The economic growth of the Bric countries of Brazil, Russia, India and China have been the driving force of emerging market investment of the past 10 years but their success combined with fears that these countries may not be able to maintain their rate of growth has prompted some fund managers to start to look for the next emerging market investment story.
In October 2010, Castlestone Management launched a Next 11 equity fund looking at next economies to experience the growth of the Bric countries. This was followed by Goldman Sachs Investment Management’s Next 11 fund which launched in January this year and last month saw HSBC Asset Management launch a Civets fund for the same reasons.
Fidelity Investments portfolio manager Ayesha Akbar says: “Ten years ago, no one was concerned about China’s economic status. Now it is set to become bigger than the US. The Civets countries of Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa are coming through now because Bric countries hit the mainstream.”
The Next 11 countries are similarly diverse, featuring Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, South Korea, Turkey and Vietnam.
While it has not launched a specific fund, Fidelity recently suggested the Mint countries of Mexico, Indonesia, Nigeria and Turkey, could be the next countries to follow the lead set by the Bric economies.
Akbar believes that what the Civets and N-11 countries may seem arbitrary but share common themes.
She says: “Why they have been put together in this particular way is something you can question but I would use these acronyms to describe specific attributes of countries.”
HSBC Global Asset Management head of macro and investment strategy Philip Poole says: “Civets are geographical slices through a group of markets loosely defined as ’emerging’ for specific reasons.”
One of the reasons for interest in these countries is their demographics.
Akbar says: “They all have young populations. These underleveraged consumers are the main appeal.”
Poole refers to the young demographics of these countries as “a population dividend.”
He says: “Think of the UK’s ageing population. It creates problems in terms of pension provision, healthcare and tax rates. With a young population, the implicit assumption is you can employ them all, so production goes up and growth is supported, as i the Middle East.”
Size of population is equally as important as age. Bestinvest senior investment adviser Adrian Lowcock says: “Indonesia is a good example. It has a population of 230 million, which is big enough for it to take over the mantle of manufacturing hub of the world from China. If you can get the population working, then wealth will follow, which is attractive for investors.”
But Akbar is less certain about the role of growing populations in securing investment returns. “I can understand why a large bank would see them as attractive, in that developing countries will need financial services, but does that mean good returns? I am not convinced.”
However, she does see the natural resources in these countries as a reason for investment. “China has heavily invested in Africa. It has been very smart by offering to build infrastructures for the increasingly urbanised new middle classes in exchange for mineral rights. These markets are commodity primaries – their agriculture is what they have got to offer.”
Urbanisation is another theme running through the Civets and N-11 countries.
Poole says: “China is the best example of this. Twenty-five years ago, only 22 per cent of the population lived in cities, now it is 43 per cent. When you urbanise, people move from lowproductivity jobs to higher-productivity ones in urban industries such as factories. The productivity increase has fuelled Chinese growth.”
Poole believes Indonesia will undergo similar urbanisation in the next few years.
These changes point to emerging markets as being significant contributors to global GDP in the future.
However, there is some scepticism about whether these changes will drive superior investment returns.
Evolve Financial Planning director James Norton says: “There is zero correlation between GDP growth and stockmarket growth. That is a fact. Academic data going back 110 years demonstrates it.”
Norton also says some of the differences in stockmarket performance between developed and emerging markets was down to different underlying economic conditions rather than demographic changes.
He says: “Ten years ago, the developed markets were in the middle of the biggest stockmarket bubble ever. The emerging markets, meanwhile, were coming out of various credit defaults. All that is happening now is the developed markets are correcting downwards and the emerging ones are correcting upwards.”
Akbar agrees that economic changes can be disconnected from investment growth.
She says: “Concepts like Civets and Mints originated from an economic perspective, not an investment one. China has been growing at 10 per cent for a lot longer than 2005 but it has only seen its returns soar since then.”
However, the issue of risk is the biggest argument against investing in Civets or N-11s.
Lowcock says: “For starters, there is huge political risk. Events in Libya and Egypt highlight how quickly these issues can come to a head.”
Other Middle East countries also present strong political risk.
Akbar says: “In Turkey, there is the chance that AKP could get a majority while Iran is just not a market that is conducive to doing business with the West. When Goldmans launched its fund it was ex Iran for that reason.”
Liquidity is another issue that many emerging markets struggle with and the problem is highlighted by the 2009 closure of New Star’s Heart of Africa fund due to illiquid sub-Saharan markets.
Lowcock says: “These markets can just close up. Regulation is a part of that. Civets and N-11 markets are certainly not as well regulated as the UK and even Asia Pacific countries have come a long way in terms of corporate governance. What you will get if regulation is less strict is high volatility.”
Another issue for fund managers to get to grips with are idiosyncracies of specific markets.
Akbar says: “In China, KFC has done fantastically well but MacDonalds has not. Anecdotally, you hear it is because people in China like eating with their hands, so chicken is great but hamburgers are not. There is also the view that Ronald MacDonald has a white face and in China a white mask is associated with death. It is that sort of thing you have to understand.”
’The Civets countries of Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa are coming through now because Bric countries hit the mainstream’
HSBC’s Poole suggests these markets should be tackled as part of a diversified investment strategy but does not see them knocking the established emerging markets countries off their perch.
Poole says: “Civets is an interesting theme but I do not think it is going to replace Bric or fully developed market equities. It is more about a diversified portfolio.”
Lowcock also says the potential for growth makes them an interesting proposition but only with very low exposure for investors that have made it very clear they can tolerate the levels of risk involved.
He says: “I would always have a small part of the portfolio in emerging and frontier markets but only 1 or 2 per cent at most. I would only recommend investing in a frontier market if my client was looking for something adventurous.
“People are always looking for the next big thing and frontier markets are just one area where this could play out. There is the potential for super-normal returns but with that will always come higher risk.”
But other advisers such as Norton take a far more sceptical view and suggests the investment case has become secondary to the marketing.
He says: “I could see the logic behind Bric. It seems like that has just turned into marketing and I think all these acronyms are ridiculous.”
Which emerging market economy offers the most potential for growth?
Fidelity Investments portfolio manager Ayesha Akbar:
“Indonesia. It has made the transition from effectively a military dictatorship to a reasonably established democracy. It has commodities and a young population. It is lining up pretty well investment-wise.
HSBC Global Asset Management head of macro and investment strategy Philip Poole: “Brazil. It has a growing middle class and is a
strong exporter of foods such as soy, meat, corn and processed goods. In a world where climate change is making food scarcer and pushing up prices, it offers trade gain to Latin America.”
Aberdeen Asset Management senior investment manager Mark Gordon-James: “Mexico. It offers well run companies and relative value, particularly among the midcap stocks.”
Bestinvest senior investment adviser Adrian Lowcock: “Qatar. It is a potential area because it is hosting the World Cup in 2022.”
Evolve Financial Planning director James Norton: “Do not go for single countries. Go for the MSCI emerging markets index and get a broad-brush approach.”