Sunday, March 18, 2012

Global Capital Flows - Developing Markets

Excellent analysis piece from Bloomberg Markets, my fav biz mag, on global capital flows to developing and frontier markets. Some call it emerging markets, but we need to divide them to developing and frontier to be more precise. Following the sub prime crisis and the subsequent Euro-crisis, the trend towards more exposure for emerging markets should be increased. 
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How investors allocate their funds is what we call capital flows. Owing to the size of the recipient countries, such flows can make a huge difference to these markets. As much as investors can plough into MSCI markets, they can also take out funds. Last year, the MSCI valuations dropped some 20% on the view that the Europe's debt crisis would curb global growth. In January 2012, the figure was 30% off its historical average. 

Realising a calmer settlement to the Greece-led debacle, it is fair to say that valuations and funds should start coming back to MSCI countries. However, not all will benefit in the same manner, fund managers will index some of their holdings but many will allocate according to "outlook".
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Using IMF data 2012-2016, Bloomberg Markets have created a top markets for attractiveness:
(country)  (cumulative GDP growth) / (gov debt/GDP) / PE / (ease of doing business, lower the better)
1  China             46.7% / 16% / 11.5x / 91
2  Thailand         23.3% / 45.3% / 12.5x / 17
3  Peru              23.7% / 13.6% / 11.6x / 41
4  Chile             19.4% / 10.7% / 18.2x / 39
5  Malaysia       18.6% / 56.8% / 17.3x / 18
6  Poland          19.7% / 55.9% / 8.3x / 62
7  Turkey          16% / 35.4% / 11x / 71
8  Russia           23.3% / 15% / 5x / 120
9  Indonesia      30.3% / 21.4% / 16.7x / 124
15 India            35% / 60.7% / 15.3x / 132

There are a few notables, the BRICs which were the flavour of the decade, have slipped enormously. Despite China still holding onto the number one position, its attractiveness in terms of growth has slowed, and that is understandable owing to the much larger base that they have grown to. Brazil has dropped out of the top 15, mainly owing to very exorbitant inflation and extremely high PE valuations. India has also dropped to #15 mainly due to inflation which is expected to average 6% for the next few years. 

One main determinant in attractiveness, which I have not put up is inflation rate expectations. The ones downgraded have exceptionally high inflation, which cancels out much of the growth and puts in a lot of side economic and operating problems. Russia's inflation is expected to average 6.8%, while the rest are maintaining below 3%.One can also argue that certain countries published inflation rate may be managed, which may explain why China is not as attractive now despite posting a likely inflation rate of just 3.1% for the next few years as many deem that to be way understated.
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Indonesia which is way more favoured by foreign funds than Malaysia is ranked lower because of its 5.3% inflation rate. Malaysia seems to come out well from the rankings, and must continue to improve its ease of doing business as that has helped a lot. However our government debt as a percentage of GDP has to come down to below 30% soon or it will just spiral out of control. Inflation is at 2.4% but we all know its actually closer to 3.5%, don't we. We also have the problem of managing inflation via excessive subsidy, and that is a bad thing. The sooner we dismantle them except for critical items, the better.

One bad sign creeping in among big listed Malaysian firms is the "tidak payah" attitude in soliciting foreign funds investment. A couple of international houses which did major roadshows to the US and Europe saw only a couple of Malaysian firms willing to join while they get some 15 firms from Indonesia. Is it because many of them are GLCs? But even the multi millionaire Malaysian owners are not keen. While the Indonesian contingent are made up of mostly billionaire owners - go figure.

I believe this attitude stems primarily from the local funds (PNB and EPF) being very substantial shareholders of many of the Malaysian big listed firms. This is not a good development for many reasons. When everything is so cosy, there tend to be too much government to big listed firms contract given at the expense of smaller players. Business becomes for the big boys only. The cosier the relationship, the more likely you are to be loose on corporate governance, related party transactions and even transparency issues. 

We have to ask ourselves honestly, are we propping up the listed index with our own money? If we reduce EPF and PNB funds by half, will foreign funds come in to buy? If not, do you know why? Or we just don't care! 
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