New Global Investing – Part 2

Emerging Market Allocations

For a USA based investor the available universe outside North America consists of three primary market categories; developed, emerging and frontier.  Many of these countries stock markets had terrible 2011 returns, especially in Europe with losses of -10% or more and many of the emerging markets off 20% to 30%.

It is important to have an understanding of what capital markets are available.  It is equally important to understand that growth will not be uniform or consistent as countries strive to access capital.  Wealth will increasingly be created in parts of the world that we now categorize as emerging or frontier.

As a result, these classifications are not static as countries can move into different categories based on capital market structure, status of economy, international monetary access, and liquidity.  Most notably in 2010 Israel was upgraded from emerging market to the developed category.  Prior to that, Greece was the last nation to go from emerging to developed status which occurred in 2001.  South Korea and Taiwan are also potential countries for developed status and are still listed as emerging due to a variety of considerations such as currency convertibility and real-time market data access.

If we look at the global markets and how they are currently designated developed Markets account for about 61.0% of world GDP, emerging markets account for 27.5% of world GDP and frontier markets account for about 3.5%.  The rest of the world, or roughly 8%, are countries that are difficult to classify due to large state ownership of assets and limited capital access by foreign investors. These nations include Saudi Arabia, Venezuela, Iran, Pakistan, Cuba, as well as many Africa.

The developed world outside of the United States and Canada, generally referred to as EAFE or Europe, Australia and Far East currently has 22 members and highlights our friends from down under in the name of the index, although they are given no other special condition: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom (with the United Kingdom comprising England, Scotland, Wales and Northern Ireland).

Emerging markets include 21 countries consisting of the “BRICs” (Brazil, Russia, India and China) and 17 other nations: Chile, Colombia, Czech Republic, Egypt, Hungary, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, South Africa, Taiwan, Thailand, and Turkey.

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Lastly the frontier markets consist of 26 members:  Argentina, Bahrain, Bangladesh, Bulgaria, Croatia, Estonia, Jordan, Kenya, Kuwait, Lebanon, Lithuania, Kazakhstan, Mauritius, Nigeria, Oman, Pakistan, Qatar, Romania, Serbia, Slovenia, Slovakia, Sri Lanka, Tunisia, Ukraine, United Arab Emirates, and Vietnam.

The debt problems – and attempts to restructure – of the US, much of Europe, as well as the BRIC’s will drive the headlines in the near term.  The developed countries have enjoyed a valuation premium over the rest of the world based on rule of law and the general stability that comes with it.  As the stability is threatened by record deficits and unrest from the associated cuts to public spending, will this premium be eroded?  2011 saw emerging markets fall more than their developed counterparts and indeed, the emerging and frontier markets are dependent on exports to the developed world.  The western premium expanded.  But these countries are creating consuming middle classes which will serve to provide support to their economies and allow them to chart their own course.

As US based investors, we desire exposure in portfolios to countries that exhibit what we define as the elixir of growth.  We will be writing more on this in future articles as well as cover discussions about the western valuation premium that is still exists despite bloated deficits.

Here is to a prosperous 2012 for all.

About Matthew Kolesky

Matthew Kolesky is a Principal at ACM, Inc. and joined the firm in 2004. Matthew Kolesky was born and raised in Alaska and has served on many Anchorage area non-profit boards.