An emerging conundrum

Ihave been focusing on emerging markets as a possible investment opportunity, although my track record has not been good. One investment in Carpathian, the eastern European property investor that was formerly part of Dawnay Day, left me nursing a hefty loss.

A recent trip to countries bordering the Black Sea also left me none the wiser. I found it hard to generate much enthusiasm for investing in equities in these areas. That’s partly because of the performance of emerging stock markets in 2009.

The MSCI emerging markets index is up 70 per cent in dollar terms since the start of the year, and markets such as Russia and Turkey have recorded triple-digit gains over the same period.

Investment in markets such as these has to be more selective than simply investing in a broad index.

In Ukraine, for example, GDP per head is low and there are very wide inequalities in income. Yet mobile phones are ubiquitous. In Turkey, Istanbul is like any European city, with an affluent population. But there is pure subsistence agriculture and associated poverty in the remoter north. It’s not really possible to capture these nuances by investing through an index fund.

I am more drawn to emerging markets in Asia and particularly to India and China, and to south-east Asia generally.

Countries such as this do not have the legacy problems of eastern Europe. In a market such as India, for example, there are already many big companies with solid balance sheets and high returns on equity.

Long-term growth prospects are better in China but the market is less transparent and prone to being influenced by government.

However, both India’s and China’s stock markets have grown strongly in the course of 2009 (both up between 80 per cent and 90 per cent since the start of the year). Have the immediate prospects been discounted? I tend to think so.

I have been puzzling over this conundrum. One interesting anomaly is an exchange traded fund (ETF) that tracks emerging market government bonds, as represented by the JPMorgan Emerging Market Bond index (EMBI).

The iShares ETF that tracks this index (EPIC code IEMB) has a running yield of 6.8 per cent and a portfolio with a broad spread of maturities. It holds mainly government bonds and sovereign eurobonds in a range of countries from Russia and Brazil to Colombia and Indonesia.

But although this index, and the ETF that tracks it, have rallied significantly in the last six months, the price movement – up 25 per cent in dollar terms – has been much less than the 70 per cent average gain seen in emerging market equities, in spite of the bonds offering greater security. In fact, the bond gains have been similar to those on sterling or dollar-denominated corporate bond funds.

So, if I do make a move into emerging markets, I am planning to match any investment with an equal exposure to the bond market through this vehicle.

Peter Temple is an active private investor, writing about his own investments. He may have a financial interest in any of the companies, securities and trading strategies mentioned.

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