In the New Emerging Markets, It's All About Political Riskby and
Low commodity prices and unstable societies raise risks
Investors visiting more often in hopes of on-ground insights
During the boom years, when China’s demand seemed insatiable and commodity prices dependable, the emerging-markets team at Stone Harbor Investment Partners in New York visited its countries once or twice a year. In the past six months, it has made four trips to Brazil and, since January, toured Colombia, Mexico, Venezuela, Poland and Malaysia.
“We are in the part of the cycle when the economies slow down and administrations have to take tough measures,” said Pablo Cisilino, who leads the group and helps manage about $42 billion in developing-nation debt. “Situations like that require being more on the ground, to be there to understand what’s happening.”
Investors are looking at numerous ways to deepen their grasp of local politics. Sammy Simnegar, a stock picker at Fidelity Investments, now dedicates some of the time he used to study corporate earnings to attend conferences on Brazilian and Turkish politics. Two years ago, Commerzbank AG’s chief emerging-market strategist Simon Quijano-Evans began basing bond trade recommendations in part on a country’s corruption ranking or by the number of female corporate board members.
The change in investing tactics stems from shifts within emerging markets -- depressed commodity prices, a drop in disposable income, heightened political instability -- and beyond. China’s economy is contracting, sovereign wealth funds are dumping risky assets, terrorism and refugees are spreading, and the U.S. is no longer a global policeman. After posting average annual returns of 22 percent in the eight years through 2010, the benchmark emerging-market stock index has lost about 4 percent every year since.
The result is a dramatic shift: firms now have analysts learn the names of politicians, prosecutors and supreme court justices, double the number of trips, scan prices at foreign supermarkets, track footprints at stores, and read facial expressions of policy makers. Global fragility, they say, is unveiling institutional weakness, graft, poor governance, and low labor productivity -- and they need to track them all.
“When growth looks great, your fiscal numbers look great, your current accounts look great, you downplay or overlook the politics or other problems of the economy,” said Win Thin, the head of emerging-market strategy at New York-based Brown Brothers Harriman.
From the early part of the century to 2012, the so-called BRICS -- Brazil, Russia, India, China and South Africa -- were seen as solid investments, combining young populations with disposable income and high-priced natural resources in growing demand.
After the prices of oil and other commodities plummeted, political risk soared, especially among populations with reduced incomes and heightened expectations, now able to better articulate dissent. This has forced a change in emerging-market investment strategy from a holistic approach to differentiating among economies by quality of governance.
For example, after losing 63 percent in dollar terms over the last three years, Brazil’s Ibovespa stock index has gained 28 percent in 2016, more than any other market in the world, on speculation that President Dilma Rousseff will soon be impeached. While the economy is mired in the worst recession in more than a century, optimism rises that her ouster could end the political deadlock that has paralyzed the nation.
Vice President Michel Temer’s party, known as PMDB, left the governing coalition Tuesday, delivering a major blow to Rousseff just weeks before she faces an impeachment vote in Congress.
South Africa’s President Jacob Zuma has also come under attack for his connection with a wealthy family, whipsawing investors along the way. Central Bank Governor Lesetja Kganyago has said that political developments are among factors affecting the rand, which was among the worst performers in developing markets this year.
Two months ago, Standard & Poor’s unexpectedly lowered Poland’s credit rating for the first time, citing concern over the new government’s push to take control of key institutions that need to remain independent. The shocking move sent the zloty to a four-year low before recovering this month.
Ian Bremmer, a political scientist who founded the risk research and consulting firm Eurasia Group in 1998, said he remembers pitching Eurasia’s services to Wall Street and hearing back, “Interesting, but why should I care?”
“You actually don’t have those conversations any more,” Bremmer said of his 150-person firm.
Policy making and politics began to play a greater role after the flurry of international regulatory initiatives that emerged following the onset of the financial crisis in 2008, he said.
“We probably have about 10 times as many in-bound requests for political risk from both clients and would-be clients now than we did during 2008,” he said.
Middle East Crisis
Bremmer pointed to the rise of al-Qaeda and Islamic State, the Syrian refugee crisis, and a series of failed states across the broader Middle East -- all at a time when the U.S. is no longer patrolling the globe as aggressively.
“You have a lot of things that would normally be 1 to 2 percent, that look like they could be 20 to 30 percent in this environment,” Bremmer said.
Rick Rieder, BlackRock Inc.’s chief investment officer for global fixed income, sees another structural change -- Chinese and Mideastern buyers of assets have become sellers. As market volatility gets “persistently higher,” investors are becoming increasingly risk averse, staying away from countries with unpredictable politics, he said.
Fidelity’s Simnegar said he saw the change in investment approach most clearly in his conversations with chief executive officers of Brazilian companies. Five years ago, they talked about earnings, market share and cash flows. Now they focus on Rousseff’s impeachment.
Simnegar, who oversees $6 billion in emerging-market equities for Fidelity, said the same goes for India, one of the last bright spots in developing nations. Indian management teams spend most of their time with investors lamenting that Prime Minister Narendra Modi is not moving more quickly on economic reforms. The S&P BSE Sensex is down 4.4 percent this year.
Of course, political risk has always been an essential part of investing in developing nations with their young and volatile political systems. Thin, the Brown Brothers Harriman strategist, said he was never searching for countries without risk, just trying to understand the nature of that risk.
“In the 1980s, it was debt crisis, so the risk was whether the country could pay,” said Thin. “Now the question is, what is the risk to currencies, growth and the bond markets?”
Market volatility is now triggered more by a country’s shifting leadership than terrorist attacks, said Viktor Szabo of Aberdeen Asset Management. He pointed to the diminishing market impact of the Ankara bombings this month. Meanwhile, graft investigations in South Africa and Brazil are having significant influence on asset prices.
Sean Newman, a money manager with Atlanta-based Invesco Ltd., says he has discovered that there is no substitute for face-to-face meetings and “on-the-ground due diligence,” giving as an example a trip to Brazil a year ago that alerted him to its growing problems and caused him to shift investments. Invesco manages about $776 billion in assets.
“That was certainly one of those eye-opening types of exercises that reshaped your views,” Newman said.