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
Know who the shareholders are and try to understand what a their motives are. Need to understand whether or not they are imperialism or value minded investors. Private equity shareholders, typically intend to maximise share price, but at the same time the fact that they have many, many, shares to be sold off means there may be downward pressure.

Incentives are not always aligned
Transactions happen between principals, usually with separate deals "on the side" of the listed companies, and more often than not it's at the expense of minority shareholders.

Some listed companies may be part of a larger business group. This is primary suspect for unfair less than arms length dealing with affiliated parties, which although protected by the securities and exchange commission, can still pads due to supermajority shareholding.

Management and board members are not what you expect
In developed markets, manaement 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, (retired) army generals, 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.  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 a number of days, if possible at all.

Market corrections can be brutal
Emerging markets suffer from both equity market and FX Market corrections. When fear hits, it hits both equity and FX market, giving a double whammy brutal pounding.  There are no "safe haven" stocks in emerging markets; cyclicals and non-cyclicals all get pounded in a market correction.  Keep in mind that such market corrections also provide good buy-in opportunity if you have the 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 investors do? Flee all EM stocks, including Indonesia.  Is there a direct link between the Russian and Indonesian market? Probably none.

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 varies -- check the offering prospectus) lockup ends, the principals summarily dump their shares, leaving small shareholders in the lurch.

Insider trading does not pay (most of the time)
It is very difficult to enforce insider trading rules in these markets.  What this means: 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.

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.  Because reputation matters especially for foreign investors -- and they drive prices.

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 --.

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