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Tuesday, September 26, 2006

Reprise on Emerging Markets- An Interview with a Practioner

From Value Discipline

The current edition of the Wall Street Transcript (subscription required) features an interview with Charles Wang of Acadian Asset Management who is Senior Portfolio Manager and Director of Research.

Given the events of last week in a number of emerging markets, I thought it might be useful to provide some insights from an expert such as Mr. Wang as well as some of my own reflections.

Years ago, when I first became involved in some emerging markets investment, the field was viewed as highly dangerous and suspect. As Wang points out, "Emerging markets are a small asset class accounting for roughly 7.5% of world equity markets based on MSCI." He adds, a small shift in investor sentiment can lead to meaningful inflows or outflows."

Wang also speaks of the greater global integration that has occurred in these economies and the freedom of moving capital around. Prior to the 1987 crash, there was a belief that most of these emerging markets were segmented...that is, would operate separately and distinctly and in an uncorrelated fashion to large developed capital markets.

The contagion of the Russian Default in 1998 and the Asian crisis of 1987 (which incidently began in Thailand) also seems to rank as a low probability event in Mr. Wang's opinion. Rather than "contagion," Wang describes it as a "liquidity-driven phenomenon." Whatever you call it, the sinkhole of collapsing confidence leads to a drain of foreign capital...stock prices feel the whoosh and the vacuum. Fortunately, this did not occur last week. I remember well what it was like to hold Hong Kong stocks in 1987 (they were considered emerging at that time) as well as some Thai bank shares. Cheap stocks became 30-40% cheaper overnight.

In the interview, Wamg recommends overweightings in Brazil and Turkey and describes "ignoring the background noise of politics and just focus on how companies are doing."

Finally, he acknowledges the importance of discipline: "It's easier said than done. We are adamant about our process and resist human temptations to second guess the strategy. We have a clear mechanism to test new ideas and continue improving the process. Second, we take a multi-factor approach and continue looking for creative ideas and techniques. Last but not least, we strive to understand emerging markets in comparison with developed markets. What's the nature of the emerging markets? Why does it differ from the rest of the world?"

As always, discipline is a significant part of any investment process. Creative, sensible thinking is always the groundwork that helps portfolios thrive. Finally, having some benchmark against which one measures value or growth is an important yardstick to consider in any investment. When measured against domestic benchmarks, Wang finds emerging markets to be fairly valued rather than being a real bargain.

"Emerging markets five years ago, three years ago, or even two years ago were a very attractive asset class, because they were so cheap and fundamentals were improving. But today, I think if you look at the valuations, they aren't necessarily undervalued, but I wouldn't say they are overvalued either. This is just a convergence story."

The most frequently asked question regarding foreign investment from my clients is what is your China or Indian exposure. But don't forget the other ASEAN countries. ASEAN already has a combined US$27billion trade surplus with China and India - as well as
tourism. At a recent investment conference sponsored by CLSA, the Finance Minister of Singapore described it as, " In ten years, people will think of Asia as having three pillars: China, India and ASEAN."

The risks may be significant, but the valuations for some markets may create substantial rewards over the years.

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