Emerging Markets…Brutal?! Not For Sissies! I/II

It has been a rough spring in emerging markets in the South [this photo is from April, obviously]. The emerging markets, as simplified and represented by the BRICS moniker [Brazil, Russia, India, China, South Korea and South Africa], have been bounced out the back of the financial services meltdown wagon. The benchmark indices catch you up on the story quickly, and the forex cross-rates quickly offer the impact - Brazilian ranches, Russian dachas or South African wine estates are cheap right now for payers in USD! Yes, as a fixed income manager mate in Cape Town will attest, this creates a serious challenge for his vacation strategy – which weakened forex rate best matches the exotic destination he would like to visit in January?!

Back in February, Goldman Sachs BRICS team spoke of the de-coupling hope…

“…expect GDP growth in the BRICs to be lower this year than last, the structural changes in these economies-and indeed in the world economy-are likely to make the impact of the global slowdown less severe than in the past…one of the key underpinnings of the BRICs' strength: capital flows”

BRIC is the original acronym coined by the GS EM team in NYC, although BRICS is my preferred acronym, and ChIndia the population-weighted current favourite on CNBC. And whether local or foreign, how tough the investment forecasting game is may be illustrated by reflecting on conclusions like…

“Overall, the deterioration in capital flows that we anticipate this year is manageable, and we remain bullish on the BRICs currencies. We expect appreciation of 8% against the USD in China, 4% against the USD/EUR basket in Russia, and 5% against the USD in India. In Brazil, we think the Real could strengthen over the next three months, but it is likely to weaken later in the year.”

The personal finance regulars in WSJ Tues covered the sad EM tale with their “SmartMoney” screens, from being up 50% p.a. in China in ‘06 and Brazil in ‘07, now down about the same magnitude in ‘08, with the Fidelity Latin America fund down -65.6% YTD @ 20 Nov. Yikes! No wonder Fidelity is letting go staff in BOS to trim expenses. Interesting as always to note the pricing – of the no-load funds, the passive tracking option from Vanguard [Vanguard Emerging Markets Stock VEIEX] proves to be cheapest as always, with 40bps annual fee. And like Wal-Mart soaring in these tough depression days as consumers know where to purchase lots of cheap stuff, maybe Vanguard will gather assets even as the regular 401k contributions have to go somewhere. But retirement advisors, a growing advisory service category according to FRC, will need to be longer-term orientated to recommend emerging markets to US clients in 2008. Like Africa, EM is not for sissies! Donald Hanna, MD and Global Head of Emerging Markets Economic & Market Analysis at CITI in New York, offered a bleak look at where EM may be for ‘09 in a presentation in BOS last Thurs. His take on Brazil and South Africa seemed fair...hard times ahead.

Standard Chartered, a bank and a solid emerging markets play based on their strong network in Middle East and Africa, is raising around USD3 bn through a rights issue and just hosted an Investor Trip to its banking operations in India, Abu Dhabi and Dubai from 17 to 20 November 2008. Standard Chartered has a network of over 1,750 branches and outlets in more than 70 countries across the Asia Pacific Region, South Asia, the Middle East, Africa, Europe and the Americas and employees about 75,000 employees from 115 nationalities. Their branding tied to marathon running and cricket hints at their EM exposure. Although without an in-house money manager [I pitched them on joining the PRI in EM project back in Dec 07], nor with direct exposure to toxic US mortgage assets or developed markets financial services, the tough times ahead imply the need for more capital on hand. STAN has some good programmes in EM, as the programme head Mariannne Mwaniki covered last July at for the Global Compact 4th annual Communication on Progress (COP) workshop at the Palais des Nations in Geneva.

Many EM banks did not have direct exposure to sub-prime. But similar to our experience in the South African market, where banks and money managers were prevented from reckless exposure by capital restrictions allowing only 15% offshore investment and hence no major exposure to the developed markets contagion, the resulting flight from risk – perceived or real – has smacked the forex rates and JSE as investors pulled back cash from every accessible liquid markets. At STAN I like some of the work done to play in local communities, for which STAN has won acclaim. STAN have used the IFC Equator Principles guidelines on STAN project finance in developing countries since their inception and adopted the revised Equator Principles 2 (EP2) in June 2006. I think EP2 is solid, but I know NGOs like Banktrack.org have their doubts, and I look forward to research to check in on progress on the ground from a former Boston College Center for Corporate Citizenship colleague now at HKS.

In the STAN [Standard Chartered PLC, LON:STAN] core banking business, the opportunity “at the bottom of the pyramid” makes sense: improving access to sustainable financial services plays an important role in empowering people, both socially and economically, and grows the STAN client base. In Q1 '08 STAN’s Robert Tacon was elected to head UNEP FI, the UNEP/financial sector initiative that organizes conferences and publishes pamphlet [see basic PPT from Seoul July '08 here]. It was a pity when he left in later this year, although I am not sure really what happened there… STAN’s above-the-line campaign, including the FT US print on p.8 of Mon 24 Nov US edition, makes clever connection to their business + community approach with a board room morphing into a well. Solid brand positioning is their reward for a clear marketing message.

STAN is not in Eastern Europe, Latin America, nor the Far East. When we last spoke in his role in sustainability at STAN, Rob's view was that it was:

• Look at what organization sets itself as objective, for example, is environmental and social factors on the agenda?
  
• And if it is, then how is it implemented?
  

His opinion was that companies that take into account ESG will do better. The aim of training is to show why ESG is important, as a long run issue, while in the short term is about reputation. But the benefits to organization need time to manifest itself, it also depends who they are investing for. In EM, he confirmed, it is very hard to convince people, far more difficult to crack sustainability in many respects.

At least STAN has not copied Barclays which has basically shattered investor confidence by rushing to the “Medici” in the Middle East for cash, apparently GBP 7bn [USD 11bn], rather than UK government money with strings. STAN is tapping existing shareholders first. Barclays, which itself bumped up EM exposure by taking a controlling interest in ABSA, one of the big four in South Africa, managed to upset all shareholders with their plan. But being stuck up a creek without a paddle, the investors apparently agreed Mon to let Barclays proceed, knowing that the whole Board is up for a vote next April. Do not be surprised when the door swings the other way at the first next opportunity. George Dallas, the director of corporate governance at F&C Asset Management [and former head of S&P’s CG effort before that was frittered away so needlessly like other ratings agencies], was piqued on Mon. F&C had “reluctantly” voted for the capital raising, but George was quoted as saying "We think that this amounts to a clear and egregious abuse of pre-emption rights. We object that the consequences of voting against this particular transaction would make a bad situation worse". F&C sees "environmental, social and governance [ESG] issues as fundamental drivers of long-term corporate performance, a principle that is central to F&C’s philosophy as an asset manager", and sell their responsible engagement overlay [REO] service.

The Barclays meeting was a fun example of live capitalism right up there with Gordon Gecko’s Wall St address. Shareholders at the 200-strong gathering were still asking questions after 2 hours when Marcus Agius, the bank's chairman, closed the meeting and one shareholder was apparently checked by security guards as he approached the stage. Chairman of Barclays? It too is not for sissies!
SRIX.GS