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Pee Dee
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Professional investor, Cogitator and periodic Agitator.
  • Emerging Markets? No, Thank You! (Part 3 of 4) 0 comments
    Sep 20, 2010 9:25 AM | about stocks: BRK.A, BRK.B, WSC, BYDDF, BYDDY

    In this third of a series of four blog posts, I further develop why investing in emerging markets ("EM") common stocks is a greater challenge than many foresee,  what Benjamin Graham had to say on the subject and how that applies today.

    Why a Small Allocation is Still not Worth It

    Pension and other institutional fund consultants scoffing at the idea that EM is not the place to be invested will say that they never recommended investors place a whole portfolio into EM.  Instead they should allocate a small portion to "optimize" the portfolio.  If it's true that time is money, Western investors should consider whether it's worth having any investment in distance EMs.  Why?  Beyond the inherent economic, financial and social volatility of these locales, the cost of knowledge is relatively expensive and entry and exit costs can be exorbitant.

    Because many of these markets don't have free presses and uncensored media, the time it takes to gain useful and accurate information can be extremely long and / or expensive.  One speculator, for example, has made note of how China's reported GDP growth rate comes in like clockwork at about 9% or 10% with hardly a reversal.  He further notes that its government can forecast GDP growth 12 months in advance down to the basis point.  A zoologist can give the broad path and direction migrating birds take but couldn't predict where a flock will be at a certain hour.  How a government could predict with such accuracy and little revision for a nation of 1.3bn persons leaves one scratching his head as to the composition of such figures.  Getting better figures will be extremely costly.

    Something happens when publicly traded investments go from popular in the media to ignored:  liquidity vanishes as does information.  For those who have lived through the '90s various boom-busts cylcles in EMs, you know what it's like to have investments go from bid-ask spreads of, say, three percent to 10% or more and traded volume for your promising stock go from $1mn / day to $50k / day while the stock is declining.  Meanwhile, the company still has equity financing plans that it wants to execute because of trade commitments--meaning more dilution than expected.  It's a thrill only a deer in headlights can appreciate.  For those rushing into EMs for the first time, that should note that thrill can be very expensive.

    Benjamin Graham Had it Right 40 Years Ago

    In Ben Graham’s last edition (1971) of “The Intelligent Investor” he posits on what is today emerging markets bonds that “For many years past we have questioned the attractiveness of such investments from the standpoint of the buyer.”  If only buyers of Icelandic, Uzbek or Kazakh bank bonds did the same in 2007.  Without numbers, I speculate that the survivorship bias of EM indices is greater than reported.  Many indices created today exhibiting some theoretical historical performance reflect companies that exist today but ignore those, once prominent or important, that fell by the wayside.  The US domestic automobile industry is left with three companies.  Few investors today are aware of the hundreds that went bankrupt or became irrelevant prior.  The consumers benefited while the investors were hapless.  The Dot-Com era experience is a perfect recent example.

    In the next and last blog post, I review the experience of one fund manager who returned 185x, without using leverage, to his mutual fund investors over 30 years and what his actions say about his dedication now to investing in China.

    Disclosure: The author owns no common shares in any of the aforementioned companies.

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