Emerging Markets Investing

By M. Isi Eromosele

While the benefits of investing in emerging markets (EM) has been well articulated: higher expected growth rates, improving macroeconomic fundamentals, favorable demographics and competitive cost structures, investors still grapple with the best way to achieve exposure to emerging markets.

Investing in emerging market equities benchmarked against the MSCI EM Index has been one of the most popular approaches, though EM equities have traditionally exhibited high volatility.

Over the past decade, U.S. dollar-denominated emerging market bonds have also secured a strategic allocation in the portfolios of many global investors. More recently, there has been growing interest in investing in the local currency debt of emerging markets, as local fixed income markets have deepened. Emerging market currencies have been another way to gain exposure.

Selectively combining country-specific exposures to EM bond, equity and currency markets might address volatility concerns with equity-only approaches and potentially enhance return opportunities.

A Holistic, Integrated Emerging Markets Approach

A total emerging markets approach is well suited to the distinctive risks and opportunities that are characteristic of emerging markets investing. In emerging markets, country-level risk is a dominant risk factor affecting the behavior of all asset classes, whether it is equities, bonds or currencies.

Country-level risk is generally high in emerging markets. These country-level risks are not necessarily geopolitical. They may reflect high levels of regulatory, political, social or macroeconomic uncertainty. As a result, investors in emerging markets might be well served by diversifying these country-level risks as much as they can.

One way of achieving a higher degree of country diversification is by expanding the traditional opportunity set; in other words, going beyond emerging market equities and looking at bonds and currencies. This is because the country universes of EM equities and fixed income only partially overlap.

Rather than allocating a portion of a portfolio to emerging market equities and a portion to emerging market fixed income, an integrated approach provides a better way of mitigating the emerging market risk generally associated with equity-only portfolios.

An effective approach would be to look at all countries individually and attempt to select what you consider to be the best equity and fixed income exposures, seeking to avoid any excessive country concentration.

Mitigating Common Risks

The holistic combined approach is an attractive option for investors contemplating an increase in exposure to emerging markets but who are concerned about the high volatility and concentration of traditional emerging markets equity products.

The fixed income exposure of the strategy may dampen the volatility associated with exclusive exposure to emerging market equities. Historical data have shown that including an exposure to EM fixed income (25 percent EM local bonds, 25 percent EM U.S. dollar bonds) would have enhanced the returns of an emerging markets portfolio over the last 17 years, which is the longest period for which the data are available, spanning up and down phases of global market cycles.

Managing An Integrated Approach

This integrated investment process should include a global macro outlook and views of individual countries. For each emerging market that the strategy invests in, you should ask four questions.

• First, is there value in equities? Look at the P/E ratio and free cash flow yields, returns on capital, growth prospects and competitive dynamics.
• Second, is there value in the currency forward? This requires understanding the balance of payments situation, the Central Bank’s priorities, the country’s monetary policy, level of sovereign risk, the overall global market and market technicals.
• Third, one should look at whether there is value in the currency-hedged bond. Here you look at inflation expectations, policy rate forecasts, sovereign risk as well as the global environment and, again, market technicals.
• Finally, one should ask whether spreads on U.S. dollar denominated bonds compensate for the unexpected losses, uncertainty and potential illiquidity. Here, too, you do a thorough assessment of sovereign risk, taking a close look at external and internal balances, liquidity and structural variables such as political and institutional risk.

A more traditional fund-of-funds approach (allocating between separate EM equity and fixed income sleeves) does not address these questions aimed at identifying the most attractive opportunities on a country-by-country basis.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

Copyright Control © 2012 Oseme Group

Long-Term Investment Opportunities In Emerging Markets

By M. Isi Eromosele

Investors are attracted to where they can find opportunities for a potentially strong return boost, and we see developing economies as a powerful growth source. That’s not to say emerging markets are merely a hot-dot asset class.

Emerging markets have a long-term story. We expect to see economies shift from focusing on producing and supplying goods to budding consumer culture on the road to economic maturity.

Growing populations and young consumer bases that typically save and avoid debt are fundamental reasons to believe the emerging world will continue developing, providing long-term investment options.

While emerging markets aren’t a new asset class, they’ve garnered a new-found popularity. The mass appeal emerging markets has found with global investors coming out of the Great Recession isn't due to an economic cure-all that helped developing economies pull the globe out of its economic mire.

Fundamental fiscal changes stemming from harsh lessons learned during economic meltdowns, such as the Asian financial crisis in the late ‘90s, are what put emerging markets on surer footing.

Governments and companies alike have strong balance sheets due to a decade (perhaps longer depending on the country) of prudent decisions, which helped developing economies ride out economic difficulties and move out of recessionary conditions.

Despite their resilience in recent years, emerging markets companies have faced rising inflation and costs, along with generally slower export levels, which has partially stifled economic activity.

It’s important to remember that fiscal strength and growth potential don’t make for bullet-proof markets. For example, we see higher volatility levels in developing economies because they’re perceived as carrying higher levels of risk.

Participating In Emerging Markets

Investors can participate in emerging markets by investing directly in developing economies’ securities, while indirect participation in emerging markets comes from tapping into multinational corporations with global footprints.

Investing directly in emerging markets securities is simple enough to understand - invest in a company that is headquartered in a developing economy. It’s also the most efficient way to invest in emerging markets. With indirect investments, do note that the U.S. does not have a monopoly on global corporations that do business in developing countries.

International businesses are just as far reaching. European large-cap companies sourced more than 30 percent of their revenue from emerging markets during 2011. We see these trends in businesses like Volkswagen, the German car company that happens to be the top automobile manufacturer in China, a market where car purchases have been on the rise.

Important Issues To Understand About Investing In Emerging Markets

Investors should remember that emerging markets are complex, and each developing nation has an individual mix of factors that influence growth. So the drivers of each economy need to be examined.

It’s easy, for example, to generalize that emerging markets have export-oriented economies. But what are they exporting? China manufactures countless varieties of consumer products, while Brazil’s main exports are commodities, which means economic cycles will flow through these two countries and companies within them differently.

In addition to unique revenue streams, governments will have varying philosophies on how to boost growth, contain inflation and create sustainable economic models. Emerging markets, as their name implies, are developing and changing, so what drives growth now may not be as economically important many years from now.

The intricacies don’t stop there. Investors should remember that financial reporting policies are different, so financial reports produced in Thailand may appear significantly different from reports in Russia.

Fortunately, more and more companies are moving to International Financial Reporting Standards (IFRS), which are more similar to accounting principles used in the U.S. and that trend should provide investors with more uniform data to examine.

Knowing where business growth is truly coming from and how management teams use capital is an essential part of finding investment opportunities that have long-term growth potential. And this shift in accounting standards should be good for investors.

Key Considerations for Investing in Emerging Markets

• Exporting economies roll through market cycles at different paces
• Macroeconomic policies vary
• Evolving growth drivers
• Financial reporting standards are different

Investing in multiple countries also provides an advantage investors sometimes overlook - currency diversification. Exposure to a variety of currencies boosts diversification potential and gives portfolios an improved sampling of global economic cycles.

Investing in emerging markets simply as a short-term strategy is not wise. Invest and participate in emerging markets using a long-term bottom-up quality growth investment process that focuses on companies’ profitability, business practices and stock prices and the belief that the financial fundamentals of the emerging market companies and consumers are sound.

Additionally, investors should ensure their choices for participating in emerging markets make sense within their respective portfolio strategy.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

Copyright Control © 2012 Oseme Group

Trade Finance Capacity In Emerging Asia

By M. Isi Eromosele

As the global and economic crises continue to run its course, many countries are struggling to secure much needed short-term financing and protection against rising commercial risks.

The higher costs and limited availability of trade finance has prompted action by international financial institutions, as the threat it poses to regional economies is significant. In Asia, a 10 percent decline in trade finance would result in a drop in total trade of $129 billion in developing Asia.

There has been an increase in the price of letters of credit – a trade finance instrument where by the bank of the importer guarantees payment to the exporter or its bank upon satisfactory delivery of a shipment.

Countries with high risk ratings have suffered the most from the drying up of trade finance, as financial institutions have reduced coverage for transactions considered as high risk. Country risk is the minimum for setting minimum risk premium rates for transactions covered by many export credit agencies.

A country’s sovereign default risk directly affects an individual exporter’s ability to get trade financing. Least developing countries such as Afghanistan, Laos and Nepal are classified in the highest country risk category.

Some countries in the Asia region have had difficulty accessing trade finance because of a general liquidity shortage in their economy. Some others have been affected because of increased risk aversion of financial institutions towards enterprises and to the higher counterparty risk of banks.

Strong interventions by Central Banks have markedly improved the situations in many economies, even as a general lack of information about trade finance has contributed to uncertainties about the solvency of counterparties in foreign markets and increased the perceived risk of trade finance products relative to other products.

Increased capital requirements have become an important factor in the rising cost of trade finance and there is a clear possibility that governments will impose tighter controls on banks’ international operations.

At the regional level, the Asian Development Bank has agreed to a significant expansion of its trade finance program, which is expected to generate up to $15 billion in support until 2013 to help counter an export slump that has been exacerbated by the reluctance of commercial banks to lend.

At the national level, many Asian countries have implemented new or enhanced trade finance schemes in response to the crisis, most of which are focused on providing export credit insurance and guarantees to help enterprises and banks to manage their risks.

These global, regional and national initiatives will ultimately to increased availability of trade finance in the near-term.

Many of the smaller and less developed Asian countries have very limited capacity to address trade finance shortfalls on their own and may not fully benefit from global and regional schemes since they lack the required national trade finance institutions and infrastructure.

Establishing or strengthening national trade finance institutions should be made a priority, since the absence of such institutions put traders at a distinct disadvantage, especially in times of crisis.

The focus should be placed on establishing government-backed but self-sustainable organizations that offer particular risk assessment and management programs to support and build the capacity of Asian countries with export potentials.

Additionally, governments need to focus on strengthening the quality and availability of credit information by supporting the development of domestic credit rating services.

Given the large gap in the availability of trade finance between countries in the Asia region, deepening cross border cooperation on trade finance and pooling resources and expertise in this area could be an effective way to mitigate bottlenecks in trade financing.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

Copyright Control © 2011 Oseme Group

Emerging Market Bonds

By M. Isi Eromosele

In 2010, emerging market bonds were one of the top performers in the global fixed income universe. Some of the major emerging market countries have pursued growth-oriented and somewhat conservative fiscal policies, increased their foreign currency reserves, and as a result their currencies have commensurately strengthened relative to their developed market brethren. The strength in emerging market equities also has indirectly helped to improve investor interest in and perception of emerging market bonds.

As such, the global market for emerging market bonds has grown significantly in recent years. The consistent growth in emerging market debt over the last five years for which data is available has been with a compound annual growth rate of 8.0% for international bonds and 18.8% for local bonds. As of December 2010, the total outstanding amount, including both groups, stood at close to USD 15 trillion.

In addition, the diversity of emerging market local bonds has been increasing. The following are the four main categories for local emerging market bonds.

• Floating rate
• Straight fixed rate
• Inflation indexed
• Exchange rate linked

Traditional instruments, such as those with a straight fixed rate, have been declining moderately in proportional terms. On the other hand, as inflation increasingly becomes a concern in emerging market countries, inflation-protected bonds have shown a rising share in many of these countries.

Regional Distribution

It is interesting to examine the distribution of bonds and equities across the various countries and regions. In fact, the Asian Pacific region is ahead by a large margin in both equities and bonds. In the country breakdown, China is the main reason behind the large size of Asian Pacific equity and fixed income markets. In addition, the top four countries in equities are the BRIC (Brazil, Russia, India, China) countries, which together accounted for three-quarters of the market capitalization of the top ten countries. In addition to China and India, markets such as Korea, Taiwan and Malaysia contribute to the pie for the Asian Pacific region. As for emerging market bonds, the market size in terms of outstanding amounts of issuance is smaller than in equities.

The top 10 countries by international and domestic bond issuance are:

China | Brazil | South Korea | India | Mexico | Turkey | Taiwan | Malaysia | Poland | Thailand.

One of the global risk factors is a Global Emerging Market Bonds factor that captures the risk of emerging market bonds. This factor covers the risk of fixed income assets issued in an external currency, either by a government in an emerging market country or by a corporation that is domiciled in such a country. A rise in this factor indicates that the prices of emerging market bonds are increasing and vice versa.

Investment Strategy

You generate returns through Emerging Market Bonds by actively managing a diverse portfolio of emerging market bond securities. This strategy takes advantage of both external and local currency debt and to a limited degree, emerging market corporates from diverse sectors and industries. This strategy exploits the entire quality spectrum and combines a top-down country allocation with rigorous bottom-up credit analysis and valuation of individual issuers. The strategy employs disciplined portfolio construction which places a strong emphasis on risk management.

Emerging Market outlook remains positive and well supported by strong growth projections, low financing needs, steady inflows and strong cash flows.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

Copyright Control © 2011 Oseme Group

Strategies For Success In Emerging Markets

By M. Isi Eromosele

In recent times, emerging markets have been experiencing phenomenal economic growth that has enabled many of these nations to collectively become the engine of global expansion. These countries, from Asia, Africa and Latin America are determined to increase their global competitive advantage, even as they strive to raise their populations’ standard of living. These markets present an important source of continued opportunity for global companies from developed nations.

Foreign investment, which been historically limited, is now purposely increasing. It is our recommendation that this is the time for global countries to increase focus, investment and resources on emerging market nations such as Brazil, Indonesia, India and Nigeria. These countries possess great global ambitions and are in the midst of a tremendous transformation phase signified by rapid infrastructure and economic development. The gross domestic product (GDP) of these nations is expected to grow by an average of 8 - 12 percent while that of the developed world is projected to grow at about 4 - 6 percent in the next four years.

The business backdrop in emerging markets does present some challenges, including scalability to meet massive opportunities, cultural differences, localization of assets and transfer of success. To be successful in emerging markets, global companies must operate from a local office and form partnerships with local companies that have industry expertise. There needs to be considerable product localization, strong local competency development and local business decision making empowerment.

For many global companies, a major hurdle is how to replicate their success in a developed economy into an emerging market with greatly different characteristics. Superimposing a business model used in a developed nation like the United States unto an emerging nation such as India on is not an option. It will simply not be feasible. A workable solution is to take the best practices from business processes in developed countries and customize them to fit economies in the emerging markets.

Global companies should establish flexible business models that enable them to develop repeatable processes which can then be applied within multiple emerging countries. The approach within each business model is replicated within each emerging market but customized to focus on new industries in which emerging nations lead, such as energy and globally needed commodities. The model is then replicated across emerging markets and looped back into the suitable developed country.

Partnering is an imperative in developing business opportunities emerging markets. Companies would to cultivate strategic alliance partners that are familiar with and knowledgeable within specific regions. They are required to help maintain communications with governments, enterprises and local service providers. Building strong relationships with the public sector in emerging markets are essential to accomplishing stated business objectives in these countries.

Now is the time to enter emerging markets and participate in the transformation that is taking place in each one of them as well as in the opportunities being created in these fast-growing areas of the world.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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