Random thoughts on Emerging Markets, Contrarian investing and Circle of competence

Since I have started the blog, I have been actively avoiding (or even shorting) anything which has significant Emerging markets exposure. This was quite a controversial strategy as for the last few years, investing in Emerging markets or companies with high Emerging market exposure was considered to be one of “THE” no-brainers in investing, along with commodities and residential real estate. Who doesn’t remember the famous “cleanest dirty shirt” slogan from Pimco’s El Erian ?

The momentum of Emerging markets carried them over the Eurozone crisis up until the end of 2012. Interestingly, even after first warning signs emerged like falling commodity prices, free-falling orders for companies like Caterpilar, the Batista bankruptcy etc. last year, the story of the “Emerging market consumer” and the swift transformation from investment led economies into happy consumer countries seemed to be still alive.

Now however, at least in the public perception, people are surprised that the infamous “decoupling” of the BRICs & Co was (as always) more wishful thinking than anything else. Interestingly again, the mood quickly turns from “no brainer” to “full panic”. On the other hand, European stocks, which 2 years ago were seen as total disaster, are touted as the most promising asset class despite being now much more expensive than 2 years ago.

As a contrarian investor, this is the time when one should pay attention and prepare oneself. On the one side, current sentiment tells me that I should become more careful with my high percentage of European stocks, on the other hand, I think it will be a good time trying to expand my circle of competence and start to look more into stocks with Emerging Markets exposure.

However, as a contrarian investor, one should be aware that one is always too early, both in the way in and the way out. This is basically the opposite side of the momentum investor. Psychologically, in my experience, most stock investors seek “instant” gratification. If you buy a new stock, you want the stock go up directly in order to have positive feedback on your thesis. Very few people can stomach declining share prices especially for new investments. In institutional environments there is a very high implicit pressure to invest into stocks with positive momentum as this increases the likelihood to look good in the short-term and this is all that counts, even in many so-called “value investing” outfits.

Back to Emerging markets: The truth is, I know very little about Emerging markets. I have documented one attempt with Pharmstandard as a special situation, where I was clearly luck to get out in time. So one clearly needs to have some sort of strategy.

In principal, there are various ways to gain exposure to Emerging markets:

1. diversified funds/ETFs of Emerging market stocks
2. single emerging markets stocks which are traded on accessible stock exchanges
3. Companies in developed markets with significant EM exposure

Personally, I think it makes most sense to extend the circle of competence in little steps. So investing in a company based for instance in China, where I have no clue how the market works and which is active in an industry where I don not have a lot of experience might be a very bad idea or the equivalent of pure gambling. One should also avoid obvious “compromised” sectors like German listed Chinese companies as the likelihood of systematic fraud is too high in my opinion.

The diversified approach has also big problems. In many markets, for instance Turkey, banks have a huge weight in the indices. As banks are the most vulnerable companies in a real crisis, index investing often turns out to be a suboptimal approach.

This leaves in my opinion two alternatives:

A) Invest in EM companies where I know the sector / business very well
B) Invest in developed market companies with significant EM exposure

Strategy B) in the current stage is relatively difficult, as especially in the consumer and automobile sector, people seem not to believe in any crisis or downturn. Yes, companies like Adidas, Yum or Volkswagen have underperformed the DAX this year, but they are not cheap.

Strategy A) has the drawback that often only a few companies are easily available to invest. In Turkey for instance, there is only a handful companies traded outside Turkey and one might not easily find traded ones in the prefered sectors.

One important caveat: In my experience, both booms and busts take longer to play out as everyone thinks. So there is absolutely no hurry to fully jump into EM stocks now. On the other hand it is very unrealistic to actually identify the low point. So once a certain investment is identified which is attractive, one should buy without trying to time the market.

In any case, for the rest 2014 I will try to look at the one or another company with significant EM exposure instead of chasing the few remaining undervalued European or American stocks. I might even start positions in some and prepare for a lot of pain, both for missing a continuing rally in Europe and for losses in new investments. But that is what contrarian investing is all about.


  • Does somebody know which brokers offer the best service for foreign exchanges?

    From my experiences most charge high commissions in percent of the necessary currency transactions. Interactive Brokers advertises small spreads and a commission of 0.20basis point * Trade Value. Does somebody use this broker and can please tell about the experience of their service?

    Comdirect, from the online brokers I browsed, offers stock trading on the most foreign exchanges. Does somebody know how currency transactions are charged there or which spread they use?

    Any ideas about value stocks in Greece or other states with problems?

    • #milud,

      many quetions here. I gues you won’t find “the” perfect broker. I use several ones and I am not comletely happy with any of these. With regard to Greece: I do not consider this an Emerging MArket country…

  • Great article, I hope you follow up with some concrete ideas for emerging markets. BTW is S Korea an emerging market?

  • Thank you for the good analysis.
    Regarding index investing, does anybody know where to find the cyclically adjusted price-to-earnings ratio, 10 years, (CAPE or Shiller P/E) for emerging country indices, e.g. MSCI Emerging Markets Index, or single country indices?

  • Do you have an estimate as to how high your current emerging markets exposure is?
    Out of my head I know Hornbach has some exposure to Eastern Europe emerging markets countries, but I don’t know all your portfolio companies that well. If I remember correctly even French Installux has some exposure to Saudi Arabia, which could be counted as emerging market.

    • #Martin, the exposure is not so clear. Yes, Hornbach has exposure to Eastern Europe, on the other hand they import a lot from EMs and profit from lower currency rates for a certain time.

      Overall I would argue that EM exposure is below 10% ….


  • I’m a fan of developed stocks with exposure to EM. Some are classics like Unilever of PZ Cussons, but you can also look at the “shovel” angle: who is selling stuff that enables emerging market to emerge?

    Aircraft manufacturers may be a good one, they have relatively stable “replacement” sales in the developed world, and most of the variation above that will come from EM demand, so they’re operationally leveraged on EM booms.

    Conversely it may not make sense to regard companies like Samsung, whose market is as global as say Apple’s, as representative of EMs.

  • The media is making it look like the EM issue is a new thing, but emerging markets have been big underperformers for a long while now, showing multiple de-rating in three of the last four years – by around 20% in total. EM equities are now cheap relative to recent history and relative to developed markets; the MSCI GEMs trades at a forward p/e of just above 10x vs the MSCI World for developed markets at more than 14x. That’s a 30% discount for emerging equities vs developed equities… a seven-year low!

    But an important point to take into account is that “emerging markets” is not a homogeneous ball. Some markets like Mexico or Peru or already look very attractive in my opinion, whereas I feel there is no hurry to get into places like Brazil or Colombia. This point takes even more relevance if you go for strategy A)… a specific EM business can thrill or bust regardless of the external environment (even more so than in developed economies).

  • Interesting article again. For myself I decided to go for B. The ideal stock does not trade in Germany, has significant and growing EM exposure, market cap below 500 Mio$. Industries I look for are electronics, robotics, automation and related stuff and of course the numbers need to be reasonable.

  • Halil Bahadirli

    I am living in Turkey and as far as I can see, we have an enormous bubble in housing. We have P/E ratios (price of the house or flat compared to yearly rent) in excess of 20 and in some popular places in excess of 30! You are getting close to 100% bank finance.! All in all, everything reminds me here on the Asian crisis of 1998 although the exchange rates of those countries used to be fixed while the Turkish Lira is floating.

    In 1998 I got interested in Asian stocks because I thought the crisis could be a contrarian buy opportunity. I decided to buy the Telcos of Malaysia, Indonesia, Thailand because they used to be monopolies in those days and I bought for instance PT Telcom, when news got out that tanks were surrounding the parliamant in Indonesia and the stock price did not drop anymore, despite those bad news.

    I thought this must be close to bottom. 6 months later I was down 45% (!) before the stock started to climb. I sold a couple of years later with a very nice profit but the point here is, although I waited until I thought that everything was factored in I was down 45%. In Emerging Markets you are almost always too early.

    • Without investments in emerging markets, I wouldn’t be financially independent since one and a half decades. First the Tequila crisis and later Thailand, Indonesia, and Korea. In Thailand and Indonesia with bad and in Mexico and Korea with almost perfect timing.
      About crises in emerging markets, there are numerous studies by IMF, Worldbank, and BIS, which helped at that time.

      Samsung was already a global market leader in 1998. Are there comparable companies (with strong export potential) in Turkey?

      • Halil Bahadirli

        No, not as far as I know. There are some local leaders like “BIM”, the leading low price grocer of Turkey, which, compared to the market penetration of Aldi or Lidl in Germany still has tremendous growth potential. In a 50.000+ mid sized city in Turkey you probably have more than 300 smal groceries. I did not count them in Reyhanli, where my father in law lives but it could be easilly many more than 300, perhaps 500. I reckon it used to be the same in Germany 40-50 years ago.

        As usual with these kind of stocks, they are always too expensive. I hope that in a stock market crash I have the guts to buy a handfull although I doubt that they will got as cheap as the rest of the market.

    • It is almost impossible to buy at the bottom. Your “tank around the parliament, but no stock drop”-decision was very correct…I would have done the same way, but that time I was an investing greenhorn. But what we see right now…is it a crash? If I check the ISE it is just 1/3 from TOP…I would see this as healthy correction. If the US-Fed (what I personally do not believe) really will stop money printing in a tougher way…then several of emerging country currencies will collapse and with such a collapse there will be chances to select some deeply discounted gems…but as I said, I do not see any significant interest rate hikes in US or Europe for a long long time…simply because the money/debt system will implode or explode…whatevery you prefer.

  • Thanks for the post.
    “Strategy A) has the drawback that often only a few companies are easily available to invest. In Turkey for instance, there is only a handful companies traded outside Turkey and one might not easily find traded ones in the prefered sectors.”

    There are no restrictions on foreign investment into Turkish stock market. Deutsche bank actually has a brokerage house in Turkey which i guess, also serve to investors from Germany.
    You also mentioned the Turkish banks in a cautious way. Briefly, the largest three public banks in Turkey achieved around 2% ROAA and 20% ROAE on average over the last 10 years and these are doing plain old banking business; lending and buying treasuries without any high yield bonds, CMBSs or CMOs etc. They are trading a little over the book value now. They may be worth a keep an eye on.

  • I have the same feeling about EM, probably they are very interesting but if I do not have a clear advantage I would only engage them as a contrarian play. Even if going against the crowd usually works in the long run sometimes the crowd is right, so to be a contrarian is not enough for me. I rather go with developed markets enterprises that have an important business in EM, I feel that I get more transparency in the financial statements. I have been a shareholder of BMW for quite sometime now and I think is a great company, with a brand that is desired by customers in developed and emerging countries, highly difficult to replicate, with superior margins than those of the competition and with transparency with the minority shareholders. It usually is not my target company because of the size but there must be few exceptions to the investment process here and there.

  • “In principal, there are various ways to gain exposure to Emerging markets:

    1. diversified funds/ETFs of Emerging market stocks
    2. single emerging markets stocks which are traded on accessible stock exchanges
    3. Companies in developed markets with significant EM exposure”

    How do you think about ADRs? They give access to many more stocks.

  • Intersting article. Just at the beginning of this week I was wondering what could be the next area worth to investigate a bit further. With the press full of panic about emerging markets currencies I came the same conclusion that emerging markets could get interesting.

    Your alternative “A) Invest in EM companies where I know the sector / business very well” is the way I will try to go.

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