Emerging markets investors should move away from the flawed BRICs concept and frame the investment landscape in terms of country blocs that perform similarly as the macro environment evolves, according to Investec Asset Management Global Strategist, Dr Michael Power.
Dr Power presented an analogy where emerging markets were at the mercy of two tides – liquidity, governed by the ‘American moon’, and commodities, ruled by the ‘Chinese moon’.
By grouping countries according to key economic characteristics, investors could better understand how markets react to the movement of the two tides, and position themselves more intelligently against future volatility, he said.
“There are four main blocs within the emerging markets asset class, and they are not a matter of geography,” Dr Power said. “It’s more useful to firstly distinguish between whether a country tends to run a current account deficit or surplus, and secondly whether it is primarily a commodity or manufactured goods exporter.”
The new building blocs
Dr Power explained that by this theory, oil exporters could be grouped in the north-east bloc; sub-Saharan Africa, South America and Indonesia in the north-west bloc; Mexico, Eastern Europe, Turkey and the Indian sub-continent in the south-west bloc; and China-centred East Asia in the south-east bloc.
“The developed world can also be handily described by this matrix”, said Dr Power. “Oil-exporting Norway is in the north-east; Australia, Canada and New Zealand are in the north-west; the US and UK are in the south-west; and Japan, the Eurozone, Switzerland and Scandinavia are in the south-east.”
The financial health of the western bloc countries is closely tied to global liquidity, while the northern bloc’s prosperity is linked to the commodity cycle. “For instance, 2011 saw the high tide for commodities coincide with strong liquidity flows from quantitative easing. This was ideal for the north-west bloc, with both the Brazilian real and Australian dollar reaching their peak values,” he said.
Areas of focus for the future
Dr Power believes the south-eastern bloc, led by China-centred east Asia, presents the strongest opportunity for emerging market investors.
“The characteristics of this bloc tend to reduce the risk profile in all asset classes, in that they tend to create a less volatile economic environment,” he said.
“As a result, smart money – sovereign wealth funds in particular – are seeking a more focused exposure to this region.”
However, Dr Power explained the approach wasn’t foolproof, with regional events playing a role beyond the twin tides of liquidity and commodities.
“As evidenced by the Ukraine crisis, specific events can and do impact individual countries, more often negatively,” he said. “But for investors the bloc approach will make much more sense going forward than the BRIC approach, which is essentially an exercise in sizeism.”
