This article by CEO Kurt Lieberman originally appeared in Finance Forward, Sept. 13, 2015.
When analysts and investors assess investment opportunities, they frequently look for numbers and other information that compare the opportunities and identify the differences. The resulting insights become the basis for estimating future valuations and hence potential investment performance of the opportunities. Perhaps surprisingly, these “apparent” differences can be less important than unseen similarities. By understanding the unseen, analysts and investors can make better investment decisions, particularly when investing in international equities.
A comparison of Malaysia and Singapore provides an interesting example of such an approach. From many perspectives the countries are different. Malaysia is a much larger, while Singapore has a much higher per capita GDP. Malaysia is mostly Muslim, while Singapore contains many religions. For investors, Malaysia is part of the emerging markets, while Singapore is part of the developed markets.
Despite the many differences, over an extended period the two countries have performed relatively similarly (see chart on the left). Performance over shorter periods are frequently impacted by various “crosswinds” with countries tending to revert to underlying value over the longer term.
The similarity in long-term performance could be explained by non-traditional factors that have been shown in whitepapers and other articles to be drivers of portfolio performance. Multiple studies have shown the importance of governance in equity portfolios. Yet, governance is tough to measure at a company level given varying reporting requirements and a lack of standard frameworks to assess company-supplied governance information. Since companies tend to follow the legal, regulatory, and reporting requirements of the country where they are listed, governance can and should be measured at a country level. The legal, regulatory, and economic infrastructure of countries is usually unseen by traditional investment analysis and, similar to an iceberg, forms the important investment information below the surface. From this perspective, Malaysia and Singapore have relatively similar corporate governance environments.
Magni has developed a process for researching and assessing the legal, regulatory, and economic infrastructures of countries. The process uses Magni’s Sustainable Wealth Creation (SWC) principles which are based on well-accepted economic concepts. Countries who receive high scores according to the SWC are required to have more than strong intent and/or rules; there must be evidence that the companies within the country adopt the intended behavior. SWC address three very important questions.
To convert principles into an objective, repeatable process, SWC is divided into twelve Economic Standards. The Economic Standards are further divided into 280 Qualitative Sovereign Factors. Countries are scored based on their declared intentions plus their actual level of adherence.
Currently Singapore ranks 27th among the 46 countries in the combination of the developed markets and the emerging markets. Malaysia ranks 32nd. Singapore is one of the lower ranked countries in the developed markets, while Malaysia ranks ahead of more than half of the countries in the emerging markets. While both have improved their absolute scores over the years, Singapore has maintained a modestly higher score for the entire period. Singapore’s somewhat higher ranking is driven by better integrity in their markets, better regulation of financial services, and slightly better laws and regulations related to legal entities and shareholder property rights. Even though Malaysia is part of the emerging markets, it has some advantages over its neighbor in the developed markets, including better transparency regarding government policies and better operation of its payment systems.
Malaysia is one of a couple of countries in the emerging markets who have an environment for corporate governance that rivals some countries in the developed markets. More important than their market classification and more important than their financial or demographic statistics, the key to understanding a country is its legal, regulatory, and economic infrastructure.
Recently the emerging markets have been hit hard. The recent rapid decline in Chinese equity markets has led to concerns about all countries in the emerging markets (e.g., some sort of contagion). By assessing the less visible information found under the waterline, countries can be compared and such a process can help determine which countries are better positioned following the current Chinese-induced dislocation.