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

The Rubber Time

Manaus, Brazil is the gateway to the Amazon, the earth's rich biosphere and carbon sink. Today Manaus counts around 2,2m inhabitants with a primary language of Portuguese, is a major port, and has 20 storey blocks along bumpy roads similar to other parts of Brazil, a busy airport shuffling TAM Airbuses dropping businesspeople and tourists. It has facilities by global majors like Samsung and Sony, and is an important industrial centre for the manufacture of electrical and electronic goods for all of Brazil. Headlights may be optional however, although the 60km/h sections to the airport do instill sufficient fear in taxi-drivers who, as in elsewhere in Brazil, seem to been training to fill Filipe Massa's shoes at Ferrari...

Manaus, whose name originated from the Manaos Indians that inhabited the region, is situated on the left bank of Rio Negro (Black River), close to the "meeting of the waters" with Rio Solimões, the Amazon’s actual name. The grand old opera house is a famous excess of the boom times, a European vestige worthy of Gabriel Garcia Marquez in equatorial America from the Rubber Time circa 1910-1950, when the indigenous Amazonian rubber tree and demand from industrializing world made rubber the commodity that oil and coal are today for Chindia [China and India]. Wikipaedia offers the “rubber boom occurred largely between 1879 to 1912, and afterwards experienced a revival from 1942 to 1945 during the Second World War.” Legend and intrigue connect it to my visit a week ago in SE Asia. Apparently two Englishmen – the local Amazonian guide looked at me with steely eyes when explaining this part for some reason – smuggled samples of the tree and started rival plantations in Malaysia, with easier land and labour…moving manufacturing to Asia, sound familiar? Today the major rubber markets include Kuala Lumpur, London, New York, Tokyo, Bangkok, Shanghai and Singapore, not Manuas nor Sao Paolo, as well as dubious looking electronic Inter-Continental Rubber Exchange (IRE). Futures contracts with different quality specifications are also offered on the Kuala Lumpur Commodity Exchange (KLCE), the Shangai Futures Exchange (SHFE) and the National Multi-Commodity Exchange of India (NMCEI).

Downstairs in this elegant old hotel, Hotel Tropical Manaus, is a regional pensions conference, the ABIPEM 2^o Seminario Norte, 13-15 De Agosto, produced by the state and municipal authorities in Manaus and Amazonia and their respective pension funds, ManuasPREV and AmazonPREV. Delgates were identified by suits and nifty eco-friendly hessian notebags, not the de rigeur bikini or Speedos around the pool. After a meeting last week in Rio with PREVI, the largest national fund and PRI in EM stakeholder, I was curious to see how sustainability+investment plays out on the cusp of the jungle. Citizens seem aware of environmental responsibility, and positive about the environmental record of the current governor [uncorroborated this, but the public impression tells its own story]. So where or how is the so-called "universal owner" theory being discussed, or promoted? Universal owner speaks to the role of public pension plans as having combined investment and public objectives, holding the whole market as is typical of large funds with passive strategies at low cost, and having the longer time horizons of long-term investors [greater than 10 years. The conference sponsors include multinationals like Schroders and UBS with regional players like Banca Cruzeiro do Sul, Bradesco, Banco de Brasil, CAIXA, PanAmericano and BANIF Investment Bank. UBS has a fairly forward approach to sustainability, although adoption and implementation in-country is mixed, so I look forward to learning more about their approach in Brazil with in-country branded firm, UBS Pactual, how it relates to sustainability+investment and initiatives at head office in Zurich. Experience of similar firms as ESG architect suggests the Brazilian tail may wag the Swiss dog.

The hotel venue offers more food for thought on making sustainability practical in 2008 and beyond. Hotel Tropical sits on the posh side of town in Ponta Negra suburb close to the confluence of the rivers, laid out in a friendly compound fashion with a sprawling estate, and the website references social responsability [sic] and environment on its homepage [strangely, English translations seem to be a little off in Brazil]. How quickly environment slips away in the stakeholder hierachy is evident in the text. The text covers guests and other humans, the environmental footprint disappears after the cursory “nowadays, it is not possible anymore to think of the future of mankind and not to consider environmental and human rights responsibility”. Time to re-think. Perhaps tellingly, the investor webpage is “under construction”.

The hotel was clearly designed by an architect without energy efficiency front of mind. Tropical Hotel Manaus is a self-described ‘eco-resort” despite its massive eco-footprint courtesy of 24 hour air-conditioners to handle the humidity, luxurious proportions [the hallways are marble-lined, long like something out of The Shining, and red carpeted, measuring about the width of the average Holiday Inn Express room]. No wind nor solar power, no recycling bins obvious. Windows seem thick though, CFLs are evident outdoors, and being riverside, the water treatment plant may be decent – no info, so anyone’s guess.

A major positive contribution is the zoo. After a sub-optimal experience at another so-called “eco-lodge” upriver [my experience in Brazil is that “eco” has fluid meanings], we toured the hotel zoo with the friendly and enthusiastic biologist who showed us a selection of local animals, and there was no doubting the passion she has for the creatures. A significant realization for me was that most were posted with signs saying “endangered species”. The zoo doubles as city amenity [a busload of kiddies in blue uniforms were noisily trooping through their live lessons!], a classic private-public partnership type typical in emerging markets where profit and social motives blend easily. The zoo holds about 10 cages with rescued animals from homes and traders, including a sad jaguar [Portugese "onca pintada", Panthera onca] and a depressed woolly monkey with an impressive prehensile tail. a cage is tough living for the animals to be sure, especially down the river from where they should roam were it not for deforestation, encroachment and human hunters, but I support such a zoo for educational value hosting only rescued animals.

It seems human rights are well covered compared to biodiversity rights. On the back of the biologist’s hotel -issue polo shirt was a SA8000 logo proclaiming the hotel rated to this global standard developed by Social Accountability International (SAI) for “ensur[ing] that workers of the world are treated according to basic human rights principles”. I understand the role of social responsibility ratings, but the juxtaposition of a 5 star non-enviro-friendly hotel and the CSR claim was jarring. The gap between some international ratings and the reality of the due diligence on the ground has caught my attention before, and here was an example of a such gap - like the absence of "fair trade" or "shade grown" food products in stores and even at the airport. A rough space comparison suggests that two hotel standard double-occupancy rooms on the second floor were the size of the jaguar cage where the impressive feline paced the wire mesh fence footprinting the fine sand with it's hand-sized paws. More puzzling was the walkway between cages was LARGER than the actual cage size itself. Who else would be up for hatching a plan to highlight and find funding to upgrade the cages using tourist taxes, and to reduce the ratios? Maybe "human monkey eat one gaioba, buy one for the monkey outside" or "big cage for human, bigger cage for endangered species outside"?

That sums up the Manaus experience, a city on the edge of the great jungle with its natural wonders, defined by the dark waters of the mile-wide river. Poor houses jostle next to each other by the river, then some grander colonial type buildings, then the newer gated communities for the industrial workforce. A potholed road features in photos in this morning's paper with Olympic coverage, stories of achievement, and claims by political rivals of nepotism. But Manaus being built in the European style with its emerging market resources, will have no bike lanes for the hard-riding Thursday night 8-man peleton on the three-lane roadway, no comfortable shady parks with fountains. It is more a city built bit-by-bit as its former glory suggests, with a progressive public leadership that diversified the industrial base away from rubber into the industries today, including Honda’s second largest motorbike factory, Harley-Davidson's only ex-US manufacturing [see SRI-Extra earlier today Harley-Davidson in Amazonia] and electronics. This frames the question architects of built environment now struggle with in for a like the US Green Building Council: building new kinds of cities with a smaller sustainability footprint, but building them while they’re still being lived in, with limited resources in any given budget period, by a heterogeneous voting population all trying to get ahead. And the Tucuxi and the Boto Dolphin (the River Dolphin) never can make it up to the voting booth...

Harley-Davidson in Amazonia

Building the HOG in the jungle, who knew?! The most startling statistic from Manaus is that in 1998 Harley-Davidson, Inc. (NYSE:HOG) opened a new assembly facility in Manaus, Brazil, which is its first manufacturing plant that is not in the United States. The winter weather makes for a fair comparison with a hairdryer-in-your-face Pennsylvania August summer day like the major facilities for HOG in York, PA [it is equatorial so the whole north/south winter/summer seasons thing is a tossup]. The leased local facility is a fraction of the size of the PA facility owned by the firm [30,000 square feet vs. >1,3m] and is the exception to the HOG distribution model in Latin America: motorcycles sold in Brazil are assembled and distributed by the Manaus subsidiary, while the company supplies all products sold in the Latin America region directly to independent dealers from its U.S. operations. No tours though, that will have to wait for next time I am back in the US with some time in WI, PA or MO.

The period from factory opening to date has been a bumpy flat stretch for HOG shares, up barely 0.11% from 3 Jul 1998 – 1 Aug 2008. Ouch! With run-up’s [Q1 2000 and Q1 2007] peaking before the tech 2001 and sub-prime 2007 crashes, perhaps HOG should be pitching its stock, reflecting the underlying forty-something free riders riding the widgets, as a leading indicator for market corrections. The numbers on sub-prime still amaze me - Merrill is off 62% since Aug 07, Citi 58%, AIG 62%, Wachovia 61% - and the chart is bad, just bad...

A browse of HOG’s most recent [2007] 10K and their self-reported “investment risk factors” [p.15] makes for an interesting read of the companies own SWOT [strengths/weakness/opportunities/threats] analysis. Unlike what all our B-school case studies taught us, the distinctive patented HOG exhaust throb is down to four on the list with the rest of the brand. Two ESG factors, labour relations [including employee benefits for its 9,755 employees] and corporate citizenship are explicitly covered, perhaps with memories of the Q1 2007 strike still fresh. The looming shadow of the sub-prime and possible prime fallout [credit and financing risk for HOG and its customers] stalks the second tier of risk factors. But no mention of the sustainability meta-theme and its impact on purchasing of heavyweight motorcycles, not even as alternatives to SUVs as macho status symbols. I would have thought the Tahoe/F150/Hummer to HOG transfer would be an easy trade for a frustrated macho in Wisconsin, Texas or PA.

The environment is tucked down in legal end of the filings Commitments and Contingencies [p.46]

• [“The Company is subject to lawsuits and other claims related to environmental, product and other matters”], Environmental Matters [p.47] and
  
• Item 3. Legal Proceedings [p.21].
  

The language is suitably vague courtesy of their lawyers and accountants [“ground water remediation may continue for some time beyond 2012”]. But it seems the cash cost to the planet just in PA ranges from US$8m to US$28m [“involved with government agencies and groups of potentially responsible parties in various environmental matters, including a matter involving the cleanup of soil and groundwater contamination at its York, Pennsylvania facility”], and HOG having pushed excess liability of course to a third party company, Ultimaster “for certain claims related to environmental contamination present at the date of sale, up to US$20.0 million”.

Now sitting here next to the black-brown water of the Rio Negro in Manaus stretching four miles wide chopped by the easterly wind heading to Peru, one wonders:

1. What is the environmental footprint of Harley Davidson’s only manufacturing facility in America outside the US in the context of local laws and regulations, and compared to the US standards, in this world-class biosphere?
   
2. What should the local pension fund investors conference in the Tropical Hotel Manaus here today be asking this prestigious, welcome manufacturing partner today in calculating the complete and integrated investment analysis profiles, including ESG factors?
   

Institutional owners account for 81% of equity. Whether in Brazilian Real or US dollars, I doubt clean water effluent nor deforestation upriver was factored into the US$40-42 trading range today on the NYSE.