What is considered an emerging market varies, at the
margin, depending on the source that you consult. However,
this term usually refers to countries with a low average
annual GNP per capita. In general, countries classified
as low or middle income by the World Bank are considered
"emerging" countries.
In simple terms, as "value" investors we
look for securities that are priced at less than their
intrinsic worth; in other words, we are interested in
bargains. However, we are careful not to confuse a stock
that is a true value with a stock that is merely low
in price or "cheap." In addition to price,
we focus on quality.
Sometimes, when a stock sells for less, relative
to other similar stocks, it is for a good reason -
perhaps the management of the company is known to
be poor, the industry is depressed, or earnings are
expected to take a downturn. In many other cases,
though, a company that has a good intrinsic value
may have been overlooked by less thorough investors
or misunderstood by the markets. We believe that by
looking carefully, we can identify companies whose
true and positive value has not yet been incorporated
into their stock prices.
In our opinion, value investing is particularly suited
to emerging markets. Unlike developed markets where
information is readily available and generally incorporated
into stock price, emerging markets are more difficult
to penetrate. For this reason, there tend to be a
larger proportion of stocks whose value is undiscovered
and underpriced. At EMM, we have a network of analysts
whose sole focus is emerging markets: this allows
us to spend more time on specialized research and
on the political and macroeconomic conditions that
may affect companies in particular emerging markets.
We believe that this gives us a "leg-up"
on most other investors.
It's not always easy to be a disciplined, value investor.
Indeed the term "discipline" implies that
we stick to our approach even when it might not be pleasant
or fashionable to do so. Indeed, there have been periods
of stock market activity - especially those of rapid
growth -- when value investing was out of favor.
Over the long term, however, we firmly believe that
value investing is the only rational and responsible
way for us to invest as a fiduciary to our clients.
We are long-term investors. Over shorter periods, some
managers may be able to "time" market fads
and changing investor sentiments. But we don't believe
in luck as a long-term strategy - we believe the "right"
approach must be based on time-tested, economic principles
and good fundamental research.
We believe emerging markets are a strategic asset
class because:
Emerging markets represent over 80% of
the world population, over 20% of the world economy,
and over 10% of non-US markets. This "critical
mass" and relative importance is likely to
increase rather than decline over the next decade.
Companies in emerging markets - contrary
to the expectations of some who have read about
them in books rather than visited them or felt their
competition - have done well rather than badly in
today's more open, competitive world. Forays by
international banks, brewers, cement makers and
supermarket chains into emerging market countries
have made markets more competitive but they have
not beaten well-managed regional and local competitors
at their game.
There are plenty of examples of bad management
and poor investments in developed markets, including
the United States. Hedge funds gambled, savings
and loans made political loans, telephone companies
threw money at third generation mobile phone licenses
and acquisitions, Internet companies "burned"
through their funds without results, and electronic
commerce was subject to unrealistic expectations.
Emerging markets have survived each of these investment
fads.
It makes sense to over-allocate an investment
portfolio toward emerging markets during some periods
and under-allocate during other periods for tactical
reasons depending on expected returns and correlations.
It does not make sense to eliminate emerging markets
as an asset class either when things look very bad
(i.e., when the temptation is high and the likely
result disastrous) or things look very good (and
cutting back may add value).
Emerging markets are comparatively illiquid,
resulting in high market impact and above-average
brokerage and other trading costs.
Selling during "bad" times increases
trading costs and market impact because liquidity
tends to dry up. Well-timed selling at the "peak"
of markets is comparatively less expensive.
While some tactical asset allocation can
add value, emerging markets are a less than ideal
candidate for active trading strategies.
We believe that it is difficult to time
any market at least without a strongly disciplined
approach.
We have little confidence in the ability
of any investor to consistently forecast crises
or political upheavals.
The main "warning signals" to sell in emerging
markets are prolonged periods of success (leading
to extended valuations), significant currency over-valuations,
drops in reserve levels, sizable current account
or budget deficits, and excessive bank lending.
We have found that good times to buy for
the medium-term are evidence of structural changes
toward greater political or economic stability,
the aftermath of currency devaluations, and the
months following substantial downward earnings revisions.
While there are benefits from investing in emerging
markets, including improved diversification, oftentimes
lower valuations and, at times greater performance,
there are additional risks which investors should
be aware of.
In any developing country, there is the possibility
of nationalization, expropriation or confiscatory
taxation, political changes, (or uncertainty), government
regulation, social instability or diplomatic developments
(including war) which could affect adversely the economies
of such countries or the value of an emerging market
investment portfolio. In addition, it may be difficult
to obtain and enforce a judgment in a court in those
countries.
Investing in emerging markets means investing in
non-U.S. securities and receiving dividends and other
distributions in foreign currencies. As a result,
the dollar, or other "hard currency" value of an emerging
market portfolio will be adversely (or positively)
affected by changes in the value of countries' foreign
currencies relative to the dollar. Changes in exchange
rates may result from a variety of factors, which
directly or indirectly affect economic and political
conditions. Government or monetary authorities in
emerging markets countries have imposed and may in
the future impose exchange controls that could adversely
affect exchange rates or could limit a foreign investor's
ability to repatriate investment income or the proceeds
from securities sales.
Trading volumes in emerging markets are generally
lower and volatility is typically higher than in industrialized
markets. Brokerage expenses as well as transaction
and custody costs are also generally higher than in
industrialized markets and settlement mechanisms are
typically less developed and reliable. Disclosure
and reporting requirements are minimal and anti-fraud
and insider-trading legislation is generally rudimentary.
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