Download Emerging Markets

Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
Emerging Markets
Christian Takushi
Macro Economist MA UZH
Sous-directeur, BCV Asset Management
08.11.2013
1.5 hours
Content
1.
2.
Importance of emerging economies
Structure of emerging markets
1.
2.
3.
How to approach emerging markets
1.
2.
4.
top-down
bottom-up
Characteristics of Emerging Markets
1.
2.
5.
6.
•
by Country & Asset Class
Developed / Emerging / Frontier / Developing
(currencies, capital restrictions, 24 hrs trading, geopolitcs)
Overview of specific characteristics & financial risks
Currency Risks
Sovereign defaults: Long history of underestimated risks
Major Macroeconomic challenges for Emerging Markets
Give real life examples, pictures,
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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1. Importance of Developing Nations has risen significantly
GDP PPP-adjusted - IMF Grouped Data
70'000
60'000
n USD Billions
50'000
40'000
30'000
20'000
10'000
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
20
10
20
12
20
14
20
16
20
18
-
Advanced Economies
Euro area
Emerging & Developing Economies
Source: IMF Macro Database, Eurozone data estimates before 1992 by Ch Takushi MA UZH
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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What are Emerging Markets ?
•
•
Also known as « developing nations », emerging markets are economies that
are experiencing rapid GDP growth, household income growth and
industrialization.
They differ from their « developed counterparts » in seven main ways.
– Positive demographics: large and young labor pool
– Low household incomes
– Significant structural changes occuring, such as modernization of
infrastructure, moving from agriculture to manufacturing and rise of middle
class
– Above average economic growth
– Higher levels of corruption and political risk
– Fast growing stock and bond markets
– Low levels of wealth accumulation per capita
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Why Emerging Markets are attracting investors?
•
Growth potential: Emerging economies are expected to grow an impressive two
to three times faster than developed nations, according to IMF estimates. As an
investor, this is important, because corporate revenues have the potential to grow
faster when economic growth is higher.
•
Diversification: By investing in emerging markets, you help diversify your
portfolio, as emerging markets can perform differently than developed markets.
•
Market Inefficiencies: Another benefit is the potential to discover up-and-coming
companies. This is because emerging markets tend to have less-efficient markets
where information is not as readily available and there are fewer or less
experienced economists and stock analysts. Diligent investors who are willing to
research and invest directly in individual companies may be able to find
investments with the potential for higher returns. Example: Samsung Electronics
•
Market Anomalies: Market Anomalies that offer persistent premiums over time to
investors are present in these markets. The advantage to sophisticated and
experienced investors is that these anomalies can last longer and producer
considerable excess returns. Example: Small Cap effect in Emerging Markets
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Factors enabling faster growth of Developing Nations
•
While there are country-specific differences, compared to developed economies, emerging market
economies as a group have:
–
–
–
–
–
–
–
Young working-age populations: This tends to add to economic growth, while retiree populations generally
subtract from growth due to less economic output, higher health care costs and the need for government
services. For example, India and Brazil have high ratios of working-age to retired populations.
Export strength: Labor costs tend to be lower in emerging markets, driving growth in manufacturing and
exports. For example, the Philippines has developed electronics manufacturing and call center industries based
on its labor resources.
Low levels of government debt: Emerging nations tend to produce more than they buy, resulting in trade
surpluses. Large state-owned companies involved in exporting are often sources of government revenues,
keeping government debt levels low, and funding infrastructure spending or programs to help raise living
standards.
Low levels of consumer debt: Debt at the consumer level is also low in many emerging nations. For example,
China has strong foreign trade and a low government deficit, as well as low debt levels at the consumer and
business level.
Growing household income: Rising household incomes afford consumers the ability to have income available
for discretionary purchases, resulting in the emergence of a middle-class consumer sector. Indonesia and the
Philippines are examples of countries with strong domestic economies and growing consumer classes.
Natural resources: Emerging market countries have a disproportional share of natural resource wealth
(although exceptions exist, such as Australia, Canada and Norway). Countries rich in natural resources tend to
benefit as emerging markets industrialize. For example, Brazil should continue to be self-sufficient in oil over the
longer term and has the largest farmable area in the world.
Prudent fiscal policies: Many emerging market countries have endured economic crises in the past, instituting
strong fiscal discipline well before the 2009 global recession. For example, Brazil has made major strides since
1994, with inflation falling from triple-digit levels to an average of 5.4% over the past five years, and decreasing
government debt levels have resulted in an investment-grade credit rating.
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Developing Nations overtake Developed Nations: historic shift !
85% of Mankind living in economies expanding by 4-6% p.a.
19 Developing Nations overtake the Eurozone in share of World GDP – each with 0.4% to 2% weight
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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2013-2018: Asia, Africa, Latin America to lead Global Growth,
Eurozone becoming less relevant for World Economy
180
170
160
Advanced Economies
Euro area
150
Central and eastern Europe
GDP Growth indexed to 2012
Developing Asia
140
ASEAN-5
Latin America and the Caribbean
130
Middle East, North Africa, Afgh, Pak
Sub-Saharan Africa
120
110
100
2012
2013
2014
2015
2016
2017
2018
Source: IMF Macro Raw Data, Calculations by Ch Takushi MA UZH, 2013
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Significant changes of global scale
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Emerging Nations affecting and accelerating Global Trends
1. East & South-Shift of Economic & Geopolitical Power
2. Intensifying Competition for Energy, Water, Food and other
Resources.
Recently also Human Resources (skills) & I.P.
3. Assertive Foreign Policies challenge G7, EU and USA
4. Projection of rising power into U.N. and the Middle East
5. Exporting ever more sophisticated Goods and Military
Equipment.
Example:
Brazil’s Military Transporter beats US and EU’s competitor
6. Social transformation & rise of Middle Class
Example:
South Korea and Singapore
2 Asian economic miracles
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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2. Structure of Emerging Markets – MSCI definition
To move up from emerging to developed status, countries need to meet these criteria:
1. Economic development: The country must have income levels 25% above $12,276 (World Bank high income threshold) for
three consecutive years.
2. Size and liquidity requirements: The local stock exchanges must have at least five companies with market
capitalizations of roughly $1.8 billion each and the amount of trading volume must be significant.
3. Market accessibility: Country must be open to foreign ownership, allow free capital flows, and have stable, efficient
markets.
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Structure of Emerging Markets: Most advanced in Equity realm
GLOBAL EM
Countries
Brazil
Chile
China
Colombia
Czech Republic
Egypt
Hungary
India
Indonesia
Korea
Malaysia
Mexico
Morocco
Peru
Philippines
Poland
Russia
South Africa
Taiwan
Thailand
Turkey
Total
MSCI
12.2%
1.8%
18.5%
1.1%
0.2%
0.3%
0.2%
6.8%
3.0%
14.9%
3.9%
5.2%
0.1%
0.5%
1.1%
1.6%
5.6%
6.8%
11.5%
2.7%
2.1%
100.0%
GLOBAL EM
Sectors (GICS)
Energy
Materials
Industrials
Consumer Discretionary
Consumer Staples
Health Care
Financials
Information Technology
Telecommunication Services
Utilities
Total
MSCI
11.6%
9.8%
6.4%
8.0%
9.2%
1.4%
27.8%
14.8%
7.5%
3.4%
100.0%
Source: MSCI, BCV Asset Management
Weights as of Summer 2013
Financial, industrial, technology
and auto firms dominate the
Emerging Markets Universe:
Financials reflect GDP growth,
Other sectors reflect massive
export growth
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Evolution of Population, GDP & Equity Markets over last 20 years
Source: BCV Asset Management, Christian Takushi MA UZH and Soufiane Matousi MSc Econ.
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Structure of Emerging Markets:
Shrinking Demographics in Developed and large Emerging Nations
Source: BCV Asset Management, Christian Takushi MA UZH and Soufiane Matousi MSc Econ.
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Structure of Emerging Markets:
Emerging Nations have outpaced Developed Nations in Output
Source: BCV Asset Management, Christian Takushi MA UZH and Soufiane Matousi MSc Econ.
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Structure of Emerging Markets:
Both Emerging and Developed Nations issuing more debt
Emerging Debt Markets
had a late start, but due
to EU debt crisis, growth
has accelerated
Growth in outstanding debt
Markets
Developed Countries
Emerging Countries
Frontier Countries
Developing Countries
Total
World Total in Billion USD
By end of 1992
By end of 2002
By end of 2012
2002-2012
179%
260%
161%
307%
190%
1'822
7'669
21'919
Source: B.I.S., BCV Asset Management, Christian Takushi MA UZH and Soufiane Matousi MSc Econ.
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Structure of Emerging Markets:
Some countries dominate Emerging & Frontier international debt
Emerging Total Debt, USD Bn (BIS)
Frontier Total Debt, USD Bn (BIS)
Turkey
Argentina
Thailand
Bahrain
South Africa
Russia
Croatia
Poland
Jamaica
Philippines
Kazakhstan
Peru
Morocco
Kuwait
Mexico
Lebanon
Malaysia
Lithuania
Korea
Indonesia
Romania
India
Saudi Arabia
Hungary
Slovenia
Egypt
Sri Lanka
Czech Republic
Colombia
Ukraine
China
United Arab Emirates
Chile
Vietnam
Brazil
-
50
100
150
200
250
300
-
50
100
150
Source: B.I.S., BCV Asset Management, Christian Takushi MA UZH and Soufiane Matousi MSc Econ.
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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3. How to approach Emerging Markets
• During 1990’s active investors who dared to enter EM’s early,
focused on Fundamental Research & Investing.
Heavy focus on company and factory visits => Bottom Up
Example: Ekran: limits of company research
• During 2000’s institutional asset managers began to apply modern
Quantitative Style and Risk Factor Models to enhance
return/risk.
• Since 2008 with intensified Globalization along rising Systemic &
Geopolitical Risks investors are gradually shifting to Global Macro
or Top-Down Approaches
Quantitative-Fundamental Blend Strategies, Smart Index
Strategies and Global Macro Strategies have - individually and
combined - added to the sophistication
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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4. Characteristics of Emerging Markets: higher risks & costs
In addition to the higher growth potential, emerging markets also have higher risks. They share
many types of risk with developed markets, but at higher levels. Main specific characteristics are:
–
Potential for political instability: Emerging market governments can be less stable politically, and events such as
external conflicts, coups, and internal tensions can create a difficult operating environment for companies.
–
Financial conditions: Emerging market countries that do not have sound fiscal and monetary policies are subject to a
number of risks. For example, growth can be undercut. Inflation can rear its head—impairing the ability of companies to
keep up with input price trends, hurting consumer's purchasing power and potentially destabilizing the country's
currency.
–
Currency fluctuations: There's the possibility that the currency of your investment will fall relative to the US dollar,
lowering the return after it's translated back into dollars. In the past some governments restricted repatriation.
–
Regulatory environment: The rules and regulations of emerging market countries tend to be under development. As a
result, market regulation, corporate governance, transparency and accounting standards may not be as reliable or
mature as in developed countries. Some countries have restrictions on how freely businesses operate, impacting their
ability to earn profits.
–
Volatility: : Shares on emerging market exchanges can be more volatile and trading can be less liquid. Emerging
market investor sentiment can respond quickly to global growth estimates, magnifying performance on both the upside
and downside.
–
Higher costs to invest: Investing internationally normally imply higher fees and emerging markets tend to have higher
fees compared to developed markets (often 50% more, but 2x or 3x more is possible)
–
Data quality: Rather patchy and varies from country to country. Macroeconomic data needs to be evaluated for
plausibility. Much higher demands on Data Analysis skills and experience on Economists and Analysts.
–
Market restriction or exclusion: Some emerging nations forbid foereigners access to some markets (i.e. China)
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Characteristics increasingly driven by large scale effects
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Currency Fluctuations are main financial Risk for investors
130
130
120
120
110
110
100
100
90
80
90
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Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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5. Sovereign Defaults and Debt Restructurings
•
With sovereign borrowing dating back to the B.C. era, the world has a long
history of sovereign defaults and their nasty aftershocks.
•
There have been already 600 debt restructurings since WW2 alone.
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Major Sovereign Defaults and Debt Restructurings 1/2
•
Venezuela - July 1998 - Defaulted on $270 million worth of domestic currency bonds
•
Russia - August 1998 - A massive $72,709,000,000 default that rattled the entire global economy.
– The trouble started in August of '98 when the country missed payments on local Treasury
obligations, this later extended to foreign currency obligations and MINFIN III foreign currency
bonds. Russian debt was eventually restructured in years later.
•
Ukraine - September 1998 - $1.27 billion dollar default
•
Pakistan - July 1999 - Defaulted in July of 1999 but quickly resolved the situation
•
Ecuador - August 1999 - Missed a payment, leading an an eventual restructuring of over 90% of
their bonds. Defaulted on roughly $ 6.6 billion.
•
Ukraine - January 2000 - Defaulted again (1.06 billion) in January of 2000.
– Defaulted on both DM-denominated Eurobonds and USD-denominated bonds. Ended up
rectifying the situation by exchanging their current obligations for bonds with a longer term
structure and lower coupon.
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Major Sovereign Defaults and Debt Restructurings 2/2
•
Peru - September 2000 - Defaulted on $4.87 billion of debt, but rectified the situation within 30
days
•
Argentina - November 2001 - A massive $82.26 billion dollar default that rattled the global
economy and worldwide markets.
– Missed a payment in early 2002 - debt obligations were restructured and the country
continued to receive funds from the IMF to aid in their recovery
•
Uruguay - May 2003 - Argentina's troubles spread to Uruguay, and the government of
Uruguay defaulted on $5.7 billion dollars worth of debt in May of 2003. The country eventually
completed a restructuring of their debt obligations with their bondholders.
•
Dominican Republic - April 2005 - Defaulted on $1.62 billion dollars worth of debt in April of
2005. Eventually completed a debt restructuring that ended up extending the maturity of their
debt obligations by five years.
•
Ecuador - December 2008 - Defaulted on $3.2 billion dollars worth of debt obligations after
calling several of their previous debt offerings "illegal and illegitimate". An unusual situation in
that Ecuador is thought to have the resources NOT to default, but chose instead to default for
"moral" reasons.
Source: BCV Asset Management, Soufiane Matousi MSc Econ.
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Massive shift into Emerging Debt by foreign investors
Many Emerging Local Currency Bond
Yields have fallen to levels similar to US
and European paper; both sovereign &
corporate
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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6. Macroeconomic & Geopolitical Challenges
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
Procrastinating on Domestic Imbalances
Deteriorating Demographics & Limited Wealth Accumulation
Most at Danger from Unwinding of “Quantitative Easing”
“Bubble” in some Emerging Bonds: Flaw of low Debt/GDP ratios
Hot Money inflows has exacerbated Corruption
USA has regained Global Competitiveness
Growth Model via Exports is crowded
Asia-Pacific: Region with most unresolved conflicts
Over USD 3’900 Bn in military spending over next 10 years
ix. Aggressive Foreign Policies by big Emerging Nations has
begun to affect Investments and FDI (future GDP growth)
x. Global Supply Chain heavily exposed to North East Asia
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Limited Wealth per capita a major challenge
1) Taiwan and Israel among
most efficient nations in
translating GDP Growth in
Net Wealth for its Citizens
2) Some Governments
prioritize National Wealth,
over Citizens’ Wealth
3) S. Africa, Russia and
Brazil with structural
problems. China faring
better. With deteriorating
demographics, underfunded
pension systems and poor
Wealth Accumulation: rising
Risk of political instability.
Source: Allianz Wealth Report 2012;
Concept of Macroeconomic Efficiency
Ratio & Calculations by Christian
Takushi MA UZH, 2013
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Personal Wealth:
Excessive Focus on GDP, Neglect of Assets & Debt per capita
Macroeconomic Analysis: Growth in Peru-Colombia more sustainable than Brazil’s
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Personal Wealth:
Indonesia overtook India, Thailand takes on China
Wealth per capita in China & India still at low levels – Excessive focus on
“nationwide figures” by financial media
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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Demographics of largest Emerging Nations
Fertility 1.5
Source:
U.N., BCV
Fertility 1.9
Fertility 2.6
ë
India has what
China lacks,
but it has not
overcome the
literacy problem
Fertility 1.6
Master en Droit et Economie / Automne 2013 / Prof. F. Alessandrini
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