On July 4, while most of us were watching fireworks or flipping burgers on the grill, a fascinating story appeared on Reuters. Headlined "Emerging Markets Was A Costly Mistake -- Goldman Executive," it featured the views of Sharmin Mossavar-Rahmani, chief investment officer of Goldman Sachs' private wealth management group, which manages the money of the 1%. If you have to ask what the minimum account balance is, you can't afford it.
Mossavar-Rahmani was extraordinarily candid. "Many investors and market commentators have been too euphoric about China over the last decade and this euphoria is finally abating," she said. "Many just followed the herd into emerging markets and over-allocated to many of the key countries..."
Followed the herd? Who led the charge? Why, Goldman Sachs, of course -- which, more than any Wall Street firm, helped create emerging markets fever. On Nov. 30, 2001, economist Jim O'Neill in Goldman's London office published a paper entitled "Building Better Global Economic BRICs." It said the four BRICs -- Brazil, Russia, India, and China -- were poised to take a larger share of the world economy as they grew much faster than their slumping counterparts in the U.S. and Europe. In 2003, O'Neill doubled down, as his team predicted that by 2039 the BRICs could overtake developed economies.
The second paper came out just as emerging markets went on a tear -- the MSCI Emerging Markets index racked up annualized gains of 37% from 2003 to 2007. The call was well-timed, but it was first and foremost a brilliant piece of marketing. It gave emerging markets a catchy acronym -- BRICs -- that would have made "Mad Men" advertising honcho Don Draper proud. But it also provided Wall Street with a story it could tell the world. O'Neill snapped the ball and the rest of the Street ran with it.
Pretty soon it became conventional wisdom that emerging markets were the place to invest, particularly the brand-name BRICs and especially China. Advisers told clients the world had changed and that they now had to invest much more in emerging markets, because that was where the growth was. Never mind that extensive research has found higher GDP growth does not lead to better stock market returns, or that the wide acceptance of the BRICs-will-conquer-the-world thesis coincided with their 2007 peak.
The MSCI EM index plummeted 53% in 2008, and weighed down by secular bear markets in three of the BRICs (Brazil, China, and Russia), it has lagged the U.S. for two full years.
O'Neill Retires and Goldman Moves On
That didn't stop myopic U.S. investors from foolishly pumping money into emerging markets long after the party was over. In September 2010, O'Neill was named chairman of Goldman Sachs Asset Management, overseeing more than $800 billion in assets. "The bank is sending a strong message: emerging markets are the future," The Financial Times' beyondbrics blog wrote. If so, the future didn't last very long. In February, Goldman announced that the 56-year-old O'Neill would retire after two and a half years on that job and 18 with the firm.
"Jim's BRIC thesis has challenged conventional thinking about emerging markets, and as a result, has had a significant economic and social impact," said a press release co-signed by Goldman's CEO Lloyd Blankfein and its president Gary Cohn. It was a gracious send-off, but at least one big part of Goldman has been moving in the opposite direction, as Mossavar-Rahmani's comments indicate. Instead of emerging markets, she said investors should stick to the developed world, especially Europe and the U.S. It's a position she has taken for four years.
Emerging market investors, she said, "are taking on so many risks compared with the U.S." She expects the U.S. and other developed markets to outperform their emerging market counterparts for a while. "The surest and best way to add value to a portfolio is to be exposed to the economic engine of the U.S.," she told Barron's late last year. "The way to get exposure to that great wealth is through owning U.S. companies." She'll get no argument from me on that.
According to the Barron's profile, Goldman's private wealth management group has revamped its asset allocation model to diversify based on risk, rather than asset class. Its model portfolio for taxable accounts of conservative investors recommends a 22% weighting for U.S. and developed-market stocks, but a mere 5% for emerging markets equities and debt together. That latter number sounds about right to me, though I'd avoid the BRIC-heavy general emerging markets ETFs like VWO and EEM and concentrate on strong markets that are hitting new highs, like Mexico, Indonesia, and the Philippines.
In an email, a Goldman spokeswoman pointed out that Mossavar-Rahmani's Investment Strategy Group is separate from Goldman Sachs Asset Management and "expresses independent views." She also wrote that "Sharmin has had a smaller allocation to EM for a while now, since before Jim's departure."
Maybe so, but isn't it ironic to see a top strategist of the firm that helped create the emerging markets boom kick these former high- flyers on their way down?