Financial advisors aiming to grow clients' portfolios through investments in emerging economies need to buckle up for a ride.
While the asset class can post outsize gains, it is also tricky to navigate, according to two speakers at the
One upshot: While emerging markets carry risks relating to countries' varying degrees of civil liberties and free flow of capital, they can also offer huge rewards to advisors and clients who hold stakes in fast-growing economies. Tolle, whose firm is the issuer of the $219 million Freedom 100 Emerging Markets ETF, and Hsu, whose asset manager advises on strategies comprising more than $15 billion in assets, gave a roadmap for getting into the asset class. Hsu said investors have greater opportunities for alpha in some international stock markets than they do in the U.S. "Alpha" refers to the excess returns above passive benchmark indices.
For instance, in the S&P 500, sophisticated and gigantic institutional investors often trade between each other, but international markets have more retail stockholders.
"You're not going to earn alpha from anyone, right? Not consistently," Hsu said. "In retail markets, especially the Asian retail markets, there's retail gambling. In China, it's 85% retail. In Taiwan and South Korea, it's 50% to 60% retail. So you kind of have a willing reservoir of losers on the other side."
The performance of emerging markets doesn't track that of Wall Street. The MSCI World Index of 23 developed economies including the United States and Japan has
The Freedom ETF uses measurements of countries' protection of personal and economic freedoms according to 76 criteria compiled by two libertarian think tanks: the Fraser Institute and the Cato Institute. The fund, launched three years ago, has an expense ratio of 49 basis points, with its largest exposure currently in Chile, Taiwan, South Korea, Poland, South Africa and Brazil.
Hsu and Tolle have known each other so long that they joked they're like siblings, but the former came to the conversation as an active manager, rather than using the passive approach of his friend's firm. Hsu's company works with institutional and high net worth clients with a focus on what it calls "generating alpha from investing in China and other inefficient emerging markets."
Nadig, whose firm provides research and analytics, asked Hsu how he manages the prospect of the Chinese government "changing the rules of the game" for international investments in certain assets in the country.
Hsu relies on watching "the ability to convert actual GDP growth into corporate earnings growth" and a grasp of the many kinds of business structures in China, he said. Some companies pose a greater risk of a crackdown due to their use of "wonky" setups that are outside the regime's rules and attracting attention from American regulators already, Hsu noted.
The SEC has warned about the transparency of some Chinese companies listed on U.S. stock exchanges and
But Tolle said there are hidden costs within those numbers. She brought up BlackRock CEO Larry Fink's 2011 Bloomberg
"Actually, markets don't like authoritarianism," Tolle said. "Authoritarianism does not provide certainty. It's actually the opposite of certainty, because you have this capriciousness in the government that is a risk there's no way to predict or calculate."
In that vein, Tolle views Taiwan as a more fruitful market than China. Taiwan has made the transition from authoritarianism to
"We're looking for the next decade's great growth stories, not the growth stories of the past," Tolle said. China "is a growth story, for sure. But it's a growth story of the past, and it was a growth story the last 30 or 40 years because the government there allowed more freedom. They allowed better policies than the policies under Mao."
Hsu said that his firm's active approach leads it to take a somewhat different course than Tolle's when evaluating the array of stocks and other investment vehicles available internationally.
"We are opposed to anything that's anti-business, anti-intellectual property, that adds red tape bureaucracy that's not conducive to business and to property ownership," Hsu said. "From our perspective, it is less about the political organization. It really is looking deeper and looking at sort of what creates an anti-success regulatory environment. And so, you know, being active."
