7659 a recipe for confusion year 2010 month 11 itemid 127


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A Recipe For Confusion

Written by Paul Amery

November 29, 2010 18:16 (CET)

Try putting together a portfolio of equity or fixed income ETFs and you’ll soon be confronted with the question of how much you want to allocate to “developed” markets and how much to “emerging” countries.

Sounds simple, doesn’t it?  Developed markets are the US, Canada, Europe with a bias to the Western part, Japan, a few South-East Asian countries, Australasia…and the emerging ones are pretty much everyone else.  The latter offer higher returns but with higher risk.  That’s the central premise of emerging market investing.

There’s a big problem, though.  As we highlighted in our last feature article (“Ratings Differences Highlight Eurozone Risk”), the credit markets now rate a number of European so-called emerging markets (Russia, Poland, Slovakia, Bulgaria) more highly than several so-called developed ones (Portugal, Ireland, Greece, Italy, Spain).

Taking bonds as an example and putting figures on it, as I did in my last blog (“Steer Clear Of Bond Ratings”), Russia is paying a yield of around 4.75% on its ten-year dollar debt, while Ireland has to pay over 9% on its euro bonds of equivalent maturity.  Which one is the emerging market here, and which one is developed?  In aggregate, traders are telling us clearly which one of the two they think is the riskier.

Maybe emerging markets are in a valuation bubble.  Personally, I’d decline to lend Mr. Putin money for ten years at that rate of interest,  and nor would I buy Mexico’s 100-year bond, given that that country has spent fully 40% of the years since 1800 in default, according to sovereign debt experts Carmen Reinhart and Kenneth Rogoff.

It’s possible that the current yield differentials, which make some emerging markets look a lot less risky than several eurozone countries, are merely a temporary anomaly, in other words, and we’ll be back to “normal” historical relationships soon.

On the other hand, I wouldn’t be so sure.  Go back to the eighteenth century and you’ll find that China alone generated a third of the world’s economic activity.  And India had an additional 25% of global GDP in 1700, according to economic historian Angus Maddison. Europe was a relative minnow, while America was still a disparate collection of settlements and colonised regions.  Go back a thousand years and you’ll find that Iraq, Persia and the silk route centres were centres of enlightenment, dominating science, the arts and global trade, while my British ancestors were struggling to keep warm.

Having visited China a few years ago and seen the country’s rail and road infrastructure, I certainly wouldn’t venture to call the UK developed by comparison.  Nor, when it comes to the “market” part of the country classification, do things make much sense either. In “communist” China government spending hardly exceeds 25% of GDP, while in the UK’s “developed market economy” the state represents over 70% of the economy in some regions (Northern Ireland, Wales, for example).

And, after teaching maths A-level to some Chinese and Indian students for a few months in 2005, I fear that the average British teenager will be struggling to compete with his or her Eastern counterparts in the future world economy. The Asian students’ general knowledge of the subject was streets ahead.  If the education standards are undoubtedly the basis for national wealth, the “advanced” nations seem mired in complacency.

To me, the division of the investment universe into emerging and developed country categories is the expression of an lazy, outdated and US- or Euro-centric global outlook that is not only no longer appropriate, but which actively hinders our understanding of the world.  It’s time to ditch development status classifications altogether.



The views expressed by those blogging are for informational purposes only and should not be construed as a recommendation for any security.

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