Monday, February 09, 2015

Thoughts on Emerging markets investing

I have been monitoring the domestic public equity market -- the Indonesia Stock Exchange (IDX) -- for most of my 12-year career.   I can't help but notice some stark differences when compared to, say the NYSE -- things that would matter to investors accustomed to the setting in developed markets.

Below I try to summarize some key differences, and other tidbits EM investors should take heed:

Shareholding is concentrated
As an investor, it's important to understand who the shareholders are and their motives.  Are they intent on expanding their "empire", or are they conservatives or value-minded?  Private equity shareholders typically intend on maximizing share price, but the fact that they typically hold many (10-30%) shares means there may be downward pressure at the time that they sell.  Don't forget that....

Incentives are not always aligned
Transactions happen between principals.  When the deal size is significant, there's typically a separate deals "on the side" of the listed companies (e.g. separate payments outside of the listed structure), and more often than not it's intended to minimize "leakages" at the expense of minority shareholders.

Many listed companies may be part of a larger business group.  This is a good indication of "unfair", less-than-arms-length affiliated party transactions.  Although local SEC protections are typically quite stringent, these transactions may still pass, as there are workarounds and shareholdings are concentrated (e.g. different shareholder groups may work in concert).

Management and board members are not what you expect
In developed markets, management usually consists of longtime professionals, while board members consist of former CEOs and industry experts.  In emerging markets, don't be surprised that management and board members may include founding family members, politicians, (usually retired) army generals or police chiefs, or strongmen that are in the payroll.

Liquidity can be limited
Because the shareholding is concentrated and often controlled by the founding family or strategic owners, only a small number of free float are traded (e.g. can be less than 5%).  Pay attention to daily trading volumes.  An investor of any size needs to be aware that accumulating and divesting a substantial investment value can take weeks or more, if indeed possible at all.

Market corrections can be brutal
Emerging markets suffer from both equity market and FX Market corrections.  When fear sets in, it hits both markets, brutally pounding stocks with a double-whammy.  There are no "safe haven" stocks in emerging markets; cyclicals and non-cyclicals all get hammered in a market correction.  Keep in mind that such market corrections may also provide good buy-in opportunity if you have the wherewithal and patience to go against the grain.

Contagion also happens quite often.  When the Russian market was hammered due to the Ukraine conflicts, you know what international investors do?  Flee all EM stocks, including Indonesia.  Is there really a direct link between the Russian and Indonesian markets? Probably not.

Beware of initial public offerings (IPOs)
IPOs have lock up periods, during which principals are not allowed to sell down their shares.  Underwriters are often tasked to support the share price.  Some do it to an extreme, propping up the shares into unreasonable territory.  Once the 6-month (actual period may vary -- check the offering prospectus) lockup ends, the principals summarily dump their shares, leaving small shareholders in the lurch.  Be wary of stocks that have rallied post-IPO, and pay attention to lockup periods.

Insider trading does not pay (most of the time)
It is very difficult to enforce insider trading rules in these markets.  Meaning: there is no such thing as insider info, because everybody trades on them.  Not only that, but insider tips from "people in the know" are often wrong, so consider yourself warned.

History and reputation are worth reviewing
Fundamentals are not the most important thing.  Some business groups may have reputation for pump-and-dump scenarios (cough, Bakrie, cough).  Others have better reputations.  Read about the history of the principals, of the company, especially during any crises.  Because reputation matters especially for foreign investors -- and they drive prices.  Astra Group and its founders have good reputation for making whole with their debts.  Sinarmas Group can't say the same.  Lippo is notorious for building things they can quickly flip to the market (or to strategic investors), then starting the same business from scratch -- competing head-to-head with the old business they'd sold.

Opportunity lies for well-connected investors
This is probably more of a conjecture than an observation.  But the sheer breadth of the market, with many small-cap stocks and new IPOs, make it difficult for some analyst dude in Morgan Stanley Hong Kong to really know what's going on.  A well-connected investor on the ground, one who speaks to competitors and actual industry experts, would have a leg up to identify those companies with an upside.


Despite my disclaimers above, the market still tends to correct itself automatically.  If you're an undisciplined investor, like I am, and don't follow the market every day, do yourself a favor and just follow the herd.  Generally I find that the most reliable strategy is passive investing.  If you're lazy, like I am, put half of your portfolio in a low-cost index fund; the rest is for your playtime discretion --.