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More About This Title Emerging Markets in an Upside Down World -Challenging Perceptions in Asset Allocation andInvestment
English
The world is upside down. The emerging market countries are more important than many investors realise. They have been catching up with the West over the past few decades. Greater market freedom has spread since the end of the Cold War, and with it institutional changes which have further assisted emerging economies in becoming more productive, flexible, and resilient. The Western financial crisis from 2008 has quickened the pace of the relative rise of emerging markets - their relative economic power, and with it political power, but also their financial power as savers, investors and creditors.
Emerging Markets in an Upside Down World - Challenging Perceptions in Asset Allocation and Investment argues that finance theory has misunderstood risk and that this has led to poor investment decisions; and that emerging markets constitute a good example of why traditional finance theory is faulty. The book accurately describes the complex and changing global environment currently facing the investor and asset allocator. It raises many questions often bypassed because of the use of simplifying assumptions and models. The narrative builds towards a checklist of issues and questions for the asset allocator and investor and then to a discussion of a variety of regulatory and policy issues.
Aimed at institutional and retail investors as well as economics, finance, business and international relations students, Emerging Markets in an Upside Down World covers many complex ideas, but is written to be accessible to the non-expert.
English
Dr Jerome Booth (London, England) is a well-known economist, emerging market expert, investor and entrepreneur. He is a sought after commentator on global economic events, was part of the MBO creating Ashmore Investment Management, which is now one of the world’s leading investment managers dedicated to emerging markets and, until May 2013, served as its head of research. Through his private office, New Sparta, Jerome manages a number of his investments. He is the principal shareholder and Chairman of the UK phone company New Call Telecom. He is Chairman of the investigative news journalism company ExaroNews, and Chairman of Walpole Publishing which produces Moving On Magazine for school-leavers. He is also Chairman of New Sparta Films, and also recently bought Icon Film Distribution UK. Jerome is also the principal shareholder of the Lloyds insurance broker, CBC UK Ltd. He is currently a visiting professor at Cass Business School, a governor of Anglia Ruskin University, chair of the Fitzwilliam Museum Development Trust, Deputy Chairman of the Britten Sinfonia and a council member of the Royal Philharmonic Society.
All proceeds from the sale of this book are donated to the Ashmore Foundation, which supports charitable causes benefitting disadvantaged communities throughout emerging markets. For more information on the work of the Ashmore Foundation and the charities it supports, please visit the website: www.ashmorefoundation.org
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Acknowledgements xiii
Introduction 1
I.1 Upside down: perception vs reality 2
I.2 The structure of the book 4
1 Globalisation and the Current Global Economy 9
1.1 What is globalisation? 9
1.2 Economic history and globalisation 12
1.2.1 The desire to control and its impact on trade 13
1.2.2 The influence of money 15
1.2.3 Trade and commodification 16
1.2.4 Nationalism 17
1.3 Recent globalisation 18
1.3.1 Bretton Woods 19
1.3.2 Ideological shifts 21
1.3.3 Participating in globalisation: living with volatility 23
2 Defining Emerging Markets 25
2.1 The great global rebalancing 25
2.1.1 Financing sovereigns 26
2.1.2 Catching up 27
2.1.3 The poorest can also emerge: aid and debt 29
2.1.4 From debt to transparency and legitimacy 30
2.2 Investing in emerging markets 31
2.3 Emerging market debt in the 20th century 32
2.3.1 Types of external sovereign debt 33
2.3.2 FromMexican crisis to Brady bonds 36
2.3.3 Market discipline 39
2.3.4 Eastern Europe 40
2.3.5 Mexico in crisis again 41
2.3.6 The Asian and Russian crises 42
2.3.7 Emerging markets grow up 44
(a) The first change: country and contagion risks fall 44
(b) The second change: the investor base 46
2.3.8 Testing robustness: Argentina defaults 47
2.3.9 The end of the self-fulfilling prophecy 48
2.4 The growth of local currency debt 51
2.5 Why invest in emerging markets? 53
3 The 2008 Credit Crunch and Aftermath 55
3.1 Bank regulation failure 58
3.1.1 Sub-prime 60
3.2 The 2008 crisis 63
3.3 Depression risk 64
3.3.1 Reducing the debt 66
3.3.2 Deleveraging is not an emerging market problem 67
3.4 Global central bank imbalances 71
4 Limitations of Economics and Finance Theory 77
4.1 Theoretical thought and limitations 77
4.2 Economics, a vehicle for the ruling ideology 78
4.3 Macroeconomics 79
4.4 Microeconomic foundations of macroeconomics 81
4.4.1 Efficient market hypothesis 84
4.4.2 Modern portfolio theory 87
4.4.3 Investment under uncertainty 88
4.5 Bounded decisions and behavioural finance 90
5 What is Risk? 95
5.1 Specific and systematic risk 99
5.2 Looking backwards 103
5.3 Uncertainty 104
5.4 Risk and volatility 105
5.5 Risk in emerging markets 106
5.6 Rating agencies 108
5.7 Capacity, willingness, trust 109
5.7.1 Rich countries default by other means 110
5.7.2 Two sets of risk in emerging markets 111
5.8 Sovereign risk: a three-layer approach 114
5.9 Prejudice, risk and markets 116
5.9.1 When you have a hammer, everything looks like a nail 117
6 Core/Periphery Disease 119
6.1 The core/periphery paradigm 120
6.1.1 Core breach? 121
6.1.2 Another core/periphery concept: decoupling 124
6.1.3 And another: spreads 124
6.2 Beyond core/periphery 125
6.2.1 Towards a relative theory of risk 125
6.2.2 GDP weighting 126
7 The Structure of Investment 131
7.1 Misaligned incentives 132
7.2 Confused incentives 134
7.3 Evolutionary dynamics, institutional forms 135
7.3.1 History matters 137
7.4 Network theory 138
7.5 Game theory 139
7.6 Investor structure and liquidity 140
7.7 Market segmentation 142
7.7.1 Warning signals 144
7.8 Investor base structure matters 147
8 Asset Allocation 149
8.1 Asset classes 151
8.1.1 Alternatives 154
8.2 How asset allocation occurs today 155
8.2.1 Investor types 156
8.2.2 Asset/liability management 158
8.3 From efficiency frontiers to revealed preferences 161
8.4 Asset allocation vs manager selection; active vs passive 164
8.5 Allocating at sea 167
9 Thinking Strategically in the Investment Process 169
9.1 Thinking strategically 169
9.1.1 Thinking strategically: appropriate discounting 169
9.2 Scenario planning 170
9.3 Global structural shifts ahead? 171
9.3.1 Asset allocation: some proposed new rules 172
9.4 Investment process in emerging debt 174
9.5 Conclusion 177
10 A New Way to Invest 179
10.1 Sense-checking assumptions 180
10.1.1 Risk, uncertainty and information asymmetry assumptions 181
10.1.2 Investor psychology and behaviour assumptions 185
10.1.3 Structure, market efficiency, equilibrium and market dynamics 187
10.1.4 Asset class definitions 188
10.2 Assessing liabilities 189
10.3 Your constraints 190
10.3.1 The decision chain 190
10.3.2 Institutional capabilities 191
10.3.3 Psychological constraints 191
10.4 Consider changing your constraints: agency issues 192
10.5 Building scenarios 193
10.6 Understanding market structure 194
10.7 Asset allocation 195
10.7.1 Route 1: Comprehensive 196
10.7.2 Route 2: Entrepreneurial 197
10.7.3 Asset allocation dynamics 198
10.8 Meta-allocation: toolset choice 199
10.9 Follow the skillset 200
10.10 Portfolio construction and monitoring 201
11 Regulation and Policy Lessons 203
11.1 Regulating financial institutions: new and old lessons 204
11.1.1 Fix the banks 204
11.1.2 Non-banks: who holds what? 206
11.1.3 Reduce agency problems: trustee incentives 206
11.1.4 Honour public service 207
11.1.5 Choice architecture 208
11.2 What to do about systemic risk? 208
11.2.1 Avoid regulation that amplifies risk 209
11.2.2 Beware market segmentation 210
11.2.3 Structure matters 210
11.2.4 Map perceptions of risk 212
11.2.5 Detect and stop asset bubbles 212
11.2.6 Preserve credibility 213
11.3 Wish list for emerging market policymakers 213
11.3.1 Allow markets to work 213
11.3.2 Proclaim and foster greater pricing power 214
11.3.3 Promote EM global banks, south-south linkages 214
11.3.4 Build capital markets 216
11.3.5 Fight core/periphery disease 216
11.4 Reserve management and the international monetary system 217
11.4.1 The dollar is your problem 217
11.4.2 Alternatives to the dollar 218
11.4.3 Too many reserves 221
11.5 What investors can expect from HIDC policymakers 222
11.5.1 Financial repression 222
11.5.2 Consequences of financial repression for banks 223
11.5.3 No early exit from quantitative easing? 223
11.5.4 Bond crash 224
11.5.5 Inflation 224
11.5.6 Appeals to foreign investors 224
11.5.7 Regulatory muddle-through 224
11.5.8 Pension reform 225
11.5.9 Pension regulatory conflict may only abate once EMinvestors exit 225
11.5.10 Rating agencies 225
11.5.11 Intellectual reassessment 225
11.6 What investors can expect from emerging market policymakers 226
12 Conclusion 229
12.1 Afinal list… 229
12.2 … for an upside down world 231
Further Research 233
Disclaimer 235
Glossary 237
Bibliography 245
Index 257
