Investment Adventures in Emerging Markets

Readers’ Questions Answered

This post is also available in: Chinese (Simplified), Dutch, French, German, Italian, Spanish, Polish

QuestionMarkWhile we’ve seen some challenges in the equity markets globally in early 2014, I remain convinced of the potential emerging markets hold, and continue to travel the world in search of potential opportunities. While I can’t always respond to each of your questions directly, I do enjoy hearing from my readers and followers and value your feedback. Here are my answers to a few of your recent queries.

Q: I’m keen on hearing your opinion on the prospects for Latin America. John, Switzerland (via LinkedIn)

A: Brazil’s government has in some cases moved in a direction we find a bit unsettling, in particular an effort to open demands for back taxes going back several years. With some market unease about public finances and the government’s commitment to control expenses, the apparent tax grab risks dissipating positive investor sentiment surrounding the FIFA World Cup, to be held in Brazil later this year, and the Summer Olympic Games in 2016. We expect the influx of some 600,000 tourists for the World Cup could benefit Brazil in terms of an immediate boost to businesses (such as brewers and hotels), as well as the longer-term advantages from substantial infrastructure spending.

In Mexico, we see its recent reform program as potentially very positive for the long term. For example, the reform of Mexico’s energy policy will likely be highly significant once the new, more market-friendly rules become clearer, but investors are likely to wait for the details to be confirmed before acting. Meanwhile, the Andean markets of Peru and Chile are exposed to the volatility of commodity prices, but we believe that this could be offset by the relatively low-cost production of Peru and Chile’s mines and the dominance of copper in those regions, a key industrial metal with relatively steady demand characteristics. In addition, both markets are seeing the continued development of major consumer populations, which could provide an interesting alternative angle for investment opportunities outside the natural resources sector.

Q: How do you rate the investment risk in Georgia that reflects Russian geopolitical interests? Alexander, Canada (via LinkedIn)

A.  We believe new leadership in Georgia is quite realistic in its need to have good relations with Russia while being part of Europe and moving into the European orbit. Since independence the leaders in Georgia have wiped out a substantial amount of corruption and have put public services on sounder footing. The country now ranks as one of the most dependable places in the world to do business, according to The World Bank’s “Ease of Doing Business” survey, which ranked Georgia 8th out of 189 countries in 2013, a dramatic move up from its ranking of 133 in 2005.1

Q: How do you reduce dramatic currency fluctuations in your portfolios? Do you utilize any hard assets? Robert (via LinkedIn)

A: We try to use currency fluctuations to our advantage, for example, if a company is an exporter and its costs are in local currency while the export earnings are in US dollars or other foreign currencies, we may try to take advantage of any depreciation of the local currency by purchasing more of the shares of such companies.

We may use what we call a “natural hedge” by evaluating currencies from a long-term perspective based on purchasing power parity, which is the needed adjustment on the exchange rate between countries in order for the exchange to be equivalent to each currency’s purchasing power. We then make individual company evaluations based on that analysis. Therefore, we do not typically use derivatives as hedge instruments. A typical portfolio would contain more than 20 different currencies and for currencies where derivatives hedges are available, the hedge usually costs as much as the expected devaluation itself. Also, for many of the minor currencies in the emerging markets, hedges are simply not available. We carefully analyze all the currencies of all countries in which we invest with an economist who, jointly with each country analyst, forecasts currencies. This forecast directly filters into the analyses of each model that is done by each analyst.

There has certainly been a great deal of volatility in the currency market. Some currencies have showed appreciation against the US dollar, while a number of others have depreciated. In our assessment of companies in which we invest, we’d evaluate the impact of currencies. In many cases, a currency devaluation could actually be quite positive for individual companies. For example, a depreciation in the Indian rupee has benefited some Indian IT outsourcing companies, since their revenues tend to be in foreign currency such as US dollars and euros, while costs are in Indian rupees. The share price of these companies appreciated in US-dollar terms as a result. So our entire approach to currencies is to evaluate them in relation to how they can impact individual company stocks and then make decisions based on the potential impact dynamics.

Q: Can you share your views on Poland? Scott, USA (via LinkedIn)

Poland is in the heart of Europe, strategically located between Russia and Western Europe. With a population of 38 million2, the country has a large domestic consumer market and a strong workforce. It may surprise you to learn that Poland was the only European Union country to avoid a recession during the global financial crisis in 2008-2009. While growth in the economy has since slowed down as a result of the eurozone crisis, signs of a recovery are evident, in our view.

Germany, Poland’s largest trading partner, has been benefiting from strong domestic demand, growing manufacturing output and improvements across the European economy over the past year. Accounting for more than 25% of Poland’s exports and imports, growth in Germany’s economy is already having a positive impact on the Polish economy. To stimulate the economy, the National Bank of Poland also cut interest rates by 2.25% from November 2012 to July 2013. A recovery in demand from major export markets and record-low interest rates currently appear to point toward a bottoming-out of gross domestic product (GDP) growth in Poland during 2013. GDP growth is forecast to increase from 1.3% in 2013 to 2.4% in 2014 and 3.3% by 2017.3

Moreover, Poland successfully competes in outsourcing of services with countries like India thanks to its well-educated workforce. These include companies in consumer-related and financial companies. In the long-run, we expect Poland could also benefit from the process of relocation of factories from Western Europe to Eastern Europe. These long-term trends could lead to the creation of additional jobs and lead to strong domestic demand, which in turn enhances economic growth.

Q: You’ve mentioned the US Federal Reserve’s “tapering” of its quantitative easing program could have less impact on the United Arab Emirates (UAE) due to its currency dollar peg. Does that also apply to Hong Kong, or other emerging markets? @micchoo via Twitter

A:  Yes, we believe it does apply to Hong Kong and to other countries that peg their currency to the US dollar. However, it is important to note that overall global sentiment is impacted by the Fed’s pronouncements and actions so the “tapering” talk has tended to cause investors to leave local currency fixed income markets in favor of US Treasuries, at least for the short term.

Q: Can the UAE/Dubai be a major player in international relationships in the years to come? Bart, Netherlands (via LinkedIn)

A: I do believe the UAE can be a major international player. The UAE has been benefiting from improving local economic data and the prospect of rising international trade flows through the port of Dubai. The recent award of the 2020 World Expo to Dubai is likely to provide extra impetus to an already solid real estate market. Most important is the fact that in Dubai, there is currently no income or profits tax. This attracts a lot of investors.

Q: Can you share your current view on Turkey’s economy? @nusybaba via Twitter

A: Unfortunately, many investors have lost confidence in Turkey this year. “Tapering” of the US Federal Reserve’s quantitative easing program and its potential impact on Turkey’s substantial current account deficit, along with a corruption investigation implicating figures close to the government, prompted a selloff in the Turkish market. After a sharp devaluation of the Turkish lira, the Turkish Central Bank surprised investors by sharply raising key interest rates in January to support the weakening currency. Political uncertainty contributed to the lira’s devaluation. However, not all news is bad news in Turkey, and we think the economy, and its markets, can get back on track. Budget revenues posted a healthy year-over-year increase in 2013, supported by strong growth in tax proceeds and a recovery in the economy, as well as growth in privatization and state bank earnings. Prime Minister Recep Tayyip Erdogan recently met his Japanese counterpart Shinzo Abe in Japan, where they announced plans to begin free trade talks during the year and discussed ways to promote bilateral security co-operation. Moreover, Turkey and Malaysia signed an Action Plan for Strategic Co-operation during Mr. Erdogan’s visit to Malaysia in January. We believe Turkey could also likely benefit from recovery in Europe generally, a major trading partner, while news flow concerning political disputes within the country should not obscure the major and still ongoing progress of investment that is transforming the infrastructure and production capacity of the country.

Dr. Mobius’ comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

All investments involve risks, including possible loss of principal. Foreign securities involve special risks, including currency fluctuations and economic and political uncertainties. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets.  Currency rates may fluctuate significantly over short periods of time and can reduce returns.

 


1. Source: World Bank. 2013. Doing Business 2014: Understanding Regulations for Small and Medium-Size Enterprises. Washington, DC: World Bank Group. DOI: 10.1596/978-0-8213-9615-5. License: Creative Commons Attribution CC BY 3.0

2. Source: CIA The World Factbook, July 2013 estimate.

3. Source: IMF World Economic Outlook database, October 2013, © By International Monetary Fund.

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