Thursday, December 26, 2013

Emerging Markets Aren't For Most Investors

Brokers have rebranded themselves as "wealth managers," and the lure of emerging markets has been part of their patter for individual investors for many years.  Emerging market mutual funds have sprouted at both new and established mutual fund companies.  Using Lipper data from the Wall Street Journal, the only wealth created recently has been for the brokers and the mutual fund companies themselves.

Over the past 3 years, 332 emerging market equity funds have generated an annualized total return of -1.54%.  Over this same period, the top five funds have generated total returns between 7-8% per annum, but they are all pan-African funds with minuscule asset bases from $6-$192 million.  

For the past 5 and 10 year periods, Lipper's emerging market equity fund universe generated annualized returns of 14.77% and 10.51%, respectively.  These historical numbers were, of course, the basis for generating sales, which were also helped by references to diversification and to overvaluation in U.S. markets.  

The problems with the naive emerging markets story are manifold.  Higher GDP growth rates aren't a guarantee of higher stock market performance on any consistent basis.  Some recent academic research suggests that if the higher GDP growth rates are consistent and sustained, they serve as a cap on the long term growth of current high growth public companies.  

Morgan Stanley emerging market fund research head Suchir Sharma has suggested that emerging markets have become a "mature asset class," and many of their stellar companies may be like shooting stars rather than homes for long-term money.  Don't forget, we're talking about equity vehicles available to individual investors and smaller institutions.  Morgan Stanley's largest emerging market fund (MGEMX), has had unremarkable performance for the time periods above, at the cost of a high expense ratio and a $5 million minimum.  

But, if GDP growth rates might be higher in some emerging markets and larger middle classes shift over to higher consumption, isn't there money to be made? There surely is, and the fact is being recognized by very wealthy private investors and by very large institutional investors.  Especially with the recent downturn in commodity prices and the visible failures of private empires built on the same, opportunities abound in private debt instruments and in real assets like production and processing plants and in the resources themselves.  

The problem?  The sponsoring organization for a superior fund must have informational, locational and institutional advantages that put its feet on the ground, with a history of actually doing business in a market. That doesn't describe the likes of  Morgan Stanley, Fidelity, or T. Rowe Price to give example of large fund families.  They rely on the same outdated, unreliable published economic and corporate statistics, freshened up with some quick visits to government officials in PR situations.  As Sam Zemurray said in his book, the only answer is to "go and see for yourself."  Few can do that and combine it with investment savvy. 

Carval Investors, a unit of global commodity production, marketing and trading giant Cargill, has some interesting offerings that have the advantages needed to be successful over the long-term in emerging markets. Their funds are open and suitable for larger, long-term investors who don't require liquidity.  For the rest of us, emerging markets will remain a crap shoot.  

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