As the balance of global economic power shifts, I’ve been thinking about a book called Guns, Germs, and Steel: The Fates of Human Societies that geography professor Jared Diamond published in 1997. Diamond set himself the task of explaining why, over the previous 500 years, Eurasian societies have been so successful in dominating societies in other parts of the globe. You don’t have to like or even believe Diamond’s arguments to be impressed with his range of knowledge about familiar and unfamiliar societies around the world. However, his central theory that geography is destiny —what he calls “geographic determinism”—is implicit in a lot of current investment thinking. We tend to think we know a lot about an investment simply because we know where our target investment is based. An example of this is “I think China is going to grow fast so I want to invest in China.”
To some extent, this way of thinking is reasonable. For instance, sovereign debt depends almost entirely on the economic vitality, fiscal soundness and currency strength of the government that issues the debt. Even for equities, accounting standards, control of corruption and currency strength are tied to specific countries and can affect an investment’s attractiveness. In rapidly evolving markets, local entrepreneurs enjoy certain advantages, such as a common language, knowledge of how to cut through the red tape and an understanding of local cultural norms. Fast growing economies will spawn companies with these advantages and investors should seek them out, but when it comes to investing, being there isn’t the game.
Without question, successful investors should understand and take into account where wealth is being created. The question then becomes “who profits from that wealth creation?” The answer probably includes many businesses that are located very far away. Sometimes, local factors offer an explanation. Hot weather and the prohibition of alcohol may help explain why Coca-Cola started out in Atlanta, but they can’t explain its global success. More recently, Infosys may have benefitted from starting in Bangalore, an area with many well-trained, poorly paid software engineers, but does the location of its headquarters fully explain its current ability to compete from dozens of offices and development centers around the world? I don’t think so.
I love to read about geography and its interplay with history, but when it comes to investing, I recognize the danger of using location as short hand for earnings potential.
Investing in foreign securities entails special risks (such as currency fluctuations and political uncertainties) and may have higher expenses and volatility. These risks may be enhanced when investing in emerging markets.”