Here are some select extracts: (Warning: not for the faint of heart.)
| 1. Driving With One’s Eyes Closed: Passive Investing
It is true that if you close your eyes this saves energy. If you do so whilst driving, this should still save you energy, but this course of action is not recommended for obvious reasons. The first job of an active manager is to reduce risk. Major sovereign problems and crises typically are well-flagged. A country does not default, or take other extreme policy action detrimental to foreign investors, out of the blue. They will typically have had highly visible macro-economic problems for months before it comes to that." |
| “2. Excessive Reference to DM: Use DM Skills
One aspect of what I call Core-Periphery Disease is the idea that everything in global fixed income revolves around the interest cycles and monetary policy decisions in the developed world. Yet emerging markets have very different, and many, cycles at present. Not only do they not face the deleveraging reality and deflationary pressures of the HDICs (Heavily Indebted Developed Countries), but they have very different cycles amongst themselves. There is no emerging market inflation problem: there is though a Brazilian inflation problem, an Indian one, a Turkish one, and so on. Ignoring the substantial range of domestic inflationary forces and policy choices facing emerging Central Banks is good strategy for missing opportunities." |
| "3. Treat EM as an Afterthought: Use a ‘Global’ Manager
A psychological support device for Core-Periphery Disease is to treat EM management as peripheral or subsidiary. I remember a conference at which a pension fund presented on the issue of whether to allow global managers to invest in EM equities tactically or to employ specialists. Their empirical conclusion was that the global managers added value (with reference to their benchmark) by tactically investing in EM, but that their portion of EM investments under-performed the EM index, unlike the portfolios of specialists. The conclusion drawn was that one should allow both. However, what was discovered were two things: tactical asset allocation works in EM, and EM specialists are better at managing EM assets than global managers (in this sample at least)." |
| “4. Hedge Out ‘Currency Risk’: Increase DM FX Risk
Money illusion is the illusion that a currency is not a price like any other, but fixed. The pattern of volatility of EM currencies against the Dollar is now very similar to that of developed currencies versus the Dollar. In other words, it is the Dollar which is volatile. Investing in 30 currencies, and ones which have huge reserves, is arguably safer than investing in one." |
| “5. Outsource thinking: Use a Rating Agency
Also,in that we are facing financial repression (see ‘The Emerging View’, October 2011) ratings are increasingly a tool by regulators to capture investors’ savings to finance governments. Such behaviour suppresses investment grade yields further, and increases investor homogeneity and so systemic risks. Those investors not so constrained would do well to think about sovereign risk for themselves." |
| “6. Follow the Crowd: Miss the Really Big Risks
Investors needs to be constantly asking themselves whether there are possible scenarios and structural shifts ahead which could damage or outwit all their peers. If so they should consider doing things differently." |
| “7. Ignore HIDC Macro-Risk: Buy Multinationals instead
If one is investing in EM in part to reduce risk from the worst scenarios, investing in such multinationals is an inferior approach to investing directly in EM companies. Any excuse not to invest is EM is often sought, and the idea of investing in Western multinationals with EM income streams is one refuge for those persuaded of the benefits of EM but still constrained by their prejudices." |
| “8. Ignore the Unfamiliar: Deny the Existence of Whole Asset Classes
With the sovereign EM local currency debt market already larger than the US Treasury market for example (see ‘The Emerging View’, February 2012), how is it that some investors are concerned about whether it is significant enough to constitute an ‘asset class’." |
| “9. Believe What you Want to Believe: that EM is Risky and DM is Not." |
| “10. Extrapolate & Ignore Factors Difficult to Quantify" |
Not much to add here except to say given high management fees and historically poor performance of many active managers, dismiss the virtues of passive management at your peril. And let’s hope investors don’t confuse apples with oranges. Or rather, apples and bushels of apples: don’t perform a quantitative comparison of one type of developed market debt with every type of emerging market debt. The EM local currency debt market, though nascent, is far from an homogenous asset class.
