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Investing in emerging stock markets

Page history last edited by Brian D Butler 13 years ago

 

 

Table of Contents:


 

 

see also: invest,  asset managementETF exchange traded funds

 

 

 

Trends in Emerging Markets

  see more underlying trends that are shaping our world today

 

1.  Transition from state-run (socialist) to market-driven economies

2.  Privatizations of state owned enterprises

3.  Liberalization of trade policies

4.  Liberalization of FDI foreign investment policies

5.  Formation of regional trading blocks and regional integration

 

*  related pages:  Washington consensus , Criticisms of the Washington Consensus

 

 

 

 

Investing in Emerging stock Markets

 

When investing in any stock market, you must remember that risk is directly related to returns.  The basic law of investing is that The higher the risk, the higher the expected returns.  The reverse is also true...if you see someone getting higher returns, then it probably means they are taking more risk.  If they are getting excellent returns, then either (a) they are extremely skillful, or (b) they are taking an extreme amount of risk (or maybe both).  When I say "extremely  skillful", I mean that they are better than the millions of other professional investors who are also trying to get the most returns possible (for their acceptable level of risk).  Remember that risk + return must be directly correlated.

 

Also investing is different than speculating.  If you are investing, do it on fundamentals

but if you are speculating, its like visiting a casino. 

 

If you visit a country or a stock market, and see everyone making money (easily), then you know that the skill is not in the individual investor.  If you are not taking any additional risk than the other local investors, then you can be sure that the risk is "systematic".  In other words, most international investors have already assumed that your entire stock market carries some level of risk.  Rightly or wrongly, they have assumed that your stock market has some level of risk which may be deterring people not comfortable taking that level of risk. 

 

For example, I visited China in the middle of 2007, and there was such euphoria over the stock market, that it seemed like just about anyone could make money in that market (and just about everyone was).  But, then something happened:  the Chinese market began to cool, and cool down fast.  Within about 6 months, all of the gains over the past year were wiped clean, and the Chinese investors were left frustrated.  Those investors that jumped in at the peak of the market lost alot of money. 

 

The point of this story is that the overall Chinese stock market was risky, not just the individual stocks.  There was a systematic risk that international investors were aware of, and should consider before investing.  (oh, and it also helps that China restricts foreign access to a majority of shares...see discussion below about Brazil vs. China).

 

 

 

 

 

Why do Bubbles happen?:

 

Illusion of control:  people believe that they are in control when in fact they are not.   This is seen when people are willing to pay 4 times more for a lottery ticket in which they choose the numbers as compared to one in which the numbers are automatically generated.  Also, people will bet more on the flip of the coin (heads or tails) if they can call it in the air, rather than after it has landed (as if they can somehow change the outcome in the air by wishing for it). 

 

So, people generally might see that a crash is coming, but the believe that they will be able to get out in time, and that they somehow have some degree of control over its outcome by being "connected" to it. 

 

Main lesson:  make sure your investments are based on your own analysis, and not on the opinions that you read in the financial papers!  Conduct your own analysis of what you think the assets are valued.  Challenge your assumptions, and invite others you respect to also challenge your assumptions to make sure you stay grounded in reality!

 

For MORE....see our discussion on speculative asset bubbles (internet, housing, commodities)

 

 

Rules can change

 

Investing is tough enough without rule changes in the middle of the game.  But that is exactly what happens in stock markets such as China's.  In order to slow down the market, the goverment raises the "stamp duty",  but then once its going to slow, and people are getting upset, they cut the rate, and the market rallies. 

 

In places like Colombia and Brazil, we see governments that are worried about the massive influx of foreign capital, and what effect that may have on their exchange rates.  So, capital controls are discussed.  In Colombia, that had the effect of killing the market.  be careful, rules change.

 

 

The Dangers of "chasing past returns":

 

Lesson for individuals temped by big returns (of the past);  Don't jump on a bandwagon as it nears its peak.  If you are going to invest, please do so at the bottom of the cycle, and not at the top!.   Do not get tempted to chase the good returns of the past.  Just because a market has gone up in the past, it gives you no security that it will continue going up in the future.  Remember, the more that a stock market has gone up, then the closer it is to its peak (and the sooner it is going to fall).  On one hand, you would have been foolish not to invest in China in January of 2007 (you would have missed one heck of a bull run), but you would have been even more foolish in October of 2007 to look at the past bull-run, and to think that it was going to happen again.  It wasn't.  If you had invested in October of 2007 (as many, many people did), you would have lost almost 50% of your money.  See the chart below.

 

Lesson:  be careful of chasing returns.  Be careful that risk & return are always correlated.  Recommendation:  stay with ETF exchange traded funds ...they are better for the long run (and there are many in emerging markets such as ETF's Brazil).

 

Dont learn this lesson the hard way.  If you had seen (as I did) the massive gains in technology stocks in '99-2000, you might have been tempted to shift your portfolio to chase those returns (as I did).  But, chasing past returns is like hoping that lightning will strike twice at the same location.  It doesnt (not very often, anyways).  What normally happens (as it happened to me) is that people invest at the top of the market, only to see the market fall, and losses follow.

But, if you are going to try and "time" the market..make sure you are very fast at getting out!

 

 

Timing a train crash

 

Its like getting onto a train that you know is going to crash eventually.  A wise person wouldn't get onto the train, because they knew it was going to crash.  But, an active investor may be tempted to jump on and ride it for a little while, with the intention of jumping off right before it crashes.  But what happens if you go to sleep, or miss the right time to jump?  Most people are in this group, and ride right into the train wreck.  See our discussion on the subprime lending and the ensuing credit crisis of 2007 in the US.   This is a clear example of investors reaching for extra returns (and not aware of the additional risk that they were taking)

 

 

 

Market potential index - which emerging market should you consider for investing?

 

see related pages from GloboTrends:  emerging markets  and  marketing opportunities in emerging markets  and Investing in emerging stock markets  and Private equity and venture capital in Emerging Markets  and Rise of purchasing power in emerging markets and International IQ

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"You started your business, you exploited the opportunities in your local markets and now, like all entrepreneurs, you are looking for other avenues of growth. In today’s economy, emerging markets are booming and providing many great opportunities for entrepreneurs looking to expand their brand.

 

However, with so many choices which market is right for your business?

MSU-CIBER has created a resource for small to mid-size companies designed to help solve this dilemma called the Market Potential Index (MPI). The MPI scores the market potential of the 26 countries considered emerging markets by The Economist - all of which are experiencing rapid economic growth and positive social change. The Index uses eight dimensions and takes into consideration size, growth, potential capacity and risk. The index has been published annually since 1995 and has been successfully utilized by many companies and investors to identify sustainably fast growing emerging countries. 

 

Two well-represented regions in this year's rankings are Asia and Central Europe. Asia is home to the top three countries: Hong Kong, China, and Singapore. These three countries have held the top spots for five years running and have been fueled by exports to developed markets and an emerging middle class. Central Europe also has three countries in the Top 10 including Czech Republic in fifth, Poland in sixth and Hungary in eighth.  Many Central European countries have recently experienced accelerated growth rates and a rising standard of living through the exportation of goods to established European countries, the privatization of state-owned corporations and the introduction laws that encourage new business development.

 

Egypt has been in the news recently for its government overthrow and is therefore a great case study for the MPI. In this year's rankings, Egypt ranked particularly high in growth (7th) and capacity (6th) and relatively low in risk (21st) and freedom (22nd). Overall, one could interpret this country to have a relatively high market potential, but the index calls into question its risk and freedom. The protests demanding greater democracy could drastically increase their freedom rankings if Egypt is able to translate its new government into a more open economy. Egypt currently ranks 16th overall and would be a great place to research more thoroughly if conditions improve. 

 

If your business is looking to expand abroad, make sure you are well informed and start your learning process with the MPI and globalEDGE’s Diagnostic Tools.

 

Most recent year:  http://globalEDGE.msu.edu/resourceDesk/mpi/

Past years:  20092008, 2007, 2005, 2004, 2003, 2002, 2001, 2000, 1998, 1997, 1996

 

see related pages from GloboTrends:  emerging markets  and  marketing opportunities in emerging markets  and Investing in emerging stock markets  and Private equity and venture capital in Emerging Markets  and Rise of purchasing power in emerging markets and International IQ

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Investing in Stock markets (General)

 

see our discussion on asset management

 

 

 

Active (alpha) funds vs.  Passive (beta) funds:

 

Active:  "alpha" is known as the skill of the investor.   This is a type of fund that attempts to "beat the market",  or offer their clients a better return that the market as an average.  The theory is that if you are better than average at picking investments, you should be able to offer your clients a better return.  Rich clients love to hear this.  They dont want to think that with all of their millions of dollars, they are just getting an average market return.  They think they should be able to do better (or else, what is the point of being rich), so they are willing to pay the "best and brightest" on Wall street a good fee for offering their skills to beat the market.  This explains why bankers in Wall Street get paid so much money.  Its all in the fees, and the psychology of the rich clients that are willing to pay to (hopefully) get higher returns.  Alpha is highly desired, and is very hard to come by (for a sustained period of time).  

 

Passive:  "beta" investors seek to return the market average.  Whether that market be the S&P 500, some foreign market, or any asset class... passive investors can play the market with ETF's, at a much lower cost than paying for active managers, and not chasing "alpha" (with your check book open).

 

 

 

Strategies to outperform the market

 

** see our discussion on alpha

 

 

 

Lessons from Colombia

 

The stock market was booming in 2006, but the government was concerned that the currency was appreciating too much (and exports were loosing competitiveness).  As money came into the country to invest in the stock market, it pushed the currency up.  To stop this appreciation trend, the Colombia government put in place capital controls (see below).  This made it more expensive for foreigners to invest in the stock market (but didnt change the cost of buying government debt, corporate bonds, etc).  The result?  Colombias stock market in 2007 was one of the worst performers in emerging markets (at the same time that Peru and Brazil's stock markets were booming).

 

lesson:  government intervention (for other reasons) can kill a booming market. 

 

 

Capital Controls in Colombia

 

 

Colombia has (4/2008) imposed capital controls to limit excessive short-term inflows that will cause high currency appreciation. These controls, which require foreigners to make a deposit of 40% of their portfolio investment for six months at the Central Bank without earning interests, have been ineffective in stopping the strengthening of the peso, and have had a negative impact in the equity market.

 

Capital controls in Colombia have been ineffective in stopping the appreciation of the currency, and have created distortions in the equity market, increasing its volatility. At the end of last year, the government announced some relaxations for the controls, including the elimination of the restriction for IPOs´. While this is a first step in the right direction, it is far from sufficient. An elimination of all restrictions, at least as far as equities are concerned, is necessary to promote the liquidity, transparency and proper operation of the stock market in Colombia.

 

IN Colombia:Due to the massive amount of FDI that has flowed recently in to Colombia, the government put “capital controls” into effect to limit foreigners ability to invest in the stock market or bond market. These capital controls are worrying due the increased spread on government bonds, and the resulting increase in borrowing costs for the government. It also indicates that the government is concerned about currency APPRECIATION and not DEPRECIATION. They are afraid that the massive influx of capital will result in currency appreciation, cutting off export competitiveness. This is an area to watch in the future to see if they release capital controls…and if they do, how will that effect the currency, but if they don’t, then it should harm their stock market (as we see, in 2007, the Colombia market was one of the worst in the emerging markets…after the controls were put into effect). 
  

 

Stock Market Colombia:

 

in 2007, the Colombian stock market had a very poor performance, and in 2008, the IGBC index is down by 12%, the worst one in Latin America.

 

This can be partially explained by the fact that the market is highly concentrated in local participants, accounting for 97% of daily transactions, 50% of which are retail investors. On the other hand, no more than 20 stocks are considered to be liquid and traded on a daily basis with volumes higher than US$1 million.

 

Last year was a historic one for the Country’s stock market in terms of IPO’s. More than US$5 billion were raised by Colombian companies through equities and the biggest IPO ever took place, when Ecopetrol, the state-owned oil company issued 10% of its shares, for US$2.5 billion. This amount was absorbed entirely by local investors, and close to 500.000 Colombians are now new shareholders of Ecopetrol. Retail investors bought 62% of the stocks and Pension funds acquired 37% of this issuance. Immediately after the stock began trading in November 2007, market capitalization increased by 50%. But contrary to what was expected, liquidity did not increased proportionally, and the rest of the stocks prices decreased by the end of the year, as a lot of retail investors reduced their positions in those equities to buy Ecopetrol.

 

Retail investors are selling, but, on the other hand, institutional investors (including pension funds and insurance companies) have been net buyers, acquiring more than US$200 million in stocks between January and March

 

What this situation shows is that the Colombian market needs to diversify its participants in order to reduce volatility, since relying only in local buyers and sellers is very risky. In fact, countries like Brazil, where 35% of daily transactions are made by foreign investors, and who bought on average 70% of the IPO´s in that country last year, have recovered more rapidly from the recent crisis. The Bovespa Index is up by 1% in 2008, after falling by 11% at the beginning of this year.

 

 

 

 

 

Brazil bigger than China?

 

In an article from FT.com, they noted that in 2008, Brazil's stock market surpassed China's in terms of the amount of equity which was available to investors. 

 

"The MSCI index measures shares available to investors rather than the total market capitalisation of all companies traded on exchanges. By that measure, China is far bigger than Brazil. The combined value of companies listed on the Shanghai and Shenzen exchanges was almost $3,900bn in January, compared with almost $1,300bn on the São Paulo stock exchange, or BOVESPA."

 

The South American country’s climb to the top of the index prepared by Morgan Stanley Capital International will have a big impact on fund managers around the world. Many investors benchmark their portfolios against the MSCI GEM index of global emerging markets. That could lead to a flood of new money into Brazilian shares, according to Geoffrey Dennis, Latin American equity strategist at Citigroup in New York.

 

Part of that relative swing was explained by a perception that Chinese shares were overvalued, Mr Dennis said. “Brazilian shares have been trading at 13 to 14 times earnings and Chinese ones at 30 to 40 times,” he said. “The frothy ones tend to do worse in a crisis.”

 

 

 

 

Other ways to Invest in Emerging Markets

 

 

Investing in emerging stock markets  (see below for more)

Portfolio managers around the world have been pouring money into emerging market economies.  This is good in that it helps these countries develop, but bad if the portfolio money is withdrawn suddenly, as we have seen with the crisis after crisis around the globe caused by "fast money".  This trend of hot portfolio money is troubling not only for developing nations but for the US as well as globalization has increasingly meant that what happens in one country is immediately felt in another. 

 

 

Emerging markets financial centers grow in importance

Rather than in London or in New York, many companies are listing in emerging markets, and raising domestic money in emerging markets them selves.  This is an interesting trend, as the worlds center of gravity seems to be shifting....

 

 

Private equity and venture capital in Emerging Markets

Private-equity funds focused on emerging markets raised a record $59 billion in new capital in 2007. This figure represents a 78% jump from the $33 billion raised the prior year. More than $118 billion has been raised in emerging-market funds in the last three years. MarketWatch (02/29)

 

 

 

microfinance and microcredit: investing in people

The two distinct fields of microcredit and Microfinance are hot right now, as investors seek ways to not only find attractive returns, but to also invest in projects with unique social appeal.  Seeking economic development of some of the poorest regions on earth, this movement was initially brought to the world stage by the incredible efforts of such groups as the Grameen Bank of Bangladesh and Professor Prahalad of the University of Michigan.  Since then, there has been a boom in the credit markets to service the bottom of the pyramid marketing, as banks, individuals and commercial stores have collectively realized the value that can be obtained by extending credit to the emerging consumer classes.  In response, we are seeing how the new opportunities with consumers of low income is transforming commodity markets around the world, as projects such as the Bolsa Familia in Brazil spur a whole generation of buyers to seek new automobiles, washing machines, etc.  See our discussion on the Rise of purchasing power in emerging markets

 

 

 

 

Links from Kookyplan

 

 

 

 

 

External Links:

 

 

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