1st June 2012
Failing at the frontier
Mongolia was the fastest growing frontier market over the past two years. According to the Financial Times, the tiny $1.5bn market gained 73% last year and 121% in 2010.
And that should make it the world leader in an investment universe of Brics and Civets – the biggest and next biggest emerging markets, the layer above the frontier. The Brics are Brazil, Russia, India and China, while the Civets consist of Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa.
Make Most Rich
Despite the Mongolian success, it has not been plain sailing for those on the frontier as this MSCI chart shows. But that should not stop the acronym creators including Mindful Money which today presents MAKE. Mineral rich Mongolia – a nomadic nation the size of Western Europe with a population of under three million – provides the first letter while Argentina, Kenya and Estonia are the other three. There are other possible acronyms of unlikely bedfellows – Most (Mauritius, Oman, Sri Lanka and Tunisia) or Rich (Romania, Ivory Coast, Cambodia and Haiti).
What links these groups of four countries? Absolutely nothing other than a convenient set of initials – just the same as the non-ties between the disparate nations of the Brics and the Civets.
Creating these acronyms is just an extension of an old investment concept which today's equity and bond buyers have fallen in love with once again. Providing they buy into the right national economy, they are on the road to riches. The countries which are held out as winners generally have one of two characteristics – they are rich in natural resources (Brazil, Russia) or have a fast growing middle class which has gained riches on the back of a still huge peasant and a low paid factory work economy (China and India).
But by focusing on the positives that make the investment case, and sucking in those who are attracted by assets which have already risen (thanks to buyers who got there before them), there is a danger that investors will miss the bigger picture, including the national negatives. Stock picking on a top down basis – start with the nation and work down to the individual company, rather than a bottom up process (starting with equity or bond) – can be fraught with danger.
A new book Why Nations Fail (and by extension although it does not work nearly so well as a catchy book title Why Nations Succeed) – subtitled the Origins of Power, Prosperity and Poverty, takes issue with whether some of the emerging and frontier market countries can make the longer term transition to developed economies without major socio-political change. It could also be that climate changes sends them backwards.
China risks running out of steam
The work, by academics Daron Acemoghu, a Turkish American economist and James A Robinson, an American political scientist, throws doubt over the inevitability of Asian success and European/North American failure. Chinese growth prospects seem to many – including investors and fund managers with an interest in the area – to be virtually limitless while those of the developed world seem to be set for long term irreversible decline. But not to Acemoghu and Robinson who warn that "China's growth is likely to run out of steam." It fails on many corporate and social governance issues.
They say that wealth based on natural resources tends to remain with a tiny elite unless – the country in question has a track record of good governance. While it is no guarantee of sustainable government, this record needs to be over a long period. Those that have more recently emerged have a far more difficult task.
Europe, and by extension European colonies such as South Africa, North America, and Australia – generally but not always win on this basis – Argentina is an exception. Europe has had more than 2,500 years of some form of successful governance while many ex-colonies in Africa have had under 50 years to get it right. Even Argentina, a European settled colony with a poor governance reputation looks good by comparison with much of tropical Africa.
Gap between rich and poor nations grows
The gap between rich and poor has accelerated over the past half century with those nations backed by a history of stable governance outplaying the others. For instance, the authors cite South Korea and Ghana, both equally poor in the 1950s. South Korea has had good governance while Ghana has suffered dictators and civil war since independence. Today South Korea is far richer and far more peaceful. Africa funds have often had a torrid time despite their ability to come up with an apparently compelling investment rationale.
Russia has immense riches to extract. But thanks to a history of bad governance which has helped engender endemic corruption, only a few have gained from these resources, despite rising commodity prices.
Natural resources a curse, not a cure
The authors claim that there is a "Curse of Natural Resources". Certain commodities such as diamonds and oil tend to promote corruption, civil war, and the neglect of women and children as their extractive industries hold back development because so few share in the wealth. And countries that use their resources too quickly – sometimes mortgaging them to pay off the interest on international loans – end up more impoverished than if they had never had the forests and mines in the first place. Without strict party control, many fear China could become an ungovernable tinder box.
Other nations, such as Japan, which have few resources, have had to invest in education and health instead.
Resources are not always a curse. The authors cite gas-rich Norway and oil-wealthy Trinidad and Tobago as nations which have benefited from what is under the ground by investing in education and welfare. Norway is now the world's 2nd richest country while Trinidad is fast approaching equal footing with much of s
The north-south divide
There is also a very clear north-south divide. In Africa, the nations at the very north and south have better prospects than those in the middle. The tropical nations have less developed agriculture thanks to a shorter history and poorer soil and weather conditions, and a greater propensity to disease such as malaria. Mosquitoes and microbes cannot winter in Europe but survive in hotter climates, leading to greater illnesses, higher infant mortality and the need for more children to be born to replace those who die.
The book is often bleak. But it has a clear message for investors. It's OK to believe in the emerging and frontier nations – providing it is for the short term as it might only last as long as others believe it will. Much of the cash powering the Brics, the Civets and the Makes is hot money which, on past experience, is ready to chase whatever is the new best thing. Anything longer term may demand an act of faith that goes contrary to the socio-political history of the past many thousand years.
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