As dust settles and investor morale improves, sovereign wealth funds are slowly coming back to the market.
But they are not going to simply repeat what they’ve done in the past few years — hunting bargains in everything from property to banks. They are likely to carefully balance out the temptation for higher returns and the need to invest in strategic assets which benefit their own economies.
The so-called “south-south” trade is set to gather pace, providing much-needed capital inflows to emerging markets.
Javier Santiso, chief development economist of the OECD Development Centre, says in a book published late last year that should sovereign wealth funds allocate 10 percent of their portfoilo to other emerging and developing economies, this could generate inflows of $1.4 trillion.
Domestic investment — previously a taboo during the oil-fuelled inflation boom — is also increasing. RAKIA, the SWF of the emirate of Ras al-Khaimah in the UAE, is offering easier financing terms to local real estate companies to help them weather the downturn.
“For raw material-rich countries, reducing resource dependence through vertical and horizontal sector diversification is a major development goal,” writes Helmut Reisen, head of research at OECD Development Centre in a Chatham House book on the Gulf region.
“By investing in world-class businesses, technology transfer and network benefits can be fostered and production efficiency can be raised as a future driver of growth.”
-- IS RATE OF ECONOMIC CONTRACTION SLOWING?
Some economic reports have been pointing to a slowdown in the pace at which economic conditions are deteriorating -- eg U.S. home sales data; auto sales data; PMIs; UK lenders seeing improved credit availability in Q2, and PMI data. While job destruction is continuing apace, signs that inventories are being drawn down leave room for hope for those inclined to look for the silver lining, or even seek a bottom to the current downturn.
-- REBOUND MOMENTUM
Investors are wondering whether equity markets can extend a solid Q2 start now that major fiscal stimulus announcements, rate cuts, QE (in most developed economies), the London G20 meeting, and other big milestones are largely behind them. A sustained narrowing of corporate spreads, the VIX clearly breaking out of ranges that have held post-Lehman, and any shift out of defensive stocks are just some of the signals that would suggest that the rebound has legs.
-- QE CLUB
The European Central Bank opted to wait another month before deciding on whether to join the QE club and unexpectedly left itself room for a further refi cut. By contrast, curveballs are unlikely from Bank of England and Bank of Japan policy meetings given their quantitative easings are under way. The relative performance of their respective sovereign debt markets is in focus as a result, as are the inflation outlooks being priced in by index-linked paper at a time when some are pondering the longer-term fallout of QE policy. The Reserve Bank of Ausstralia also meets this week week but markets finding it tough to call the outcome.
-- EMERGING
The MSCI emerging market index's year-to-date performance is in positive territory and investors' willingness to venture further into these waters could rise given the International Monetary Fund is ready for new business with a hefty increase in resources and has found its first client for the new credit line that doesn't impose conditionality for those strong economic track records. Just knowing such a backstop is there could foster confidence in well-run emerging economies and see their outperformance against less well-thought-of peers become even more pronounced.
-- FIXING BANK BALANCE SHEETS
A drive to improve health of financial sector balance sheets is being pursued at regulatory/industry/firm levels. M&A activity, rights issues, and bond buybacks or exchanges are being deployed to improve health of bank capital. Relaxation of mark-to-market rules in the U.S. is expected to flatter Q1 earnings results -- and has already helped U.S. financials. Interest in how many U.S. banks plump for the option given not all European banks moved away from market-to-market rules when given the choice in 2008. Stock markets look more inclined to hope for a break in financial sector gloom.
The recent spate of shark attacks on Australian beaches could mark a turning point in global deflation and signal a change in fortunes for some beleaguered emerging economies, if Nomura strategist Sean Darby is to be believed.
Speaking at a Nomura investors forum, Darby said a chance sighting of a shark on Sydney’s famed Bondi Beach three weeks ago made him realise that prices of grain and other soft commodities — punished of late by global recession fears — could be due for a rebound.
“I actually saw a shark on Bondi Beach and that made me wonder about the impact of La Nina and how there’s a severe drought around the world at a time when many farmers are finding it hard to access credit,” said the Hong Kong-based analyst.
The La Nina meteorological phenomenon has been blamed for bringing deep ocean creatures — such as sharks — closer to shore and also for a long-running drought that has hit farmers in Australia, China and North America.
Persistent drought could push food prices higher, potentially benefitting soft commodity-producing economies from Vietnam to Ukraine, Darby said.
“This is one area that could disrupt the picture of global deflation that bond markets have,” he said.
As a fallout in emerging markets — once hailed as a safe-haven from the global financial crisis — gathers pace, asset managers are scrambling for newer markets.
What about North Korea? The Stalinist country boasts large untapped natural resources with deposits of gold, coal, zinc and other minerals. It has virtually no capital markets and its banks are all state-owned — making it a true safe haven from the global financial crisis.
The communist state has a good logistics route. It has borders with China, Russia and of course South Korea and a short sea route to Japan. South Korean firms such as Hyundai and LG already invest in the North.
KoryoAsia Limited has just launched subscription to the ChosunFund, a fund designed specifically for investment in North Korea. It is seeking to raise an initial $50 million.
“The DPRK (Democratic People’s Republic of Korea) has effectively been cut off from the international business community for decades. The country holds huge natural resources but is capital starved and lacks the technology and management skills with which to develop them.” Colin McAskill, Executive Chairman of KoryoAsia, says.
The fund will focus on North Korea’s extractive industries and energy sector, as well as the country’s defaulted London Club Debts. Its investment objective is cash flow plus capital growth with investors getting part of their money back initially through redemption of the loan capital, followed by dividends.
But this may be for long-term investors only — it has an initial life of seven years. McAskill also warns that the fund perhaps has more risk attached to it than most funds.
Investors may also want to look at the country’s rocket sector — the ex-”Axis of Evil” country says it is preparing to launch a satellite on one of its rockets, which analysts have said would actually be the test-firing of a long-range missile designed to strike U.S. territory.
No sign at a Fitch Ratings briefing today that things will get much better this year for emerging market debt. The 100 or so mainly industry attendees were asked to give their thoughts using a machine not unlike the “Ask the Audience” gadget seen on “Who Wants to be a Millionaire”.
Only 10 percent said credit quality would improve over the next 12 months. By far the largest vote — 59 percent — was for credit quality to “deteriorate” somewhat.
As for a wholesale crisis on emerging markets, the attendees were fairly sceptical. Only 12 percent thought there was a more than 50 percent chance of such event. Half the respondents said the odds were between 20 and 49 percent. SOme 38 percent said it was less than that.
Fitch, meanwhile, said it agreed that emerging market credit quality was likely to deteriorate further. It was corporate rather than sovereign debt that was most most likely to defauls. And emerging Europe was the most at risk.
I once paid a cop 30 ringgit (about $10 then) for making an apparently illegal left-hand turn in Kuala Lumpur. Scores of drivers in front of me were also handing over their "instant fines", discreetly enclosed within the policeman's ticketing folder. It was days ahead of a major holiday and the cops were collecting their holiday bonus from the public.
Malaysia opposition leader Anwar Ibrahim holds a disc he says contains evidence of judge-fixing in Malaysia
I felt bad about this, of course. What I was doing was illegal, immoral and perpetuating an insidious culture that goes by many names in the East -- "baksheesh" in India, "Ali Baba" (and his 40 thieves) in Malaysia, "swap" in Indonesia (means "to feed"). But the policeman pointed out I would have to take off the good part of a day to go to court and pay 10 times as much to the judge. So I rationalised: "When in Rome..."
Alas it was not the first time, nor would it be the last that I have (ahem) paid an "informal levy" to officialdom. I've given baksheesh to the phone company in India to get a telephone installed, and to get a driver's license without a test (no wonder there are so many accidents in India.) I've paid the immigration officer at Jakarta airport to let me in with a nearly expired passport.
Many of my friends in Asia have similar tales to tell about bribing customs agents, power companies, hospitals, schools -- anybody with the power to give a license or provide a service. A couple of bucks here, a couple there. Pretty soon you're talking about real money. Daniel Kaufmann, who spearheaded the World Bank's efforts to improve the study of governance and the rule of law estimates that $1 trillion of bribes are paid every year. A Reuters series on corruption in Asia found that perceptions of corruption in the emerging markets of Asia have not improved much over the years and have even declined in some cases. This is despite a growing revulsion among people in those countries for business as usual on the "demand" or government side, and a growing realisation from companies on the "supply side" of the bribery equation that payola is simply bad for business.
Protester holds a wanted poster for ousted Thai premier Thaksin Shinawatra at a mass anti-government rally in Bangkok.
Part of the problem is mindset and a major attitude adjustment might be needed. People may be fed up with "money politics" and crony capitalism in their countries, but they still pay off people in their neighbourhoods. A U.S. National Bureau of Economic Research study on unpaid parking fines issued to diplomats in New York, home to the U.N., showed Southeast Asian nations again among the league leaders and a remarkable correlation with more conventional measures of corruption. You can take the man out of his corrupt country, but you can't take the culture of corruption out of the man.
Anti-graft fighters model uniforms that those convicted of corruption offenses inIndonesia willbe required to wear in court and jail.
For years, Indonesia ranked among the most corrupt countries in the world. It permeates almost every level of society, reducing the country's appeal to foreign investors, and curbing Indonesia's potential for growth. Today, Indonesia's anti-corruption agency, known by its acronym KPK, has won plenty of media attention with its Jame Bond-like undercover exploits against corrupt officials. The government is also trying to get at the root of the problem by sending officials and judges to "anti-corruption school.
Passers-by in Jakarta walk past a poster that reads "fight corruption."
Some OECD countries will even let you take a tax deduction for providing "facilitation payments" to get routine services such as a phone installed. Facilitation payment? Hello, it's called a bribe, payola, grease, ice, a backhander. It's corruption, the dictionary definitions of which include moral perversion, depravity, debasement, not to mention rottenness. Okay, that's a little harsh. We're not talking about the moral equivalent of, say, paedophilia. But it's surely a slippery slope from giving the cop some lunch money, to bribing the customs guy to look the other way on a smuggled shipment, to paying off politicians.
Ramon Navaratnam, 73, the Transparency International Malaysia President told me the battle for him started when he was a young man in the finance ministry and he came home one night from work to find a case of whisky on his doorstep from a company bidding on a government contract. "It took a lot of doing, but the company finally took the whisky away. "If I had taken that box of whisky, I can never say no later on."
With emerging market stocks taking a beating, now would not seem to be an obvious time to launch new equity funds for the asset class. Benchmarker MSCI’s main emerging market stock index, after all, has lost more than a quarter of its value so far this year and concerns about the U.S. economic slowdown spreading are rife.
Despite this, U.S. investment manager Putnam says it is set to launch two new emerging market equity funds in October - one for U.S. investors, the other for Europeans. Is this perverse or prescient?
Putnam, of course, reckons it is the latter. During a chat with Reuters in London, Boston-based officials said the move reflected the long-term outlook for emerging markets which has not changed during the current market ructions. Growth projections for emerging economies remain far more attractive for equities than do those for developed markets, said Matthew Scales, a senior investment product manager.
His colleague, currency chief Parker King, went further. He said that despite a decade long slump in the 1990s in Japan, anyone investing there after World War II would still have made far more money than they would have in U.S. stocks. A lot of this, he said, was because of currency appreciation and that would happen in emerging economies too. “The mantra out there right now is just insane for emerging markets,” he said.
Interesting juxtapositions at a Barclays Capital chat. On the day when oil prices were plunging below $106 a barrel — more than $40 below their July record peak — the investment bank held a lunch seminar to discuss trading strategies on inflation. ”It seems odd to have an inflation seminar when oil prices more or less collapsed,” said Tim Bond, head of global asset allocation. He added, however, that there is still structural upward pressure on inflation and this theme is further to run.
Rodrigo Valdes, Barclays’ chief Latin American economist and former head of research at Chile’s central bank, talked about the varying impact on inflation from food prices, as those gathered tucked into roasted sea trout with razor clams, carrot puree and sorrel velonte.
He said the surge in food and other resource prices hits emerging markets more than others, predicting Latin American inflation to peak in Q4 or Q1 with quite a lot of interest rate hikes to come. “If you buy a cup of coffee here, there’s not much coffee in it … In Brazil, it’s not the case,” he said.
Decidedly un-Brazilian coffee was served with chocolate mocha tart and creme Chantilly.
It’s not all doom and gloom — just ask steelmakers.
Germany’s ThyssenKrupp and Salzgitter have both raised their profit forecasts, fuelled by demand from fast-growing China, India and Russia. Profits are soaring on sky-high prices for rolled and flat steel.
Both companies are cashing in on growth outside Europe, and they join Hochtief and Kloeckner who this week also showed that industrial Germany is insulated against a global economic slowdown.
Britain’s Association of Investment Companies is making the case that the Beijing Olympics will have a major, positive impact on investors’ perceptions of China.
They cite a number of portfolio managers who argue that there has already been a major economic boost to the Beijing area from the Games to add to the red-hot national economy.
Beyond this, there is talk of the Games as a showcase for China’s achievements. As John Millar of Martin Currie Pacific notes: “As we saw with South Korea in 1988, such an event can have a major impact on the international perceptions of a
country.”
As with nearly everything, though, there is also the flip side. Atlanta 1996, anyone?
