Disentangling Emerging Markets

I get quite cross when I hear people talking about ’emerging markets’ or even ‘BRICs’ as a single great lump of investment. To me, investing in Russia is completely different from investing, in, say, Brazil or China.

How do we distinguish one emerging market from another? Let’s look at what’s available in the market right now.

There’s one kind of emerging market, which I call the post-colonial market. Russia is a good example. What’s good about Russia? Well, it’s big, and it’s got loads of natural resources – aluminium, oil, gas, precious metals, you name it, it’s got it. In fact it’s got so much gas that it can hold its neighbour Ukraine to ransom just by turning off the taps.

Unfortunately most of those natural resources are in unfriendly environments, like Siberia – a frozen waste most of the year which turns into a mosquito-ridden waste for the remaining few months of it. The cost of extraction is high, and when I took a look at Russian aluminium a few years ago the cost of production was actually higher than the market price. Commodities prices has rocketed since then, but it’s probable that Russian plants still have a higher cost of production than more efficient producers – since most of the profits of high prices seem to have gone to buying Premier League football clubs, rather than investing in more up-to-date facilities.

‘Post-colonial’ emerging markets don’t do well in the long run. Much of Africa runs this sort of economy, exporting oil or coffee – and failing to create new industries with the returns. These markets are tied to commodity prices, and if commodity prices fall, they’ll do spectacularly badly.

Then there’s, say, China. Far from being a natural resources producer, China is now a net importer of many commodities. For instance Chinese demand (or lack of it) is the usual quoted reason behind moves in the copper price. Instead, China has become a major exporting economy competing in labour intensive sectors such as textiles, electrical equipment, and industrial machinery.

I like to think of this as a ‘truly emerging’ market. It’s not just ’emerging’ in terms of being a long way away and having an increasing GDP – it’s also emerging in the sense of structurally changing its economy. It’s emerging from an agricultural and commodity-driven economy into a capitalist manufacturing and services economy – something which, if you read your Christopher Hill, England did back in the 17th century.

India is another market that’s emerging in this way. True, it still has a huge hinterland of rural poverty relying on the agrarian economy, but it has managed to build companies like Wipro that are competitive on a global scale. Visit the call-centres and IT companies of Bangalore, even, and you’ll see a tin shack with two cows lying in the dust next to a gleaming Norwich Union office building – but despite fits and starts, despite incredible bureaucracy and uneven development, the economy is changing.

Of course you could take the view that finding the term ’emerging markets’ deceptive is a piece of pedantry on my part – it’s a convenient term for the non-developed world. In my view, though, that’s a bit like Columbus found ‘India’ a useful description for that little set of islands he found – a basic navigational mistake covered up later by calling them the West Indies.

More seriously, though, an increasing number of collective investments including ETFs and OEICs market themselves to investors using the ’emerging markets’ label. Investors obviously think they’re getting one clearly defined thing – and my worry is that if they don’t do their research in depth on the funds, they’re going to get another.

An investor who thinks they’re getting into ‘the next Taiwan’ or ‘the next Korea’, looking for an economy based on mass production of industrial goods, is going to be pretty disappointed if they end up with a fund whose main holdings are oil, copper and palm oil producers.

Fortunately investors can pick and choose which emerging markets they want – at least to some extent. For instance Lyxor offers ETFs that focus on specific markets – there’s an MSCI India ETF, a China Enterprise ETF, and an MSCI AC Asia-Pacific (ex-Japan). First State offers a set of investment funds including Indian Subcontinent, Greater China Growth, and Latin America. (It also offers interesting funds playing particular aspects of world markets, such as the First State Global Listed Infrastructure fund and Global Property, though these are not focused on emerging markets per se.)

Saying ‘I want an emerging markets percentage in my portfolio’ is not enough. It’s like saying ‘I want to buy some stocks’ without any idea of whether you’re a value investor, a growth investor, an income investor, or what sectors might be attractive. Investors need to decide on what kind of emerging markets they want to buy – and why.