Investment

An emerging market strategy for family offices

Emerging markets barely rated a mention in the Family Office Association’s January asset allocation survey. And you can see why.

A hundred dollars put behind them in 1989 would now be worth $1,340, against $1,900 invested in the S&P 500. 

Dan Rasmussen, founder of data-driven Verdad Advisers, believes investors should change tack, by backing emerging markets during a crisis and steering clear when sentiment gets hot

Over ten years, the MSCI EM index returned 4.2% compared to 9.5% from the MSCI World. EM private equity saw 9.9%, against 15.6% in the US, in the same period, according to Cambridge Associates.

Contrary to the bullish views of the World Bank, and others, emerging markets have, by and large, failed to emerge. When backing them, family offices have ended up with more risk, for less reward. They have become reluctant to pour money into the sector, putting aside social impact deals. 

Sloane Robinson, a renowned emerging market hedge fund struggled to raise money last year and decided to close. Hedge funds specialising in tech ventures like Tiger Global, are far more popular. 

Dan Rasmussen, founder of data-driven Verdad Advisers, believes investors should change tack, by backing emerging markets during a crisis and steering clear when sentiment gets hot.

He says an investor using this crisis strategy would have made an annualised 16% since 1993, against 9.5% from the S&P 500. 

Rasmussen is a value player who likes to take advantage of a crisis. 

In March 2020 he said investors would do well to pile into bombed-out US stocks.  Good call. 

He says crises happen twice as often in emerging markets, as in the developed world, defining them as events where markets halve. 

The Asian financial crisis of 1997, for example, triggered a 70% correction and a global panic. 

Since 1987, Verdad says there have been 71 emerging market crises in 18 relatively liquid markets. Emerging markets are less likely to recover quickly than developed countries, making it crucial to buy at the bottom when ratings are truly depressed. Investors who buy at the top, often in a commodities boom, risk losing large sums, leaving them with little capital to recover lost ground.

Extreme market volatility in an EM crisis reflects their vulnerability to economic turmoil, with Covid-19 merely the latest challenge. 

Overseas investors are quick to pull their money out as sentiment sours, triggering liquidity shortages, capital flight, massive current account deficits and stagflation. All of which leads to political or military upheaval.

Emerging markets hedge fund Greylock Capital has just filed for bankruptcy.  Chief executive Hans Humes says some EM central banks, particularly in Africa, lacked market access to prop up parts of their bond market during the pandemic. 

The military coup in Myanmar has led to a sudden freeze in private equity transactions. Share prices in the Philippines never recovered from the 1997 crisis although better-run economies have risen with China.

Argentina is dealing with yet another debt crisis following an election which produced a left-wing government. This hit Michael Hasentab’s Franklin Templeton emerging market bond fund, previously troubled by Ukraine, which is now worth $15 billion, against $70 billion in 2014. 

Latin America is unique in producing a negative return from private equity over the last ten years.

Rasmussen says investors should overcome their anxiety to buy relatively liquid EM bonds or equities in a crisis. After two years, they can bank their gains and switch to US Treasuries until they find another one.

Yale professor William Goetzman calls catastrophic crisis events “negative bubbles” which can produce wonderful investment opportunities.

Verdad research suggests large EM value stocks are the best opportunity in a global crisis, returning an average 91% over two years, against 23% for the S&P 500. 

In a more local crisis, EM debt tends to be the best bet, generating a 50% gain over two years, with the 18% risk of losing money. 

 

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