Gavekal CEO Louis Gave is one of my favorite people to speak with on anything related to portfolio construction and the non-US perspective, and I knew our latest conversation about emerging markets (EM) would be anything but conventional.
Our discussion begins with the obvious: While investing in emerging markets is en vogue these days, the monicker misses the mark. I’ve been hearing about it in places that I’d never have expected to before, but many people are talking about EM with limited understanding. That’s where Louis comes in, with a reframing of how to think about investing outside developed markets.
If you’re one of the many US investors suddenly discovering the world of opportunities beyond our borders, you need to hear this because simplifying the opportunity abroad into one big blob is a mistake. “There are many ways to skin a cat,” as Louis points out, whether you’re looking to invest in Latin America, South Africa, Asia, or elsewhere.
The very structure of most emerging financial markets has changed—in fact, Louis and I found ourselves in agreement that “EM” is an ill-fitting term.
A Marketing Gimmick
Louis doesn’t pull any punches in this week’s Global Macro Update. “Emerging markets,” he notes, is a term invented decades ago as a marketing ploy. After our conversation, I did some digging on the term. Turns out, “emerging markets” was coined by Antoine van Agtmael, an economist at the International Finance Corporation (IFC), a division of the World Bank, in 1981.
Van Agtmael introduced the phrase at a Thailand conference to rebrand the IFC’s Third-World Equity Fund after learning that investors reacted negatively to “third world.” He felt the new terminology conveyed growth and momentum rather than poverty and despair.
Forty-plus years ago, you had the US, Europe, and Japan. Everything else was small enough to lump together and give it a catchy name. Yet here we are, still using that limited framework. We’re treating Vietnam the same as Brazil, Mexico the same as South Africa, India the same as Indonesia. It’s like saying “everything that’s not New York or LA” in the US and expecting that to be a useful guideline for making investment decisions.
The problem isn’t just semantic. When you think of emerging markets as one monolithic block, you dilute the real opportunities by adding everything else.
Know What You Own
Here’s a key takeaway: If you’re buying an emerging markets ETF, you need to understand what you’re actually getting.
As Louis noted before we started recording, if you are an institutional investor, you can develop a view and take a targeted position. For example, you can buy Brazilian bonds if you believe Brazil’s interest rates will drop (and their bond prices will increase). But if you are an individual, you cannot (yet) be so targeted.
In the past few years, there has been a big increase in the number of niche ETFs. Many are focused on markets outside the US, ranging from the ill-informed “emerging markets” monicker to ETFs tied to the public markets in individual countries. You can now buy an ETF with equities solely from Vietnam, Singapore, South Korea, etc.
Better, but still, you need to know what you are buying. For example, the iShares MSCI South Korea ETF (EWY), an ETF I own, currently has 93 positions. That sounds well diversified. But when you look at the individual holdings, you’ll see (as of this writing) that EWY has two holdings comprising 46.77% of the entire ETF. Those companies are Samsung and SK Hynix. If you are bullish South Korea but bearish information technology, this might pose a problem for you. None of this discussion is a recommendation, just an example of what you’ll find when you are mining the prospectus of niche ETFs.
Early Days
US investors are waking up to opportunities outside our borders, and that’s a good thing. Louis notes these are early days for growth in many markets outside the US, giving us a few ways to think about various emerging markets in an environment where so much has changed since the term was coined.
I encourage you to watch (or read) my full conversation with Louis, which goes a lot deeper. You can watch it here.
A transcript of our conversation is available here.
You can learn more about Louis Gave here.
Lastly, a mea culpa moment on my end: I was unable to include specific reader questions this week. We had to wrap the recording out of respect for Louis’ time and schedule. We’ll get the Macro Mailbag off the ground here soon, though!
As always, thank you for watching and reading.
Ed D’Agostino, Partner & COO
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