What is an emerging market?
The question has gained currency in the aftermath of the global financial crisis, which was a crisis of the developed world. The superior economic fundamentals of many ‘emerging’ markets in contrast to the developed world has turned traditional notions on their head.
Ashmore Investment Management’s economist Jerome Booth argues a maximalist view that the term ‘emerging’ is irrelevant and condescending.
“I define emerging markets not by their risk, but by risk perception,” he says. “All countries are risky. Emerging markets are those in which risk is priced in; developed markets are those in which local investors don’t perceive their own risk. To be a developed market is to have a licence to be irresponsible.”
He argues that Iceland was able to perpetuate its “Ponzi scheme”, as he terms it, for many years because “it was triple-A, white and Nordic”. The same lack of care allowed Bernie Madoff to scam many investors, including his fellow Jews.
“The idea of emerging markets is all about prejudice,” Booth says. “There has been a huge delusion among investors about risk.”
He argues that truly conservative investors should have all of their assets allocated to emerging markets.
However, most central bank reserves are in Treasuries, supposedly for their liquidity. Booth says liquidity must be defined in part by how investors behave in times of stress. If one central bank begins to sell its US Treasuries, the rest will follow suit very quickly.
“And then there’s actually no liquidity, because the only buyer left would be the Fed,” he says. “Central banks are suddenly realising there’s no such thing as a risk-free investment.”
He argues that conservative investors should avoid what he calls the ‘crash zone’ (ie the US, Europe and Japan), and only hold those assets if an investor has liabilities denominated in their currencies.
If an investor must invest in the ‘crash zone’, then it should be able to shift portfolios in case either US monetary policy works and helps the West gradually recover, or in case it doesn’t and there’s either a massive recession or a dollar crisis. He argues that the best insurance against a dollar crash is to buy local-currency debt and currencies in emerging markets, because most of these units are safe.
He does not think gold will help, however: “Oil would be a better hedge because it has real links to the economy.”
Third, Booth argues, investors exposed to the US and Europe must understand that there’s no such thing as a risk-free return. They should invest in Treasuries for a return, not because it’s a safe haven.
Fourth, he urges investors in the ‘crash zone’ to avoid anything illiquid, because they may need to sell quickly. He believes that infrastructure, which is currently a popular choice, is risky in the West, because tariffs and terms are likely to be changed by governments that need to find new sources of revenue. He believes foreign investors would have no leverage if such a thing occurs in the US or Europe, whereas governments such as New Delhi are still keen not to be embarrassed by foreign investors.
Within emerging markets, he says equities will be volatile and will also suffer if US stocks do poorly; therefore, only investors prepared to ride out volatility should seek EM equity exposure. However, there are many other ways to play emerging markets, from credit to Reits to real assets, Booth argues.