In defence of co-investing with the state
It’s hard to avoid state-run companies if you are investing in emerging markets — after all they make up a third of the main EM equity index, run by MSCI. But should one be avoiding shares in these firms?
Absolutely yes, says John-Paul Smith at Deutsche Bank. Smith sees state influence as the biggest factor dragging down emerging equity performance in the longer term. They will underperform, he says, not just because governments run companies such as Gazprom or the State Bank of India in their own interests (rather than to benefit shareholders) but also because of their habit of interfering in the broader economy. Shares in state-owned companies performed well during the crisis, Smith acknowledges, but attributes emerging markets’ underperformance since mid-2010 to fears over the state’s increasing influence in developing economies. (t
Jonathan Garner at Morgan Stanley has a diametrically opposing view, favouring what he calls “co-investing with the state”. Garner estimates a basket of 122 MSCI-listed companies that were over 30 percent state-owned outperformed the emerging markets index by 260 percent since 2001 and by 33 percent after the 2008 financial crisis on a weighted average basis. The outperformance persisted even when adjusted for sectors, he says (state-run companies tend to be predominantly in the commodity sector).
Past performance and state support aside, Garner sees two inducements to buy shares in state-run companies. Firstly, they tend to trade relatively cheaply to their private sector peers (almost certainly because of the risks that state involvement is perceived to bring). Morgan Stanley calculates these companies are a fifth cheaper than the broader index, both on a forward price/earnings basis and on a price/book basis.
Secondly, many of these companies now pay decent dividends. Garner’s sample group of companies exhibits a dividend yield of 3.2 percent versus 2.7 percent for the MSCI index. That’s up from 1 percent in 2007 and should rise to 4 percent in 12, Morgan Stanley predicts.
It also expects a 15 percent upside to the share price for state-run companies.
Home is where the heartache is…
On a recent trip home to Singapore, I was startled to learn just how much housing prices in the city-state have risen in my absence.
A cousin said he had recently paid over S$600,000 — about US$465,000 — for a yet-to-be-built 99-year-lease flat. Such numbers are hardly out of place in any major metropolis but this was for a state-subsidised three-bedroom apartment.
Soaring housing prices have fueled popular discontent — little wonder as median monthly household incomes have stagnated at around S$5,000.
For its part, the government — which houses 80 percent of people on the densely populated island — insists that public housing prices are shaped by ‘market forces’, pointing to a raft of financing schemes to help first-time buyers.
What’s less contentious is that Singapore is only part of a regional real estate boom that has driven property values by as much as 70 percent since the start of 2009 in cities such as Sydney, Hong Kong and Beijing.
Like Singapore, the government in China is acting to cool house prices that have skyrocketed in recent years out of the reach of a large swathe of its middle classes.
Chief among Beijing’s policy arsenal is social housing. The government is stepping up construction of public housing, targeting a rollout 36 million affordable homes from now until 2015. At the same time, clampdown on property speculation has also helped ease Chinese housing prices.
Can Eastern Europe “sweat” it?
Interesting to see that Poland wants to squeeze out more income from its state-owned enterprise (SOE) sector in the face of slowing economic growth and financing pressures.
Warsaw wants to double next year’s dividends from stakes in firms ranging from copper mines to utility providers to banks.
Fellow euro zone aspirant Lithuania has also embarked on reforms aimed at increasing dividends sixfold from what UBS has dubbed “the forgotten side of the government balance sheet”. It wants to emulate countries such as Sweden and Singapore where such companies are managed at arm’s length from the state and run along strict corporate standards to consistently grow profits.
The impetus isn’t entirely ideological. Poland and Lithuania are desperately trying to balance their books and under European Commission rules, privatisation proceeds cannot be taken into account when calculating the budget deficit but SOE dividends can.
But “sweating” government assets to yield higher profits doesn’t always come easy for central and eastern Europe. After all, this is a region where state ownership has been synonymous with inefficiency and stagnation.
Even so, the track record of emerging European governments on privatisation is mixed.
The haste at which state resources were sold off following the collapse of the Soviet Union had disastrous repercussions for economies such as Russia and Croatia. Recent efforts at state divestment from Poland to the Czech Republic to Romania have run aground on unrealistic price expectations, corruption or regulatory obstruction.
Who is in greatest need to reform pension?
This year’s fall in global equities (down nearly 20 percent at one point) and tumbling bond yields, along with the euro zone sovereign debt crisis, are sowing the seeds for a new financial crisis – in the pension funds industry.
But which country is in the greatest need of pension reform?
Everyone, you may say, but a new study from Allianz Global Investors finds that Greece, India, China and Thailand need to reform their pension systems the most.
The study, which charts the relative sustainability of national pension systems in 44 countries, shows that India and China — two of the fastest growing emerging economies — suffer from low pension coverage and lack of adequate measures to improve the situation.
Thailand, on the other hand, has a sporadic pension coverage and an extremely low retirement age of 55 years.
Who is best prepared? Australia, the study shows, followed by Sweden (no surprise), Denmark, New Zealand and the Netherlands.
“Australia… has a two-tier system of lean public pensions and highly developed funded pensions which means it is best prepared with respect to potential burden for public finances, thus, it is under the least pressure to reform,” says Brigitte Miksa, head of international pensions at Allianz GI.
Turkey’s central bank: still a slippery customer
The Turkish central bank has done it again, wrong-footing monetary policy predictions with its latest interest rate moves.
On Thursday, the central bank hiked its overnight lending rate by widening the interest rate corridor. While most analysts correctly predicted the central bank would leave its policy rate unchanged, few foresaw the overnight lending rate hike to 12.5 percent from 9 percent.
As Societe Generale’s emerging markets strategist Gaelle Blanchard put it: ”They managed to find another trick. This one we were not expecting.”
In August, the central bank shocked the market by cutting its benchmark rate despite inflation running well above its 5.5 percent target. Relying on higher banks’ reserve rate requirements to curb credit, it argued then that the rate cut was necessary to fend off the threat of a domestic recession heightened by a slowdown in global demand.
Initial market disapproval dissipated soon enough. Other emerging economies grappling with rising prices — including Brazil and Indonesia — also decided that the global recession threat was more significant than inflation.
Now, however, the Turks are warning of rising inflationary pressures.
Containing the weakness of the lira — down 11 percent since August despite foreign-exchange auctions to support the currency — is crucial in this respect.
Sustainable investing in emerging markets?
Emerging markets may not be the obvious destination for your ethical investment. Rapidly expanding economies are consuming a lot of energy, pumping CO2 in return. Many of these markets suffer from legal and political problems that keep investors on their guard. BRIC legal systems have room for development. Their financial disclosure is still patchy.
However, BNP Paribas sees opportunities as it believes fast growth in these markets and increased inflows would create the need for a socially sustainable environment for investment.
“Our analysis has unearthed a number of particularly promising sustainable investment strategies in emerging markets. In each of these cases we see a real economic need linked to maintaining high growth rates, but also evidence that policymakers are recognising this need and are putting in place the necessary policy measures to facilitate this development,” the French bank said in its latest Sustainable and Responsible Investment (SRI) newsletter.
In other words, emerging market expansion creates growing environmental problems and thus a desire from emerging market economies for sustainable investments.
Emerging market countries are also most vulnerable geographically to climate change, said the bank. It’s targetting its investment in industries including education, water, waste, mobile phone banking, microfinance and clean transport. Among others, it likes Nine Dragons, a Chinese waste paper company and SABSEP, a Brazilian state owned sewage and water utility.
All of which makes sense. If there’s any place where people would benefit greatly from SRI, it’s probably emerging markets. SRI, as the name suggests, targets ethical investments, evaluating them through environmental, social and governance criteria (ESG). With the global downturn, the world has now turned to emerging markets, namely the BRIC economies – Brazil, Russia, India and China – which Goldman Sachs predicts will be the biggest economies alongside the United States in 2050.
But if emerging economies were to attract more SRI investment, they must do a lot more. Some 70 percent of investors surveyed in 2009 by the Social Investment Forum, a US non-profit association for SRI professionals, saw the lack of corporate ESG disclosure there as their biggest concern.
Concerning efforts to confront climate change, microfinance emerges as an important sector with a unique ability to help those who are the most vulnerable. For more information on what microfinance institutions can and are doing to curb global warming and assisting the poor to adapt to a changing environment, I would direct you to the paper Climate Change and Microfinance. Published in November 2009 by Asif Dowla, a professor of economics at St. Mary’s College of Maryland, the paper addresses the dangers presented by climate change to the poor and the tools that microfinance institutions can implement to help their clients. These tools range from disaster plans to weather insurance and are geared towards enabling the poor to continue to move out of poverty in the face of global warming.
With the goal of socially and environmentally sustainable economic development, microfinance institutions, at their base, help the world’s poorest by providing them with the capital they need to create a steady income for themselves. Looking forward to an uncertain future, the services that they offer and the relationships that microfinance institutions have built with their clients have become even more important. Through innovation and the expansion of their services microfinance institutions can remain sustainable while helping their clients move out of poverty.
Sincerely,
Remy Olson
Grameen Foundation
