Farewell Emerging Markets Investing (III) Russia, China, Ukraine, Turkey

While I was skiing yesterday, EM bonds and stocks got the sh*t kicked out of them, along with equities everywhere else.  As a hedge fund, we are supposed to be quick and nimble and have the foresight to see the turns in the market.  I don't have that foresight being an analyst rather than a nimble trader and that is why I leaving EM investing behind in one week.  I have 3 things for a possible reinvention that I will start working on after a ski vacation in Northern Vermont and Maine.

Russia and China took different paths and each offers a level of stability to investors that is not available in parts of Latin America and Africa.  We own assets in each and for the most part, long/shorts are a matter of valuation rather than political risk.  But each presents a long term political risk to investors and one must choose assets with an eye on those risks.

Russia (25% of my ancestral home, the rest is 50% Finland and 25% somewhere in the Habsburg empire) chose privatization with the Oligarch's and a form of democracy with Yeltsin who in turn promoted the Oligarch's and further elections.  Putin uses those elections to control things like an autocratic leader, but he can only do that so long as he wins elections.  And he keeps winning elections.  So clearly the people are happy with him.  Yet, small business seems to have a problem forming in Russia and capital formation seems limited to companies that can feed off the old state economy. Also, the rule of law for foreigner investment seems to be enforced unfairly.  This is not healthy and you need look no further than what is going on in the Ukraine where there is a small war on-going in the streets around Parliament in Kiev to see the danger for investors than can happen when the population is divided around rigid desires and an autocratic leader says my way or the highway.  (This is also happening in Turkey, which is another place to avoid for the time being).

So we do not invest in Turkey or the Ukraine because of autocratic tendencies in leadership and unhappy citizens.  While I worry about Russia, they have a current account surplus and they export a lot of energy from companies that are tight with Putin.  So that is where we invest.  Stay very close to the center of power which has indicated they believe in repaying debt.

China, on the other hand, started its liberalization by encouraging farmers to become entrepreneurs and then letting people become factory workers, business creators, office workers etc.  They had 1.3 billion people to turn into economic entities and they have accomplished that.  China is a very capitalistic economy below the government.  It is not necessarily kind to foreigners as the rule of law is opaque.  So we invest there very carefully.  We don't want a bankruptcy and generally want Chinese management which works well within in the system.   China is a fascinating country, with parents who care about education and kids who want to achieve.  Also, the savings rate is through the roof.

So, what is there to be concerned about.  Well, mostly it is a question of valuation, but it is also a question of transparency, a lack of regulation, and what will political transition look like and when it will start.  Transparency issues dog the financial system (not unlike the U.S. Japan and E.U.) and the lack of awareness on the need for environmental regulation has made the air unbreathable much of the time in an extraordinary number of places.  Water quality is also an issue.  The people will put up with a lack of democracy if their environment, personal safety and economic opportunity are acceptable.  But the environment is not acceptable and I believe that will lead to a desire for opening up the political process.

I have no idea how the tradition of Confucian society, autocratic Communism, and a ruling class that wants to maintain control will open up in a way that satisfies most of the people.  I also have no idea when the pressure for this will opening up will occur.  That means I keep my investments in China limited and small.  There is tremendous opportunity for extraordinary gains in the right companies.

I wish the best government possible for China, Russia, Ukraine and Turkey.  The people I have met from each of these countries are smart, well educated and have western values.  I hope each of these countries finds a way to become stable self-sustaining capitalistic democracies.