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The misuse of acronyms does damage to your investment portfolio

Sep 01, 2013

RRIC, BRICS, PIG, PIGS and now PIIGS and BIITS! Whatever next?

It is convenient to classify countries into blocks to sell thematic stories (John Authers FT, Sept 1, 2013, Piigs in Biits as markets suffer acronym anxiety). Reality isn’t so simple. The dynamics of nations differ substantially despite the fact that the US economy predominates when it come to foreign portfolio flows as well foreign direct investments.

Domestic politics and policy as well as geopolitics and the inherent strengths of countries and the balance between export led growth verses domestic growth impacts the path of development. Still from time to time, the greater influence of US events can for a short period sweep through markets, as may be caused by the often talked about tapering by the Fed.

John Authers intelligently recognizes and highlights many of these differences and influencing factors for countries. Watching Bloomberg and CNBC one hears constant talk about the impact of tapering and its impact on emerging markets. More recently there is increasing talk about Frontier Markets.

At the first sign of re-allocation of investments by foreign investors, panic sets in among the traders and researchers, which is taken up by journalists with glee. One should sit back and analyse the self interest of banks to promote a more volatile world. Traders make more money when there is more flow. Certainty is the enemy of trading desks.

Creating financial instruments also serves other purposes. Have a Global Emerging Markets Index helps to create liquidity in that instrument. Liquidity that would not be available in a given country for the vast sums of money that the big institutions have to deploy. Never mind that the instrument may lose 50%-70% of its value when panic sets in. That is just put down to the vagaries of the asset class. Whoever thought that countries such as Brazil, Russia, India and China will end up having a similar trajectory for growth may have had another agenda when they came up with BRIC. The idea of creating a liquid instrument to make money, that by its design was risky and volatile and good for trading was brilliant and may have been at the core of lumping these four vastly different nations together in one bucket. The lesson with acronyms is that what may sound good is not necessarily a good investment. And what may turn out to be a good investment over the long term, maybe very painful in the short term.

Country and currency risks are quite unique. Whilst in shock to an external agent, the Fed for example, the impulsive initial reaction may be the same. The impact, however, for each country will vary and recovery will often have its own unique path.

Having said all this, investing in emerging markets remains a good overall story. These countries have a lot of catching up to do and in the fullness of time they will catch up or close the gap between the rich and poor nations. But we know that the path can be arduous and the risks in each country have to be managed individually as is obvious if we reflect on the MENA region or LATAM or SEASIA or SUBSA.

To understand the impacts of events and the path to recovery one has to understand the risks of each country and its capacity to overcome. If we are using the rather imperfect financial architecture and instrument such as EEM which are the tools we use to participate in the emerging markets as a whole or in accordance with some acronyms, then we have to understand when to hedge or get out and perhaps even more importantly when to get back in.

At Algoam we try to find these types of solutions. We try to answer these questions in a systematic way: Which country, which currency and when?

Please collaborate with Algoam to help to better understand how financial markets actually work.