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Laurence Lavelle
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I have been investing and trading since 1998 in multiple markets and timescales using both fundamental and technical analysis within cyclical and secular psychological and economic trends. Follow me on Twitter: ‏@LaurenceLavelle Faculty Page: https://lavelle.chem.ucla.edu/ Author Page:... More
  • Frontier Markets: An Antifragile Suggestion 11 comments
    Oct 9, 2013 6:21 AM

    International markets across asset classes have increasingly become interdependent making what should be balanced portfolios more volatile.

    The internet has facilitated instant communication but intra-market and inter-market correlations result from headline noise, or 'news' depending on one's viewpoint, and the growing appetite for trading trends replacing fundamentals. The former, technical analysis, is a useful tool but it is not a replacement for sound productive investments and long-term balanced portfolios. Technical analysis in the hands of computer trading programs ("algos", "bots") and their high frequency trading cousins can and does lead to huge and nonsensical swings in individual stocks, ETFs, and entire indexes. May 6, 2010 is a well-known example with US equity markets and individual stocks undergoing wild swings: the Dow Jones Industrial Average (DJIA) plummeted 1,000 points within minutes and Proctor Gamble (PG, market cap ~USD200B) dropped 37% instantly - the second part of its name taking on new meaning. Less well known but just as crazy algo trading occurs daily and can be seen in all asset classes (stocks, ETFs, options, gold futures, etc.).

    Correlated intraday trading trends are also seen real-time across international markets that are plugged into this electronic world, and their longer term performance is correlated as economic news and numbers, along with political, fiscal, and monetary policies impact developed (USA, Germany, France, etc.,) and emerging markets (China, India, Brazil, etc.,). For example a portfolio with investments in American, Chinese, and French companies as part of the S&P 500, Hang Seng, and CAC 40 respectively, would be considered by some investors a diverse equity portfolio. The 6 month plot below shows they are very much correlated and such correlation does not make a robust or antifragile portfolio which is the objective of diversified equity investments.

    6 month plot ending October 4, 2013 (click to enlarge)

    Stock markets that are independent and therefore contribute to a truly diversified investment portfolio are frontier markets (Mongolia, Pakistan, Sri Lanka, etc.,). They trade independently of daily international news and their longer term performances are significantly less correlated to developed and emerging stock markets and economies. For example the Mongolian MSE 20 versus the MSCI World Index has a 5 year low correlation of 0.28 compared to a very high 0.91 for the MSCI Emerging Market Index versus the MSCI World Index. Few investors appear to be aware that the traditional emerging markets do not give the performance diversification they expect. Whereas frontier markets, as one part of an investment portfolio, do add true diversification creating more rounded, robust and hence antifragile investments.

    In a related article I will discuss the drawback of crowd psychology, trend investing, and how they negatively impact investments and markets with huge potential.

    Footnote:
    Highest positive correlation: 1.0
    Highest negative (inverse) correlation: -1.0
    No correlation (essentially noise): 0.1 to -0.1

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Themes: long-ideas
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Comments (11)
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  • hiiidave
    , contributor
    Comments (2) | Send Message
     
    Agree. Many trade emerging markets believing there is little correlation with SPX - simply not true. Frontier markets does add diversification but difficult to trade due to lack of country specific ETF's. Good points from the article. Thanks.
    9 Oct 2013, 06:07 PM Reply Like
  • Laurence Lavelle
    , contributor
    Comments (340) | Send Message
     
    Author’s reply » Thanks. Yes difficult to trade frontier markets which is why they are independent and therefore add diversification. There are ETFs and mutual funds specific to frontier markets and some of them are suitable for buy and hold. Maybe I'll post something more on these although Seeking Alpha editors wanted me to add ETFs, etc., which I refused to do as they are not suitable trading vehicles. This article is also indirectly about long term fundamental trends which require a diversify-buy-hold approach.
    9 Oct 2013, 09:45 PM Reply Like
  • Sean Patterson
    , contributor
    Comment (1) | Send Message
     
    Good article. Emerging markets are highly correlated with developed market especially when markets go South. Agree ETFs are not best way. There must however be some good frontier market fund managers?
    10 Oct 2013, 04:38 PM Reply Like
  • Laurence Lavelle
    , contributor
    Comments (340) | Send Message
     
    Author’s reply » Thanks Sean. Matthews has a new fund Emerging Asia (MEASX) but it does include some of the larger countries and therefore not strictly Frontier only. Templeton (Mark Mobius who has an excellent frontier market background) did a soft close recently, so some frontier markets are too hot, while others languish for capital. To better answer your question I'll post details in a follow up article.

     

    If anyone wants to send me performance numbers for some of the smaller frontier funds I'll consider including them in a follow up article.
    10 Oct 2013, 09:47 PM Reply Like
  • Adventures in Capitalism
    , contributor
    Comments (2) | Send Message
     
    Frontier markets are less correlated specifically because they are less liquid--leading to longer term investors. They are also harder to access. Just setting up brokerage accounts is a headache unto itself. This means that there aren't really ETFs that trade these markets actively and so they are less influenced by hedge funds arbitraging different frontier markets against the S&P 500 or other liquid equity proxies.
    14 Oct 2013, 12:42 PM Reply Like
  • Laurence Lavelle
    , contributor
    Comments (340) | Send Message
     
    Author’s reply » Very much agreed and will follow up with more comments in my 3rd article. As noted above any market that is not plugged into the electronic trading world is less likely to show inter-market correlation. Appreciate the feedback.
    14 Oct 2013, 06:50 PM Reply Like
  • vanhow
    , contributor
    Comments (2) | Send Message
     
    Nice article Laurence

     

    Rgds

     

    Howard
    17 Oct 2013, 04:35 AM Reply Like
  • Laurence Lavelle
    , contributor
    Comments (340) | Send Message
     
    Author’s reply » Good to know. Appreciated.
    17 Oct 2013, 03:35 PM Reply Like
  • Pring Turner
    , contributor
    Comments (27) | Send Message
     
    Thanks for sharing Laurence. Unfortunately almost all stock investments are highly correlated.... when they are dropping, which is when investors need diversification the most! Nevertheless it will be interesting to monitor the progress of these frontier markets. I came across this article recently discussing these markets which might be of interest to you. http://bit.ly/15MuZ6w
    17 Oct 2013, 05:42 PM Reply Like
  • Laurence Lavelle
    , contributor
    Comments (340) | Send Message
     
    Author’s reply » Appreciate the feedback and the article. This weekend I hope to finish my detailed article on investment opportunities in frontier markets and in particular Mongolia.
    18 Oct 2013, 01:43 PM Reply Like
  • Laurence Lavelle
    , contributor
    Comments (340) | Send Message
     
    Author’s reply » My article, "Frontier Markets, With A Focus On Mongolia", is available at: http://seekingalpha.co...
    29 Oct 2013, 04:51 PM Reply Like
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