This is the second part of a two-part transcript in which Fool.co.uk's David Kuo chats with emerging market specialist Jerome Booth from Ashmore Group (LSE: ASHM.L ) . They look at quantitative easing from the perspective of consumers in emerging markets and also from the perspective of financial repression in the West. They consider whether there is any truth in the assertion that the creation of fresh money in the West is ending up as hot money in emerging market assets. They also look at whether emerging markets are inherently risky, and how much exposure investors should have.
EDITOR'S NOTE: What follows is a lightly edited transcript of David Kuo's conversation with Jerome Booth.
David: So how much should people have in their portfolio, of emerging markets?
Jerome: Now you're asking me a question, you're leading me on here! The answer, of course, is a lot (let me build up to this). We have different ways of valuing assets. I love the west of Ireland, it's a wonderful place, but as you know, it's full of empty houses. You could value those in two ways: one, the replacement cost, x billion; or the income that you're generating from these empty houses -- zero. I would argue that most investors care much more about the income, so we really go away from cap-weighted indexes, and how much money's gone into things, which is basically how asset management is done at the moment, how asset allocation is based on indexes, and I don't believe indexes should be used at all, by the way, for asset allocation, so that's another topic, because it's so biased, and you should look at income. So what's the best measure of global income -- GDP. What is the share of GDP in emerging markets? On a purchasing power parity basis, it's about 50%. If you've got 20-year liabilities, because you're not going to die tomorrow, then it's clearly sort of 50%. So if you're neutral, forget about the macro-economics, forget about the doom-and-gloom scenario in Europe, forget about all the leverage -- you're just in an environment where you think the risks are fairly balanced in both the emerging and the developed world, you should have 50%.
David: But the point is, Jerome, why would you need to go all the way to the emerging markets, in order to get that exposure? You look at the FTSE 100 index, and you will find it jam-packed full of emerging market companies. It's either emerging market companies like Standard Chartered, or HSBC, or alternatively you're going to get companies that supply to the emerging markets. So going back to Burberry, yes -- a big chunk of its income comes from the emerging markets, so why would you need to go all the way there, in order to buy the emerging market debts, in order to get exposure to them?
Jerome: Well, my first preliminary comment to that is, it's of course psychologically very difficult to take the plunge, when investing in emerging markets. We have enormous prejudice basically about these countries, so any sort of excuse.
David: Not me, because I come from over there!
Jerome: No, I know, but a lot of people do, and so any sort of excuse, like, oh -- there's a China hard landing, which by the way doesn't stack up in any, unless you're Humpty Dumpty, and you've changed the meaning of the words, is a nonsense theory. Or you come up with this idea, well, I don't have to really invest in emerging markets -- I'll just buy a big U.S. company. But let me tell you why you shouldn't do that. You shouldn't do that because it's not the real thing, for a start, but also, if that company...
David: It is the real thing, though!
Jerome: If that company has very large liabilities in the West, then it doesn't reduce your risk. You can get the upside, but not the protection. This is about risk. It's also about the fact that, yes -- you talk about the FTSE 100, well, the FTSE 100 is about two trillion dollars' worth of market cap, and by the way, because of index trackers and all the rest of it, it does actually go up and down together. So even if you're interested in short-term volatility, actually they all go up and down together. You get much more diversity by doing the real thing.
David: So if an equity investor over here doesn't want any kind of emerging market debt in their portfolio, that's their choice, but if they didn't want that, what kind of sectors should they be looking at in emerging markets? As an emerging market specialist, what kind of sectors do you think they should be looking to get...
Jerome: Specifically in equities, you mean?
David: Kind of, yeah. We talked about companies over here that had exposure to emerging markets. I'll give you two of them: one is SAB Miller, which makes beer; the other one is Unilever. I'll give you a third one: PZ Cussons. Now, these are companies that have exposure to emerging markets, and some people think, well, that's going to be enough. What could be wrong, what could be so dangerous about investing in Unilever, for Pete's sake?
Jerome: Well, you could have said that about General Motors, that's all I'm saying. The answer is, I think, there are sectors that are clearly going to be stronger than others over time, but it does depend on your timeframe, and these countries are very different. So in different economies, you'd be picking very different sectors. This is why it's complex, life is difficult; it's not simple. Generally speaking, I love stuff which is going to be catering to the domestic consumer in emerging markets. You've got to remember that the emerging consumer is the consumer of the future. The middle class in India is the same size as the population of the United States, and that's the consumer which is going to be buying health services, through to beer, through to everything else.
David: You mentioned health services -- GlaxoSmithKline would be another one that sort of crops up, because it's selling pharmaceuticals to...
Jerome: And doing its trials in India.
David: Well, kind of, but also it's able to sell things like Lucozade to China. If every Chinese person drank a bottle of Lucozade a day, that would be phenomenal.
Jerome: I don't think I'm disagreeing with you here. I think you're right to focus on emerging market earnings. I'm just saying, I'm actually, I mean, look -- I'm the emerging markets guy. I'm the one who's being prudent here, because I'm saying, maybe you shouldn't just gamble and put everything just in stocks; you should think about diversification. The point about the stock market, as opposed to the debt markets, is the stock market still is really dominated much more by the retail investor, and has got much more momentum. If there is correlations which are high, of emerging market asset classes to the developed world, it's equities -- it's not fixed income, it's equities. So I do think, and by the way, you can get very good returns in the fixed-income market. It's not a question of having low returns.
David: But if you need an either/or, which one would it be?
Jerome: But it's like saying, which country would I invest as well. I think it's much, much better always to have diversity, and have a portfolio. This is one of the truths of finance theory, which probably will stand the test of time, that it's better to diversify. So Jim O'Neill at Goldman Sachs came up with the term BRICs, and it didn't really take off, but I came up with my own term called CEMENT, which is, the Countries in Emerging Markets Excluded by New Terminology -- the idea being, why invest in four countries, when you can invest in 64? Likewise, why invest in one asset class, equities, when you can invest in corporate debt and sovereign debt and real estate and infrastructure and REITs, and all the other asset classes out there, which by the way are bigger, and have much more diversification impact overall.
David: Do you know what? You've convinced me. I'm going to pack my bags, and I'm going to go out to the East.
David: What, good riddance, or just good?
Jerome: No, no -- good, I'm glad!
David: No, thank you ever so much for joining me today, Jerome.
Jerome: It's my pleasure.
David: I have one more chore to perform, which is to find a quote to sum up today's podcast, and today's quote comes from Jonathan Swift, who said: "He was a bold man that first eat an oyster." Now, thank you so much again for joining me on Money Talk. This has been Money Talk, I have been David Kuo, and my guest has been Jerome Booth from Ashmore Investment Management Limited. If you have a comment about today's show, please post it on the Money Talk web page, which you can find at fool.co.uk/podcast. Until next time, happy investing, and enjoy those oysters!
That was the second part of a two-part transcript in which Fool.co.uk's David Kuo chats with emerging market specialist Jerome Booth from Ashmore Group. They discuss whether emerging markets are inherently risky, and how much exposure investors should have.
In the first part of the transcript, David and Jerome look at quantitative easing from the perspective of consumers in emerging markets and also from the perspective of financial repression in the West. Just click here to continue reading.
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