Last month I suggested that a useful means of
looking at global investing is to split the developed countries, including the
U.S., into one sector and put the lesser developed countries in to another.
Opportunities to invest in developed countries abound for both active and
passive investors. The emerging markets are more difficult and as I
highlighted last month, best left to professionals. Nonetheless, you should
still give some thought to your investment before you send off your money to
an emerging markets investment manager or fund. Here are some of the more
important things to consider:
What is my risk tolerance? As the saying goes,
"if you can’t stand the heat then get out of the kitchen." Emerging markets
are very volatile and can change direction quickly. You need to be prepared
for the risks involved. No matter how tempting past returns may be, consider
also the past losses and if you can stomach that kind of risk. Remember, high
risk does not automatically mean high gains.
Am I inadvertently magnifying my risk? If you
limit the breadth of investments a manager can pursue it can work both for and
against you. It makes sense that a manager of an all China fund you bought to
take advantage of growth in China has very limited ability to cut exposure to
China in a downturn. A broader fund covering the Pacific Rim and China, as an
example, has more options.
How experienced are the Managers? The markets
in lesser developed countries can go through some major gyrations. Choosing a
fund and/or manager that has been through these cycles is important not just
because the manager has had the experience but also because some of his/her
investors probably have as well. Managers faced with high redemptions in
falling markets can be forced to sell their most liquid investments leaving
the longer tern investors with a less than ideal portfolio.
What kind of diversity do I have? Investment
risks vary greatly from country to country. A mix of investments in Mexico,
South Korea and Taiwan has a very different risk profile than one investment
in China. Be realistic about your diversity. While emerging markets tend to
move in the same direction, some are much more volatile than others. Also,
consider the associated regional risks. A crisis in Korea may trigger a
broader crisis in the region but a crisis in the Pacific Rim may have
relatively little effect on your investments in South and Central America.
What is the hidden risk in my global mutual fund?
There can be big differences in how global fund managers take emerging market
risks. Inevitability some managers will be comfortable in some markets others
wouldn’t touch with a ten foot pole. Do your homework and investigate how the
global manager you are considering makes his/her return. Do they have large
exposures to countries that make you uncomfortable? You can not always rely on
the manager, no matter how skilled, to be able to successfully navigate the
ups and downs of volatile and illiquid markets. If a certain market scares you
then be sure the global fund you’re considering doesn’t make companies in that
country a big part of their portfolio holdings.
Investing in the markets of lesser developed
countries can be very rewarding but, like all risks, be sure to go into it
with your eyes open and a full appreciation for what can go wrong. Just
handing your money to a skilled manager and trusting that he or she will be
able to make it work out is not a good strategy.
Please feel free to call me if you have any
questions about this or any other related topics.
Randy Gridley
June, 2006
