Emerging Markets Equities Done Right

Frontier markets are in the pale blue shade; emerging markets in the royal blue shade

I attended a CFA Society Tucson-sponsored investor call March 18th presented by Kevin T. Carter, Founder and Chief Operations Officer of EMQQ. To call it and emerging markets equity exchange traded fund would not do it justice. Kevin gave a great presentation and here are my takeaways.

Not all emerging markets equity funds are alike. He urged us to consider the presence of State Owned Enterprises in the fund. These, he asserted can have severe management shortcomings that can serve to diminish the efficiency of the company and might even make such a company vulnerable to corrupt raids by government officials. One very striking example of such an intrusion he gave was of President Lula de Silva of Brazil. He and his successor, Pres. Dilma Rousseff were charged in a corruption case involving the state-run oil company Petrobras. The business model of Petrobras presents a vulnerability to investors whereas a chief executive can intrude on operations and cause problems.

Kevin described business models that have more efficient management not dependent upon the favors of government officials. These typically rely upon private or institutional investors instead. He cited two of these: Berkshire Hathaway and the Yale Trust fund. Such as these will have to exert much due diligence before committing their investors’ funds to an enterprise. Due diligence includes an investigation of the corporate executives and the the finance of the company.

EMQQ ETF has 96 companies in their investment portfolio with a large concentration in China. Kevin told us that these have dissimilar investment weightings and these change as prices shift. The ETF is rebalanced semi-annually and the weightings will change as a result. I was pleased to see that the profile of a company considered for inclusion includes those with investment capital as little as $300M. This is in the Microcap asset class. In a previous post, I described this asset class and why I think it is a useful one to include in an investment portfolio. Those in this portfolio will be in non-US countries so they will carry even greater risk than US domestic ones.

Kevin showed us a performance chart that compared the EMQQ fund with the Morgan Stanley emerging markets index (MSCIEM). there was a surprising contrast. He said that this was due to EMQQ’s concentration on consumer products and service providers in the space. Further refining the company profile, these are internet and e-commerce companies.

The talk was about a “confluence” of three important socio-economic forces: first; demographics, especially population growth. The populations of countries considered “emerging” or “frontier” are growing at a much faster rate than that of the developed world. More people means larger and larger workforces producing more and more value. Faster growing populations that are hungry for the consumer goods enjoyed by the developed world means high consumer demand. Consumer demand signals sales of product and services. Those sales translate into corporate earnings; an important fundamental for share price. Production and sales are measured in economic growth statistics. China is forecast to have 7.6% growth in 2021; the USA, in a banner year and coming off 2020 with a growth LOSS of about 3.5% is forecast to have about 6.4% a net/net of about 3.5%. The second force of confluence is the smartphone. Kevin had a bar graph that showed nations and their per capita share of smartphones. The developed world, of course is very high while the developing one has a large but slowly declining gap. The smartphone leapfrogs over the personal computer by bringing access to the third force of confluence; the internet.

Internet connectedness brings a host of advancements to a population. The first is a very streamlined medium of exchange for goods and services. He showed a photo of a produce truck in China that had two QR code cards on a table. This shows that even for such informal retailing, consumers are buying without exchanging hard currency; by debiting the consumer’s online banking account and crediting the seller’s. E-finance commerce is multiples more efficient than currency commerce.

Not stated so clearly but in a comment I made, the proliferation of smartphones and the information people have at their fingertips make it harder for despots to ascend to power and restrain economic growth as they typically do; creating systems of cronyism. Internet access also provides access to the various social media platforms. Social media streamlines personal communication. This can be a huge advantage for business formation. Internet access generally increases access to information; to knowledge. The intangible benefit of this to a population cannot even be easily measured.

The confluence of factors influencing the developing world is a very exciting prospect for global socio-economic growth that can greatly enrich the savvy investor. Keep your eyes on EMQQ.

Microcap Stock Investing

Microcap companies are plentiful but frequently obscure

Publicly traded companies are categorized according to the amount of investment capital they hold. This is determined by the number of shares they have issued and the price per share. There are “Giant caps” “Large caps” “Mid and Small caps” and “Micro caps”. Microcaps generally have investment capital of less than $500M. By comparison, Small caps have between $500M and $1B market capitalization. Some define Microcaps as having between $200 million and $350 million of market capitalization. 

A microcap company is usually a newer company of an age between just issued and ten years old. Some brand new companies are issued and immediately appeal to investors and start out as small or even midcaps. The microcaps I am interested in are newer and relatively unknown. Because they are so new, the products or services they are marketing are almost all innovative. Their products or services are unusual and may take some time to find wide public acceptance and applications to the economy. The following are some examples.

Medicines and medical appliances are innovative. They are developing cures or preventive measures for disease. Research and development can be very expensive and trials of these may take a long time. However, if they prove to be effective, they can find very large consumer demand and be very expensive. The new company can become very profitable in a very short time. On the other hand, many new pharmaceutical companies fail to produce viable medicines or they may fail to be approved by regulators. Investors lose their money.

Some companies develop new materials that have the potential to be used in a wide variety of products. Think of polyester and other petroleum-based plastics. The development of these materials may have taken years and been very expensive yet these have found very wide application in thousands of products. Companies such as DuPont became wildly profitable. Once, they were new, and small. 

Globally there has been much discussion about the climate. Many people, and many scientists are convinced that the climate is changing due to human activity; principally by increasing amounts of carbon dioxide being released into the atmosphere. There is wide agreement that this is happening because of the use of fossil fuels to create the energy to power machinery such as cars and trucks. So there is a very strong movement to reduce the consumption of fossil fuels and find alternative sources of energy. This is a disruption to social and economic life. Disruption is the gateway for innovation. Electric vehicles are widely viewed as superior to gas engine cars and will replace them in the near future. This has made Elon Musk, the founder of Tesla, the richest man in the world. Tesla is viewed as the most likely producer of vehicles of the future. Tesla has disrupted the automotive industry. 

Due to their small size, newness, and innovative products and/or services, microcaps are risky. They have great potential for gain or loss. For this reason, it is prudent to limit exposure to this asset class. It should be part of a total allocation to equities. It is important to carefully assess your risk temperament to ensure you have the proper allocation. The risk of loss can be mitigated by investing in more than one company and companies of a variety of industrial classes. Since these are typically volatile, it is important to keep a close eye on them and rebalance them as their prices change.

Keep investigating microcap companies. Learn their stories. Check out their management. When you are satisfied this is a company you want to see succeed, invest in it. Your investment returns will follow.

Prospects for hyperinflation

This article from the New York Times today “Europe’s Pandemic Debt Is Dizzying. Who Will Pay?” by Liz Alderman is a good survey of the way the EU central bank has financed some $850B in COVID 19 damage relief, and the threat posed for currency inflation such as the 120% Debt/GDP ratio France has racked up. The USA has increased its currency by $2.7T or 66% February 1 year over year. Some call this a currency “debasing”. The US Debt/GDP ratio as of Sept. 2020 was at about 127.28%. It didn’t break 70% until 2008 and the long term average, including the rapid increases since 2008 is about 60%. By comparison, the World Bank’s policy on lending to countries is that a Debt/GDP ratio of over 50% is not favorable. Pres. Biden’s “American Rescue Plan” is poised to cost another $1.9T. This is to be financed by more US Treasury bonds that the Federal Reserve will buy. This will add to the current almost $28T national debt.

Prospects for near-term economic growth in the USA is almost wholly dependent upon the course of the pandemic. Americans are now at 4.7% fully vaccinated and 12% with one shot. We’re giving an average of 1.7M shots per day. Wednesday we hit 40.3M with at least one shot; and 15.5M who’ve gotten both shots. As the number of vaccinated rises, activity ramps up.

There is a lot of pent up consumer demand, especially in the leisure and hospitality sector. People are going to be booking flights, dining out, and hanging around in nightclubs. If the pandemic aid has the intended outcome, workers in these depressed industries will be ready to return to work and ramp up production to meet the surge in demand. While we have some 14M on extended unemployment, we also have almost 40% of the labor force not participating. That is another enormous labor pool if the demand surge exhausts our current excess productive capacity of about 25%. A Federal $15 minimum wage will help spur the non-participants back to work. The April plunge of excess capacity to 36% was the lowest by far since at least 1967 when it was just over 10%.

Meeting the debt obligation means the USA and other deeply indebted countries must ramp up production. The “new normal” of 2.5% GDP we were seeing pre-pandemic will not cut it. Economic growth forecasts for 2021 of 5% will have to become the new normal if the debt service is to be sustained. This will keep prices low and prices are what is measured when inflation is considered. It could be very, very, rosy.