Monday, May 12, 2014

Booth, Emerging Markets in an Upside Down World

Jerome Booth, a British economist, investor, and entrepreneur, has written a refreshing book. Emerging Markets in an Upside Down World: Challenging Perceptions in Asset Allocation and Investment (Wiley, 2014) is not the usual whirlwind trip around the emerging market world—“if it’s Tuesday it must be sub-Saharan Africa.” Rather, Booth looks at some generally accepted notions that both inform and misinform emerging market investors and tries to set the record straight. The book is, to labor the travel metaphor, a tour of ideas conducted by a knowledgeable, articulate guide.

Booth challenges the reader, as the title indicates, to turn the world map upside down (and, for good measure, make it a Peters projection—that is, an area-accurate map). We no longer see emerging markets as peripheral. They occupy much of the middle area on the map and account for most of the land mass. Moreover, as the map doesn’t show, they also account for “over 85% of human population, the bulk of industrial production, energy consumption and economic growth, and around half of recorded economic activity using purchasing power parity.” And, contrary to standard perceptions of the investing world, “many emerging markets are now safer from some of the worst loss investment scenarios than many developed countries.” (p. 2)

The goal of the book is to help the reader develop new frameworks for investing, “frameworks which may cope better with structural shifts and risk.” (p. 179) The first step, and perhaps the most important, is to become conscious of starting assumptions that require reevaluation. Booth suggests four areas that investors may want to reexamine: “i) risk, uncertainty and information asymmetry assumptions; ii) investor psychology and behaviour assumptions; iii) structure, efficiency, equilibrium and market dynamics; and iv) asset class definitions.” (p. 180) Fortunately, these are areas that Booth himself explores in the book, so the investor has a leg up—whether or not he agrees with all of Booth’s conclusions.

One of the central themes of the book is risk, and one often neglected component of risk (a dangerous oversight) is the nature of the investor base. Prior to the ruble crisis in 1998, “perhaps a third of the investor base in emerging market dollar-denominated debt was highly leveraged and speculative.” But, as hedge fund money and other speculative investment left the emerging debt market, a more stable investor base took their place—long-only Western institutional investors and local institutional investors. “With local liabilities, these [local] investors do not have the same propensity to flee the market when risk perception rises. Indeed, since the mid-2000s local bond markets often rally in most of the larger markets during episodes of risk aversion—because the dominant movement of funds is by domestic investors moving from domestic equities to domestic bonds. At the time of writing,” Booth notes, “local currency debt, largely locally held, is over 80% (and growing) of all emerging markets debt.” (p. 47)

Although Booth focuses on emerging markets, much of his analysis can be extrapolated to other markets. He explores some key investing principles and defines areas ripe for further research. Investors as well as students of the financial markets can profit from his thorough work.

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