Is it easier to beat the stock market at emerging countries?

By | May 9, 2022

It depends.

MSCI Emerging Markets was constructed during a time when South Korea, Taiwan, and Hong Kong were emerging markets and China was very poor.

These days, most of the countries in the emerging market index are mid-income or developed:

What is easier is “frontier markets” – those countries which are at the lower end of the emerging market spectrum or are about to become emerging markets.

This is especially the case if you are looking at small and mid-caps in these markets.

The reasons are simple

1. In developed markets, and most of the countries on MSCI Emerging Markets, institutional investors are dominant.

70%-80% of the money is held by banks, hedge funds, and other institutional investors. Buffett was competing against the milkman and teacher in the 1950s when most stocks were held by individuals. Times have changed.

Therefore, unless there is a panic like in 2008 or 2020, it isn’t easy to find undervalued opportunities, because of all the competition.

If an opportunity was so obviously undervalued, relative to the risk, then most other players would get in as well.

2. “Boots on the ground” and “research from the group up” are less likely to work with large caps in developed markets.

Let’s put it this way. Would visiting Microsoft’s offices give you an advantage over a remote analyst? Would knowing a top Microsoft executive give you an advantage?

The answer is no because the information is all available to the public, and if you have been given an advantage, that is illegal insider trading.

In comparison, the small caps (especially in frontier markets) are a different thing. There are fewer institutional investors and being on the ground can help, in some regards.

They are also more volatile, which means that you can have inefficiencies in terms of pricing assets, which in human terms just means that some companies become too undervalued versus the fundamentals.

These concepts were explained by a fund manager at my recent client webinar:

However, frontier markets, focused on small and mid-caps, is also risky in some ways.

Therefore, it only makes sense to have a sensible allocation to that kind of thing – maybe 10% of the total portfolio.

This is the same reason why some “professional gamblers” I have met, who come from mathematical and probability backgrounds, bet on smaller football leagues and other similar opportunities.

There is a miss-match in the pricing, unlike for “tier 1” leagues where millions gamble on.

The same concept applies to private investments like private equity. Unless it is your start up, I wouldn’t put a majority of your portfolio in those opportunities, but a small allocation can make sense.

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