It had to happen. After nearly a decade of infatuation for the Emerging markets as an asset class, the passion has worn out. Sobered by: (i) 5 years of dramatic underperformance , (ii) tales of corruption that would make the tax-payer rescue of Wall Street firms seem like an act of angels, (iii) policy making that is inept at best while disconnected from the needs of the people most of the time, and (iv) unending images of social strains and street protests, investors have thrown in the towel.
On recent visits to the source of capital in the developed world, the question hanging in the air is: Why should we invest in Emerging Markets? We have all the global companies with all the growth and exposure to the developing markets listed right here in the developed world. Why should our capital leave the safe shores of the US and some developed markets?
Is this a Roxy Music “Shake your head back with your pony tail / Takes me right back, when we were young” moment?
In late 1999 when the dotcoms were ruling the world and economic cycles were about to be relegated to the dustbins of history, respected strategists, asset allocators, and fund managers were merrily chanting the mantra: Why be in emerging markets when all the growth is right here in the developed markets – in the technology sector? The gurus claimed that – with all the liquidity on NASDAQ, where listed companies adopted solid accounting rules and followed the highest standards of corporate governance - there was no reason to be in EM. We know how that ended.
Is there a case for investing in EM – or in India?
In early 2003, Subbu and I met with the then CIO of one of the largest India-dedicated pools of capital. During the meeting we were told very matter-of-factly, that “equities as an asset class is dead”. I recall turning to Subbu and saying, “the bull-run in Indian equities is about to begin”. And it did. There is something about blanket, carte blanch statements that make you take notice and question the “conventional wisdom”.
But there are reasons why “wisdom” swayed the hearts of many investors in India. In 2003, the world was tottering from a triple whammy of the bursting of the tech bubble, the psychological humiliation of 9/11 orchestrated by a dozen men with limited ammunition on the World’s Super Power and all the Progress that it stood for, and the uncertainty of SARS. It sure felt that risk-taking (or risk evaluation) was dead. And when in a “risk-off” mode, equities as an asset class tend to languish – globally. So, ceteris paribus, “equities as an asset class” was dead.
By 2005, the re-discovery of risk, glorified by Goldman’s BRIC report, took romancing with the emerging markets as an asset class to the other extreme. Having an Indian or Chinese name was fashionable. Teaching your children Mandarin or heading out for your Yoga-spinning session became a great talking point on TV. The “wisdom” of those times was: invest in EM, ignore the developed world.
Full circle: Goldman is underweight on India.
Goldman has thrown in the towel on India. Given the cyclicality of the love-hate relationship with India, it had to happen. After nearly a decade of infatuation for the Emerging markets as an asset class, love is no longer in the air. The BRICS have become BRATS that investors wish to see locked up in a style box and avoid like the plague. India, Goldman has declared, is an “underweight”.
There have clearly been disappointments in the governance and in economic policy across the major emerging economies. To name a few:
1) India’s corruption-riddled auctions of natural resources has further decimated its poor, brought in less money to the government, and dramatically enriched the well-connected.
2) China’s focus on exports ignored the opportunities of catering to a domestic audience.
3) Brazil and South Africa seemed more intent on building stadiums for hosting the World Cup for Football rather than the needs of their citizens.
4) Russia remained in an era wrapped in cloak and daggers.
In every nation, the policy-makers were so swept by their new found mathematical power of population – or their God-given gift of natural resources - amplified by unrealistic assumptions on an XL sheet, that many have lost touch with reality.
A rectification of past errors is now more complex because local dissatisfaction has given rise to protests of a kind, variety, scale - and frequency - never seen before. The Indian government, despite credentials of being part of a 66-year old democratic process that many times totters on mutiny, is as clueless as authoritarian China on how to handle protesters.
A more realistic expectation for EM?
Maybe the XL sheets and the convenience of dragging that right clicked cell to infinity will be reworked to better model the real social and political issues facing the various Emerging Markets. The expectation of a world ruled by BRICS will be muted by the stark realities and severe limitations of each country. And these very different countries will, thankfully, no longer be seen as one homogenous entity for the convenience of an acronym.
But there is something real happening in those economies. The facts of growing consumption from a larger number of people should not be ignored. The passion and skill that drives many of the western-educated, western-trained (or locally-educated and locally-trained) personnel building or driving businesses should not be discounted. The infrastructure build-out will happen – but in a time span and funding pattern that remains an unknown. The dance of capital, resources, and labour will ensure that the emerging economies will grow – but inconsistently. Consider that the savings pool of many of the emerging economies is pretty sizeable. Many of the emerging economies are not short of capital – they are short of policies and mechanisms that need to convert this savings into productive use for the benefit of their societies and not a favoured few. A disease now spread to the developed world.
So, to answer the question: is EM as an asset class dead? No, but the passionate love affair with the BRICS is thankfully over. Now allocators and fund managers can start to do more intensive work: identifying regions, countries, companies, and managements that will build some real wealth.