Saint Paul, Minnesota – March 10, 2015 – After two consecutive years of negative returns investors are increasingly speculating about whether 2015 will be the year that emerging market equities rebound. Through the end of February, the MSCI EM index is up 3.7%. Magni is cautiously optimistic that these equities will move even higher over the course of the year. However, there are a number of headwinds (including Greece, ISIL, energy prices and rising U.S. interest rates) that will continue to buffet this asset class. More than ever, identifying the countries best able to weather this environment, rather than picking individual companies, will be vitally important for separating the winners from the losers.
Traditional analysis attempts to identify the most attractive country opportunities by relying on metrics such at GDP, inflation measurements, trade data and government debt. The most recent example was a ranking just released by Bloomberg Business*, in which 80% of their evaluation was based upon such data.
At Magni, we have found much of this government-reported data incomplete, unreliable, inaccurate, or all of the above. We measure the quality of the information disseminated by the government and find this measurement of information quality more important than the actual numbers that are reported. Put simply, relying on such self-reported, numerical output and evaluating a country as one would a large-cap US stock can lead to poor returns and unanticipated risk. For example, if the accounting and auditing systems in a country are weak, financial ratios such as price to earnings or price to book are suspect. We believe it is necessary dig deeper and evaluate less traditional data to get a clearer picture of the real investment opportunity.
Magni scores countries on the quality of their economic infrastructures, which we gauge according to their adherence to a set of metrics we call the Sustainable Wealth Creation (SWC) principles. We believe that countries where the financial statements of companies accurately reflect their operating performance, where shareholder rights to future company profits are well protected, and where the business environment provides company management the clarity necessary to act confidently will outperform countries where these characteristics are lacking.
Of course, this type of data is much more difficult to gather than traditional government-reported data. But the resulting difference in ranking of the opportunity set can be striking and, we believe, make a significant difference in investment results. The recent Bloomberg ranking provides the opportunity to compare these different approaches.
Below are the top five emerging market countries according to Bloomberg and Magni research.
Except for South Korea, the ranking of most attractive opportunities are entirely different. A closer look at a few of the countries helps provide some insight into how evaluating less traditional data can provide a significantly different set of opportunities.
Magni ranks Mexico third among emerging market countries, yet Bloomberg has the country 18th out of 25 through primarily their use of public data as described above. Bloomberg’s definition of emerging markets includes Latvia and Morocco as well as the 23 countries considered emerging markets by MSCI.
Magni Research finds most of Mexico’s infrastructure in the process of adhering to the SWC principles. Additional improvement in the areas of corporate governance and auditing regulation would further improve Mexico’s ranking. After a difficult January in emerging markets, Mexico was up 7.4% in February, fifth best among emerging countries.
Bloomberg ranks Qatar the second most attractive investment opportunity. According to Magni’s SWC principles, Qatar ranks second-to-last on our list of emerging countries. Although Qatar gets somewhat high marks for their accounting requirements, the country gets fairly low scores in most other areas of economic infrastructure. In addition, the government is fairly opaque and hard to measure.
Magni Research has found that government opaqueness is often used to conceal ‘crony capitalism’ and other undesirable practices intended to benefit the privileged elites, thereby significantly diminishing a country’s score and, in Magni’s view, the prospects for their equity market. Qatar, which was upgraded from ‘frontier’ to ‘emerging’ by MSCI in May 2014, has returned 0.3% so far in 2015, placing it 16th among the 23 MSCI emerging countries.
These two processes do not result in every country being ranked differently. As previously noted, both Bloomberg and Magni rate South Korea highly. Likewise, both lists rank Egypt near the bottom. But the rationale in each case is derived from different data.
Presumably, Bloomberg ranks South Korea highly and Egypt (lowly) based upon good (bad) economic and financial metrics, respectively. Magni Research rates South Korea highly because its economic infrastructure rivals that of some developed economies. Korea exhibits a high level of transparency, regulatory oversight and commitment to good corporate governance. On the other end of the spectrum, the Egyptian infrastructure is often weak or, where not weak, opaque. There is little data in which Magni Research can place a high degree of confidence, and the connection between opaqueness and ‘crony capitalism’ seems especially strong.
Magni research has always found that Countries Matter™; especially when investing in emerging markets. This year this mantra could be especially important, where getting the countries right could make the difference between positive returns in emerging markets versus suffering through a third consecutive down year.
*Khan, Sarmad. “The Most-Promising Emerging and Frontier Markets, Ranked,” Bloomberg.com, Feb. 11, 2015.