both in private and public securities and across the globe. Every reader should find something useful, interesting, or beneficial but should accept that this is only one book. There are already many publications and there will be many more to come and in only a few years we will rewrite history in these markets that can double in size and attractiveness over such a short period.
As always, all errors, omissions, unsupported facts, or political incorrectness remain my responsibility. I ask all those who are critical of some points or phrasings to look for the substance and intent and not the form. Many of the markets described are considered countries in one part of the world and not so in others. Many economic judgments invoke philosophical and emotional reactions. National sentiments are high, arbitrary country borders injurious, and inequalities great. Anger is prevalent and may be fueled. That is not intended.
This book is about investing money for profit and thereby ultimately providing a future for every individual, family, company, economy, and regional market that is willing and able to perform. This as the only stable way I know to increasingly align legitimate global interests and individual aspirations across the arguably widest range of possible markets and cultures. If we can achieve this through rational investing, politics and conflicts will have a much smaller role, as they deserve to have.
The book is divided into three parts.
The first part discusses more conceptually the nature of developing markets and the current state of selection of investable markets by major service providers and asset managers. We take a critical view on the prevailing classifications that guide and benchmark capital flows. We also suggest that the emphasis on stock market attributes is not the necessary condition for investors—for traders yes, but not for investors. We argue that stock market attributes are the sufficient condition but that the endowment of an economy in terms of legal and governance frameworks, economic freedoms, and resulting competitiveness is the necessary condition. Essentially, we take the view that although both are required, quality outweighs size. This aspect is largely missing in current perspectives.
We take some guidance from private equity that traditionally is at the forefront of investing. Based on their considerations, flows, and outlook, we develop a framework that harnesses both quality (enabling conditions) and quantity (size) of an economy and its capital markets. This makes for interesting results.
The second part is an advocacy for developing markets investing, largely in emerging economies, from a variety of perspectives. The allure of investing in emerging markets has a solid foundation. Several contributors generalize this theme and offer insights and arguments for taking an investment position. They highlight some of the risks but remain fervent supporters of emerging market investments. Mostly they are regional specialist investors, analysts, or general economists.
Both the outlook of developed economies and the resource endowment of developing economies are analyzed and commented on. The merits of investing in developing economies stands to reason from two angles: (1) the weakness of developed economies and their imminent plight (moderate growth with large debt burden and unemployment as well as depletion of their resources) and (2) the refreshing nonconformity and potential of many developing economies on their own merits based on their resources and human capital.
A review of regions such as sub-Saharan Africa, Southeast Asia, or the wider Middle East–North Africa, demonstrates where future market value and growth could be found. They are no longer or not much longer blips on the radar screen.
The third part takes the advocacy for developing markets investing one level deeper. More pragmatic aspects on developing economies and even some hereto unclassified economies dominate the contributions. A true and different insight into the global elephant China aptly demonstrates that size does not overcome structural boundaries. Economies grow faster than they can build foundations. Accepting some inherent weaknesses in any accelerated economic development is critical to investors fascinated by macroeconomic statistics and population size.
Credit markets, frontier economies in the wider sense, economies with newly established stock markets, and property markets across some of Southeast Asia are other more real-time subjects treated. These outlying countries and assets are on the way to making a name for themselves and are on the way to joining the group of investable economies. Although they have the narrowest of bases, they can deliver valuable returns and are determined to increase their offerings for investors. They could be but a few steps away from becoming worthwhile frontier economies. To complete the picture we take a current “non-market” and review their prospects for joining the ranks of an economy to think about much further out.
We consider a few subjects traditionally not considered by many investors. They address some critical business and operating issues such as the growing coverage of UK and US anticorruption laws, a subject very relevant to any developing economy investment, the substance of marketing, and the complexities of information aggregation and collection. It is but a glimpse into what direct investors have to deal with every day but also a reminder to public market investors that not all that seems to be, actually is. We complete the book on the lighter side with some experience and advice by pioneer investors and advisors.
These contributions highlight the inherent contrast and contradictions in developing economies that mirror the very challenges emerging markets investors face. While frameworks are often in place, they may not be applicable or institutions lack any practical experience as to how they should be applied. Not all that is legislated, written, or said about frameworks, rankings, or even ratings in emerging markets—and is true on paper—also happens in reality. This lesson is the most realistic and insightful balance to the allure of investing in emerging markets.
My profound and primary thanks go to all the contributors who have mostly stayed within the (moving) timetable and provided material and support as and when required. They are the spice and backbone of a multiperspective publication. Without them and the multitude of their backgrounds, this book would be a one-sided affair and could not even aspire to be valuable to some readers.
Thank you, Nick Wallwork, of John Wiley & Sons, for inviting me to this largely insane commitment of writing and editing a book. As it is customary but not less sincerely, I thank the Wiley team for their forthcoming support and hope that this will be plain sailing despite the quirkiness of the authors and commensurate quirkiness of publishers today about what you can/should say, the use of the English language, and how to discuss or display matters.
I thank Robert-Jan Temmink, a contributor who also kindly edited some of the writing using his fine command of (British) English, which was then largely Americanized. In the end, it does not matter which linguistic rules are used although for any classically educated reader some of the language and wordings may seem at odds with past usage.
1. Jim O’Neil, Goldman Sachs, “Investing in Frontier Markets,” Clear Path Analysis (London, 2010).
2. Karen Ward, “The World in 2050,” HSBC Global Research (2011).
3. UNU-IHDP and UNEP, Inclusive Wealth Report 2012, Measuring Progress toward Sustainability (Cambridge: Cambridge University Press, 2012).