Which single asset class are you most bullish (or bearish) about in the coming year? What ETF position would you choose to best capture that?
As growth remains tepid in the United States and Europe, I expect investor attention to be focused on emerging markets. The single biggest macro trend of the next two decades or more will be the continued rise of the new urban middle class in the developing world. With the exception of Tokyo, every megacity in the world is in a country that would be classified as an emerging market.
When we think of the world’s great cosmopolitan cities, we generally think of New York, London or Paris. These are incredible cities, of course, true cosmopolitan gems. But these cities are practically small towns compared to the megacities of the developing world. London and Paris do not make the Top 20 list of world’s largest metropolitan areas. New York makes the list only when you include much of neighboring New Jersey. Meanwhile, Mexico City, Delhi, Bombay and Sao Paulo all have in excess of 20 million residents.
More important, new migrants to New York, London, or Paris do not drastically change their lifestyles upon moving there. Yes, New York is livelier than, say, Muskogee, Okla. But an Okie from Muskogee is as likely to own an iPhone and have a wallet full of credit cards as a die-hard New Yorker.
In the emerging world, a migrant to the city encounters an entirely new world. As a case in point, I’m giving this interview from Lima, Peru - a city roughly the size of New York proper and getting bigger every day. The demographic transformation of this city in just the past decade is incredible. The typical migrant from the Peruvian highlands arrives on the coast wearing traditional peasant garb, but within a week they’re wearing jeans, talking on a mobile phone, and - perhaps unfortunately - driving a car. The transformation from rural campesino to urban consumer is complete. All first-world countries went through a similar process on their path to industrialization. The difference is that it is happening on a much larger scale today because the populations of the countries involved are so much bigger.
I see this as a profitable investment opportunity for the next year, but I also see it as a long-term strategic allocation. My preferred way to get exposure to this trend is via the new EG Shares Emerging Markets Consumer ETF (ECON).
How does this ETF fit into your overall investment approach? Tell us a bit about your strategy and goals.
In recent years, I have looked for different ways to get exposure to the rise of the emerging market consumer, but most have been somewhat indirect. One of my favorite sectors for the past several years has been global luxury goods, for example. This is a broad class that includes everything from scotch to women’s designer handbags to German high-performance autos.
Collectively, emerging markets consume roughly 30% of all luxury goods, compared to roughly 20% for the United States. Figures here are somewhat subjective and vary based on what is considered a “luxury good.” But no matter how you slice the numbers, this is an emerging markets growth story.
China is already the world’s biggest market for the Mercedes S-Class. Brazil is the largest consumer of Mont Blanc pens. And naturally, high-end Swiss watch brands are ubiquitous among the newly rich across the developing world. I see this as an excellent growth story for years to come. But again, this is an indirect investment. In these cases, you are still buying Western firms, and you’re targeting only the top tier of emerging-market consumers. To capture the broader theme of the development of the new middle class, you need exposure to the companies that provide products to the masses. You want packaged foods, beer, cigarettes, etc. You want the emerging-market equivalents of General Mills, Wal-Mart, Procter & Gamble, or Budweiser.
If you are an American investor more or less limited to buying ADRs traded in New York, your options are fairly limited. But herein lies the appeal of ECON. Of the fund’s 30 holdings, only four are ADRs. The rest are locally traded firms that target domestic consumers. The fund’s largest holdings are Brazilian beverage king AmBev (ABV), South African media conglomerate Naspers (NPSNY.PK), retailing giant Wal-Mart de Mexico (WMMVY.PK), and Indonesian auto conglomerate Astra International.
Compare this with the top holdings of the iShares MSCI Emerging Markets ETF (EEM), the most popular by trading volume and assets under management. EEM’s top holdings are Samsung and Taiwan Semiconductor (TSM) followed by a string of banks and oil companies. China Mobile (CHL) is the only major holding in the index with any real exposure to emerging market consumers.
Tell us a bit more about emerging-market consumers. What makes this area your top pick?
The rise of the emerging market consumer is the macro trend of the next 20 years. I am not a “permabear” on the United States by any stretch of the imagination. But I do expect growth to be relatively tepid going forward. I believe the entire Western world has several years of deleveraging in front of it, and every dollar used to pay down existing debts is a dollar that does not get spent growing the economy.
In the emerging world, the dynamics are entirely different. Credit at reasonable interest rates has long been a privilege reserved for the upper middle class and wealthy. But today, home loans, auto loans, and credit cards are becoming more and more mainstream every day. Asia and Latin America will likely have consumer debt crises of their own someday. History suggests that these are all but unavoidable in the modern financial world. But I see this day of reckoning, if it ever comes, being years or even decades in the future.
So, while I would never recommend that investors invest solely in emerging markets, I do believe that emerging markets should be a significant portion of any growth allocation. And for the reasons I mentioned, I see ECON as the best ETF vehicle to achieve this.
Are there alternative ETFs that could be used to capture the same theme? What makes ECON your first choice?
Not exactly. As I mentioned, the most popular emerging markets ETF is currently the iShares MSCI Emerging Markets ETF (EEM), but this fund is exceptionally weak in the areas where I want the highest exposure - those that are directly tied to the growth of the new mass-consuming emerging market middle class.
There are two relatively new funds by Global X Funds that are focused on the emerging market consumer, the China Consumer ETF (CHIQ) and the Brazil Consumer ETF (BRAQ), and there is some amount of overlap between these funds and ECON. Brazilian megabrewer AmBev, for example, is a significant holding of both BRAQ and ECON. The key difference to me is ECON’s diversification. I’m bullish on the consumer segment of both China and Brazil, but I want broader exposure to emerging markets in general, not just the “B” and the “C” of the BRICs. ECON gives this exposure better than any other ETF currently trading.
Does your view differ from the consensus sentiment in this area?
I’m a contrarian at heart, so the current popularity of emerging markets as an asset class does irk me to an extent. I can credibly say that I am approaching emerging markets from a different angle with ECON, though. Thus far, few investors really “get” emerging markets, though I expect this to change in the near future.
What catalysts, near-term or long-term, could move this area significantly?
Capitalism is working in the developing world, and income - slowly but surely - is becoming more evenly distributed as millions escape the poverty that has long plagued much of the world. As incomes continue to rise, so should the profits of companies that target this new middle class. That is the long-term story for ECON. Short-term, it’s a matter of investor perception. Sooner or later, I expect investors to reach the conclusion I did. Slow growth in the West will be a drag on the performance of emerging market companies that rely on exports. I expect investors to figure this out relatively soon and rotate into companies less affected by global trends.
What could go wrong with your pick?
There was an excellent white paper published last year by Carmen Reinhart and Kenneth Rogoff titled “This Time Is Different.” The paper was about the recent real estate and financial sector crisis, but you could just as easily write a paper by the same name on investor fascination with emerging markets. The emerging markets story has been a seductive one for decades, and in every boom there was a belief that “this time is different.” The instability and tendency to descend into crisis was a thing of the past.
Of course, it wasn’t different. Every time investors get too enthusiastic about emerging markets, they have to be reminded that, yes, investing in Latin America, Asia, Russia and the rest of the developing world is, in fact, risky.
So, I have to throw that out as a caveat. Western investors have been burned in emerging markets again and again, so you have to accept that there will be periods of volatility. I would also worry about contagion effects. For example, were China’s infrastructure bubble to burst, commodities exports from Latin America and the rest of developing Asia would suffer, potentially dragging down both regions. A severe slowdown in exports would slow the rate of growth in incomes.
Political instability is also a risk, particularly in Latin America, where ECON has the highest exposure. I would not go so far as to call Mexico a “failed state,” but the drug-related violence along the border is unsettling to say the least. The rise of the radical left in the region led by Venezuela’s Hugo Chavez appears to have reached its high-water mark. Bolivian and Ecuadorian leaders Evo Morales and Rafael Correa have softened their anti-capitalist rhetoric somewhat, and even Argentina - that perpetual problem child of the region - has made efforts to rejoin the global financial system. Still, it was just a few years ago that the radical left appeared poised to take over the region.
I also see anecdotal signs that some consumers may be living above their means. Again, the growth of the new consumer culture that I have watched develop here in South America, though inspiring, is also a little unsettling. Though reliable data is hard to come by, consumption growth appears to be outpacing income growth. As an anecdote, I do question at times how a Peruvian taxi driver affords to carry a better mobile phone than I do.
Still, with all of this said, I consider these risks tolerable. I hesitate to say it, but in at least a few countries it appears that it really might be different this time. Chile has been remarkably responsible in managing the windfall it has received from high copper prices, putting much of it into an investment fund for the country’s future. Brazil instituted capital controls a few years ago, which briefly spooked the market. But this was not an attempt to prevent Western capital from leaving the country. Far from it. Brazil put a small tax on funds entering the country as an attempt to pre-empt an investment bubble forming. The country rather enjoys its newfound economic stability and doesn’t want to put it at risk.
The one country that I do view as a likely candidate for a bust is China. All signs there point to a dangerous infrastructure bubble forming. ECON has little direct exposure to China, but were investors to flee emerging markets en masse, ECON would not be immune.
In the event that we have a resumption of the global financial crisis, I would not want to own emerging-market commodities producers, banks, or export-oriented companies. These I would view as being at severe risk of contagion. Consumer stocks, represented by ECON, would suffer some amount of volatility as well, at least in the short term. I would consider any such risk little more than a bump in the road, however.
I will repeat that I consider the rise of the emerging market consumer to be the single greatest macro trend of the next twenty years. And ECON is the best “one-stop shop” ETF investment that I have found to take advantage of it.
Thanks, Charles, for sharing your ideas with us.
If you are a fund manager and interested in doing an interview with us on just one stock or ETF position you'd hold, please email Rebecca Barnett.