The Jonathan Davis Column: Emerge from the global gloom
As Professor Malkiel points out: `The emerging markets road to riches is not for the faint hearted'
Saturday 31 October 1998
This is sound advice in theory, but awfully difficult to follow in practice. As Keynes perceptively observed more than 50 years ago, many people would prefer to fail conventionally rather than succeed by doing something out of the ordinary.
Granted the importance of having a contrarian streak, is the place to be investing now in emerging markets? A quick scan through the statistics tells a painful story of decline over the past year. A glance at the share price history of Templeton Emerging Markets, oldest and largest of the specialist investment trusts in this area, shows what a volatile ride this particular sector has been over the last 12 years.
Despite the flight to quality by investors all over the world in recent months, one man who thinks that emerging markets are the place to go hunting for bargains these days is Professor Burton Malkiel of Princeton University in the United States. As anyone who has read his classic book, A Random Walk Down Wall Street, will know, Professor Malkiel has done as much as anyone in the last 20 years to demystify stock market investment.
He is a distinguished academic who - unlike many of that breed - has not been afraid to put his money where his mouth is. Although a firm believer in efficient markets, and hence one of the earliest advocates of the merits of index funds, he was also one of the first to predict that the Eighties would be the start of a major boom period.
Now, like many other commentators, Prof Malkiel is wary of current valuation levels on Wall Street and in other major equity markets. But, as I discovered when I caught up with him the other day, he is positively gushing about the potential for emerging markets.
Emerging market funds now offer "the best bargains anywhere in the world", he says confidently. "In five to 10 years time, people will look back and say `boy, when those bargains were there, why didn't we do something about it?'."
A year ago, Prof Malkiel was putting the finishing touches to a new book, Global Bargain Hunting, written with a colleague at New York University, which made the case for buying shares in emerging markets even then. That, of course, was before the dramas of the past year which have sent most markets in Asia crashing and precipitated Alan Greenspan into what looks like mildly desperate measures to prevent the world succumbing to "the worst financial crisis since the War".
Prof Malkiel makes no bones about the fact that the current crisis has badly damaged investors' confidence in the emerging market concept. But his view is that the recent turbulence is merely a demonstration of the fact that the risks in emerging markets are - and always have been - high. These risks are the flip side of the equally high potential rewards to be earned from investing in what have been some of the fastest growing and vigorous economies in the world. "This road to riches," he writes in his book, "is not for the fainthearted."
The basic arguments for emerging markets have always been that they enjoy higher growth rates and lower market valuations than our own markets. But a crucial third element in the case has always been that they tend not to move up and down in line with the big markets in the USA and Europe. As a result, they offer powerful diversification benefits to anyone with a high degree of stock market exposure.
Even this hardened optimist, it is true, does harbour some doubts about the case for emerging markets. Malaysia's decision to reimpose capital controls is "a worrying development" which, if echoed elsewhere, could undermine the attractions of emerging markets for investors. His book chronicles in detail the threat posed by the lack of enforceable legal constraints on managements and governments in many emerging market countries.
The bottom line, however, says Prof Malkiel, is that the best response investors can make to the current turbulence in financial markets is to increase rather than reduce their diversification across different types of asset. Emerging markets have an important part to play in that equation.
The current widespread gloom is an unprecedented buying opportunity. "It is the nature of markets to go to extremes. If we weather the storm, the bargains will be better than ever."
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