Not All Emerging Markets Will Emerge

Narratives can be useful constructs, capturing the essence of a subject. However, their conceptual elegance can lead to misguided generalization. Today, two common constructs have the potential to mislead investors simply because they imply more than they should: First, ‘emerging markets’ is a term past its prime in terms of economic relevance. Second, the term ‘BRIC’ refers to what are arguably the largest of the developing economies but adds almost nothing in terms of analytic utility.1 These narrative constructs distort the deep heterogeneity across the developing world. Not all emerging markets are ultimately going to ‘emerge.’

The developing world is unbelievably heterogeneous in most respects. Indeed, there is little, outside of relative poverty, tying the 90% of the world’s population living in it together. These are vastly different countries in terms of levels of wealth (i.e., Russia v. Peru), distribution of wealth (South Korea v. South Africa), commodity endowment (Russia v. China), balance of payment, or net savings exposures (Taiwan v. Turkey). So whether it was misplaced enthusiasm about the universality of extraordinary growth in the ‘emerging market’ middle class or more recent universal despair about ‘emerging market’ economic fragilities, we would caution against assuming homogeneity.

The only real generality that can be made straight across the developing world’s countries is that they all have the potential for economic ‘catch up’ with the ‘developed’ economies of North America, Japan and Western Europe. Catch up has two important sub-themes. First, relative wealth is really all about relative productivity. Less developed countries are less productive—hence poorer. This is almost entirely a result of relatively fragile and volatile political and financial institutions. Second, catch up is about potential, not inevitable convergence.

Our approach to heterogeneity

So how should investors approach investing in the developing world? We have our fair share of strong opinions about relative convergence prospects, economic and political reform prospects, and thoughts on cyclical shifts in growth, inflation and currencies across the developing world. We don’t mind standing on soap boxes to pontificate once in a while, ourselves. However, this is not core to what we do as one of the more successful investors in these markets. This is not the essence of our approach to investing in the developing world. Instead, we approach the developing world really the same way we approach investing in the developed world.

  • We figure out what matters. We identify the big themes most likely to propel durable structural growth and create potential for sustainable increases in earnings and cash flow.
  • We focus on companies, not countries. For example, we are not of the view that Russia is necessarily the hottest structural growth story on the planet at a macro level, but we have 7.53% of the portfolio invested in three extraordinary companies which are amongst our five largest positions. These stocks have been massive contributors to fund performance over the past three years, against a rather uninspiring performance for the broader Russian bourse.
  • We focus only on companies with ‘massive advantage.’ These are a relatively small subset of emerging market companies. They all possess the following rare economic characteristics: unique and durable advantage, long-tailed growth opportunity and high returns on capital.
  • We focus on companies with real options. Great companies often embed real options. These options are the potential to develop entirely new markets or products that result from dominant market positions or innovation.
  1. BRIC is a grouping acronym that refers to the countries of Brazil, Russia, India and China.

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Foreign investments may be volatile and involve additional expenses and special risks including currency fluctuations, foreign taxes and political and economic uncertainties. Emerging and developing market investments may be especially volatile. Diversification does not guarantee profit or protect against loss.

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