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Emerging Markets We Are Investing In Right Now (for Canadians)

Start Investing Now and Invest in an ETF or Good Mutual Fund

In various posts we have written for the mass market (our fellow professionals who are nurses, social workers, plumbers), instead of just investment banking hopefuls, a few notes that repeat the same general themes.

We espouse the need to invest your money while you are young to grow your capital – you work hard for your money and your money works hard for you.

1. You Need to Invest Your Money – You work hard for your money and you should have your money working hard for you – instead of seeing your savings dwindle in a bank account where inflation erodes your capital, you could be doubling your money every 10 years with a 7% per annum return and every 7 years with a 10% annual return – this is instrumental for life goals such as funding your child’s education or for an ideal retirement

2. You Should Not Be The One Who Makes the Investment Decision – There are people who spend there whole lives dedicated to the markets who understand investing better than you or I (maybe just you) and are better insulated from the natural biases and behavioral flaws we have when we purchase stocks. Unless you are willing to dedicate a material amount of time in becoming a student of the markets, you are better advised to go with a mutual fund (active management) or an exchange traded fund that replicates a broad basket of stocks representing the stock market (passive management)
The right active manager will generate you excess returns against a benchmark over time – an additional 2% return per year compounded can result in a large difference in your retirement savings

3. Picking the Right Manager is Important – For passive investing, you can keep your eyes closed and forget about your investments. However, if you are choosing a fund such as Fidelity or Eaton Vance to invest your money you need to make sure that the portfolio manager is a prudent investor that is conservative (so to not lose your money) and generates a return that consistently beats the stock market NET of fees over time (no point in investing in a fund that grosses 11% a year when the market is doing 10% but charges a 3% management fee)

These things we will stand by always and consider them to be infallible and supported by a wealth of literature. Over a reasonable time horizon, stocks have always convincingly trounced a savings account. Most people who invest do not beat the stock market and often lose all their money. There are numerous value investors who have consistently beaten the market net of fees over a long period of time.

Consider Investing in Emerging Markets for Higher Returns (Especially If You Are Young)

Now we can progress to something that we do not consider infallible but are personally backing this thesis with our own capital (as in we have dumped all of our money not tied to real estate into this). We are putting all of our incremental cash flows into Emerging Markets – think China, Brazil, Russia, India. Even if you can make just 2% more per year it goes a long way in compounded gains. If you do this correctly, you may well outperform by more than 2%.

Our rationale is as follows:

1. Emerging Markets are “cheap” compared to the US
2. Emerging Markets have economies that are growing faster than the developed world (this is tied with #1)
3. Emerging Markets are far less efficient than developed equity/stock markets (this can only be exploited with a good active manager with their finger on the pulse)

Investing is a balance between risk and reward – if the future cash flows of an investment are less certain, the return for that risk must be conmensurately higher. All emerging market stocks will see their future cash flows more heavily discounted than similar US companies operating in the same industries. As each year progresses, assuming those cash flows actually appear, they are “derisked” by one year, you would have done better investing in the Emerging Market than a similar US stock.

As you would expect, an emerging markets stock that has similar characteristics to a US stock should trade at a lower multiple of earnings or cash flow. As their market matures, you can expect this discount to narrow (or for the multiple to expand).

Naturally, as the US cash flows are seen to be more stable than the Emerging Market cash flows, you should expect relative cheapness in Emerging Markets – however, the gap has widened today in 2018 given US stocks are historically expensive while emerging markets stocks are not compared to their valuations over time.

This comparison is also usually measured in terms of a multiple of a company’s next twelve months net income or cash flow. This obviously does not factor in the growth clip where an India or China will exceed the US over the next 10 years. The expected growth rate is higher than the US but the multiple is lower. Are Emerging Market stocks so uncertain as to warrant this discount?

Trick question – the answer, as it usually is, is that it depends. You have to pick the right emerging market and from what we can see, if you do not want to spend an incredible amount of time reevaluating the future prospects of the domicile you are investing in (and you may well be wrong), you can only really pick China – controversial? Maybe, but we will elaborate on why later. If you disagree, we will probably be richer than you than we are already.

China is Now the Most Reliable Emerging Market

China is the only emerging market where you know you are getting growth – even if the headline figure has fallen to this 7% “soft landing” or whatever nonsense they tout on Bloomberg or CNBC, 7% of an economy second to the US and first by purchasing power parity is an enormous amount in dollars. China is also the only large emerging market which has a reasonably stable political regime – Russia is not a growth engine and has immense key man risk with Vladimir Putin. India is a democracy with entrenched vested interests, but still may take on sub-optimal policies to satisfy single issue voters. Brazil is a mess right now and does not have the institutions or infrastructure in place to be a world beater in growth – there is a lot to be fixed and nothing on the horizon that suggests it will be any time soon.

That is not to say that keen investors that know these markets well will not offer incredible returns every year. We have met hedge fund analysts at shops specializing in India that have consistently outperformed on a relative level to benchmarks and have provided incredible absolute returns. They have made their investors very rich and have lined their own pockets as well using their insights and finger on the pulse in a niche market.

The problem is that their stock picking skills are not available to you – the average person who does not have US$5 million in investable assets. The only avenue available to the retail investor is to purchase a Blackrock India index – unless you have very strong conviction and are ready for some swings, this may not be ideal.

How to Invest in Chinese Stocks and Profit

What should provide the most lucrative returns is to have a manager (not you) that knows the Chinese market well and has a good understanding of the culture and government because these are inseparable from business performance. This means that the portfolio manager or the analysts at the very least should be fluent in Mandarin beyond a textbook level but also a social level.

On one hand, the Chinese market is still fairly new. Markets are inefficient, but for the most part, mature markets such as the US, UK or Canada are far more efficient than China. What does efficiency mean in this context? It means that events that should influence the future earning potential of a company are reflected in the share price as they become public knowledge. So for instance, if there was a fire at a toy warehouse and a month of uninsured inventory was lost, you would expect the share price to dip when the news becomes public.

In China, these things are more opaque while the number of intelligent market participants are fewer. Additionally, it is difficult for the average investor on Seeking Alpha to understand the ramifications of government issue Five Year Plans and upcoming regulation without an intricate understanding of the inner workings of the state.

As such, a good manager can pick stocks that outperform far more easily than someone who specializes in the US. China is extremely competitive, but there is some cushion in the way that as the economy is growing quite quickly, even if the portfolio manager picks #2 in the space instead of #1 you may still see a lot of growth (or the company gets acquired, depending on the sector concentration). People have made a lot of money on Tencent but not many people who held Alibaba are complaining either.

So what differentiates Chinese managers from Indian ones? Are the best managers out of reach for the average person?

Similar to that of elite funds that specialize in India or anywhere else, investing is reserved for high net worth individuals or pooled managers who can part with $5 million at a minimum. There are funds in China who are fairly sizable but did over 300% returns last year – Bloomberg is becoming obnoxious finance porn and likes to throw out sensationalist, clickbait articles (fund manager makes xxxx a year; THIS just happened in China; freedom fighters attack oppressive Chinese regime in Xinjiang), so we know. You will not be able to invest in them.

However, China is now large enough and mature enough so that you can still get a good steward of capital to manage your money to make informed decisions that should beat the market without having US$5 million. For example, you can look at Fidelity or a variety of other asset managers. These are available for the average Canadian or American (Americans have far more choices). You will be able to get these via an investment advisor or through the premier service platforms of most banks (think CIBC Imperial Service).

Other Ways to Invest in China

The easiest way to invest in China is via ETFs. These are cheap, have extremely low management fees and offer direct exposure. Blackrock has a multitude of funds that will replicate the returns of large Chinese stocks (FXI) or the MSCI China Index. These have done very well as China has done very well.

There are also many ETFs that offer exposure to a specific sector in China – tech, consumer discretionary etc. for a more concentrated investment.

These are all great choices for passive investing (or semi-passive, smart beta if looking at industry/sector specific ETFs) and given that the Chinese government (which is the absolute ruler of China) wishes to maintain market integrity and the trust of financial institutions, it is not the wild west of the past with wholesale fraud and violent gyrations – although you can expect more of both versus the TSX for instance.

Another way is to invest in megacap tech companies – and we only really endorse two – Alibaba and Tencent. One way to look at it is that these companies are not really standalone technology businesses anymore, but also investment houses themselves. Alibaba and Tencent have fingers and capital in every new promising technology coming out of China via their venture capital arms, which are supported by their massive scale dominant businesses with the blessing of the Communist Party.

So indirectly, a bet on Tencent or Alibaba is a bet on all facets of China. The stocks are not cheap and they have been breaking new highs consistently, but a good comparable would be investing in Google or Berkshire Hathaway as an enhanced version of the S&P 500. Both bets have done well to date.

Past performance is not indicative of future results.

A post on China’s advantages as an investment conduit to come.

InvestingReal Estate Investment Considerations and Strategies · Why Investment Bankers Are Bad Investors · The Sky Is Falling · Beginning Investor Q&A · Choosing the Right Investment Advisor · Understanding China and the Investment Thesis · Emerging Markets We Are Investing In Right Now (for Canadians) · Investing in Stocks Today with the Trump Backdrop · Buying Property as an Investment for Young Professionals · Observations on Chinese Assets and Investing · Should You Enroll in the Company Employee Share/Stock Purchase Plan (ESPP)? · Dividend Reinvestment Plans (DRIP) · Investing Mistakes for Family and Friends · A Conversation About Risk and Reward ·
ChinaWhere is the S&P 500 and Where Will It Be in 6/12/18 Months – Part II · Interview with Sales & Trading Associate in Hong Kong · Understanding China and the Investment Thesis · Emerging Markets We Are Investing In Right Now (for Canadians) · Observations on Chinese Assets and Investing · Trends in Chinese Technology Stocks · Best Languages To Learn For Investment Banking – Part II: Chinese · Chinese Energy Companies in Canada · Liberalization of Chinese Markets and Oil · Corporate Banking in China · Shadow Banking in China ·
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Matt
ex investment banking associate
https://www.linkedin.com/in/matt-walker-ssh/

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