Manager Views

Are you investing enough abroad?

Risk is part of investing. And the majority of Canadian investors have decided that it’s safer to invest at home, with just a small percentage of their portfolios in foreign funds. But James Morton, Portfolio Manager, Mackenzie Cundill Emerging Markets Value Class and Mackenzie Cundill Recovery Fund, thinks Canadians have it wrong. From his perspective, by staying at home they are missing out on a chance to invest in many of the fast-growing economies that will soon dominate the world. “When I say ‘emerging markets,’ risk is the first word that comes to mind,” says Morton. “A lot of that is perception and looking in the rear-view mirror. To use that old Chevrolet advertising line: ‘These are not your father’s emerging markets.’”

If they are not “your father’s emerging markets,” what’s changed? It’s a question that Morton likes to answer in two ways. He can cite a long list of statistics showing that emerging-market equities are competitively priced and analyze debt-to-GDP rankings to show how far emerging markets have come and how sound they are.

Just as important, Morton has been travelling in emerging markets for almost 30 years. He has seen the iron curtain lift on Eastern Europe, watched China’s Communist regime embrace private investment and witnessed the transformation of their economies as millions of people climbed out of poverty. Still, Morton says unless you’ve seen it first hand, “It’s very hard to fully understand the scope, scale, extent and pace of change that is taking place out there. It’s truly dramatic.”

Is there more risk in Western markets?

Many of these countries have come so far that Morton believes there is now more risk in Western economies than in emerging markets. Take the question of sovereign debt that is plaguing Europe; which may soon arrive at America’s doorstep and is at the root of nearly every major financial calamity – from the Asian currency washout in 1997 to the financial crisis in 2008. Europe has nearly four times as much public debt as a proportion of GDP as Indonesia, whose ratio is around 25%. By comparison, Japan’s debt-to-GDP ratio is 200%, Greece is 115%, Ireland, 64% and the US, 52%.

These debts will continue to rise as Western governments pump money into their economies to keep the sluggish economic rebound going. But in the long run, this money has to be paid back. And, as it is, it will slow economic growth for years to come. “We’re now at a point in the US, Europe and the UK,” says Morton, “where putting money into the economy through debt expansion is going to have a negative effect on GDP growth. We have reached this point and passed it.”

Consumer spending in emerging markets is growing?

Consumer debt also weighs on Western economies. In the US, consumer or household debt-to-GDP has reached almost 100% and is at a similar level in Britain. By comparison, in China consumer debt-to-GDP is 16% and in the Philippines it’s 2%. With lower consumer debt in emerging markets, the rapidly emerging middle class has room to spend. China’s middle class alone, notes Morton, is already spending $7 trillion a year, and that number is expected to triple over this decade. As it grows, Chinese consumers will be spending twice as much as their American counterparts, triggering a material shift in spending patterns around the world.

This growth is not restricted to behemoths like China and India. Indonesia, notes Morton, will soon surpass the UK as the seventh largest economy in the world and Nigeria’s economic output will soon match Germany’s. In India alone, the number of households that have $5,000 to $15,000 a year to spend over and above basic necessities has increased tenfold in 20 years to over 100 million households. “That’s a serious amount of spending power,” says Morton.

Perceptions are hard to change

 Still, for many Western investors, their perception of emerging markets remains anchored to the manufacture of plastic toys made in China. But Morton says emerging economies are changing rapidly, with the service sector accounting for 40% of economic output in China in 2009. So while plastic toys are still being exported, he points out that the manufacture and insertion of plastic hips is also growing in China.

And Thailand, a world leader in development of communications and electronics products, has the highest number of people filing patents per million of population. Internet usage is a modern barometer of economic development, and by 2015 internet use in the BRIC countries (Brazil, Russia, India and China) is expected to rise to around 1.2 billion people – three times the current user base in the US and Japan.

Even as growth accelerates in emerging markets Morton says these changes are still in their infancy, and investors should ask themselves these questions: “Where as investors do you want to be? Do you want to be positioned in front of this remarkable economic change or try to play catch-up? I know where I would rather be.”

As bullish as he is on emerging markets, Morton has also taken steps to reduce the risk of holding Cundill Emerging Markets and Cundill Recovery. For example, he owns Panin Financial, an Indonesian insurance company, which owns the Panin Bank – the only national bank in Indonesia that has not been acquired by a foreign owner. Based on other asset sales in the sector, if it is sold it would likely go for 500 rupiah a share, up from its current 200 rupiah trading price.

Still, no matter where they put their money, investors are taking some level of risk. So as an investor, he says you want to make sure you are compensated for any risk you are taking. “And in emerging markets,” adds Morton, “you will get paid properly for taking the relevant degree of risk.”

To see whether an emerging markets fund is appropriate for your portfolio, speak with your financial advisor.