Emerging Markets Article by bill Bernstein

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Chuck T
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Emerging Markets Article by bill Bernstein

Post by Chuck T »

I found this article by Bill Bernstein very interesting. It was posted on the Money website.

http://money.cnn.com/2009/07/15/markets ... 2009071606
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Post by Robert T »

.
A similar take by Jeff Troutner http://www.capitalspectator.com/WM/2007 ... ill_1.html

My earlier take: Risk, not GDP, is priced into EM equity. EM “flight-to-quality” shows up in US Treasury returns. The latter has been a good diversifier for EM equity.

Robert
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Post by bhmlurker »

I find this funny. Title says "Betting it all on emerging markets", while Bernstein wrote in the last paragraph "put no more than 5-10% in an emerging market fund." I guess the title draws the audience to read what it actually says.
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Post by yobria »

I see no reason to underweight EM. As Bernstein alludes to in the article, markets are pretty efficient these days, so believing developed markets are a free lunch (the only reason you'd overweight) doesn't make sense.

In reality, the long term returns of a country -developed or emerging- will be determined by unpredictible future events.

Nick
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Post by speedbump101 »

Here is the archive of last weeks Index Universe Webinar... "Emerging Markets, Emerging Core"

http://www.indexuniverse.com/webinars/E ... layer.html

SB...
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Post by Kenster1 »

That doesn't mean you should avoid the emerging markets. They offer useful diversification. But spread your bets and invest in moderation - put no more than 5% to 10% in an emerging-markets fund.
Seems like a fair assessment.
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Post by Valuethinker »

yobria wrote:I see no reason to underweight EM. As Bernstein alludes to in the article, markets are pretty efficient these days, so believing developed markets are a free lunch (the only reason you'd overweight) doesn't make sense.

In reality, the long term returns of a country -developed or emerging- will be determined by unpredictible future events.

Nick
If we look back at past 'Emerging Markets' of the 19th century.

We see Argentina and Uruguay, which have never really emerged. They were huge areas for foreign investment in the 19th century, with some of the highest living standards in the world.

Shanghai was a major stock market but you dropped to zero in 1949.

Other major markets (that had periods of 100% loss in the 20th century) included Budapest, Cairo, Berlin, Moscow, Vienna and St. Petersburg.

Then there was the USA, which had many strengths, but probably even in the 1830s the fact that a major civil war was blooming was evident to at least some acute observers. The secessionist tendencies were very large and of course the British sat on the borders, ready to invite themselves back in ;-).

One could perhaps have predicted a bloody civil war, with the death or serious injury of 5% of the male population, culminating in either a fission of the country and economic collapse, or conversely a brutal occupation of the Secessionist states leading to permanent economic and racial division. Influxes of immigrants from Ireland, southern and eastern europe would pollute and polarize the national culture and identity.

And one would have been right, but of course the US turned out to be the greatest investment ever.

Of the US, Canada, Australia, Argentina, Brasil, Russia, it might have been quite hard to pick the 'winners' and 'losers' as investments in 1830.
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Post by Lbill »

I see no reason to underweight EM. As Bernstein alludes to in the article, markets are pretty efficient these days, so believing developed markets are a free lunch (the only reason you'd overweight) doesn't make sense
EM is about 12% of the world equity index. Bernstein suggests no more than 5-10%, so he's not much underweight at the top end of his recommended range. He makes a good point about investing in the EM "story." As a example, most people who invested in auto stocks at the beginning of that story lost money, even though the industry itself was massively successful. I'm sure the same was true for investors who might have piled into the U.S. emerging market story at the beginning. There are smarter ways to play these stories than by piling directly in, along with everyone else. If it looks like a great story and you don't know who the greater fool is - it is you. :D
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Post by saurabhec »

Lbill wrote:I'm sure the same was true for investors who might have piled into the U.S. emerging market story at the beginning. There are smarter ways to play these stories than by piling directly in, along with everyone else. If it looks like a great story and you don't know who the greater fool is - it is you. :D
Emerging market mutual funds available to retail investors have been around for over 15 years, so it is hard to call "Emerging Markets" a new fad. During that 15 year period they have been through several major upheavals (1997-98, 2000-02, 2008), so I think that their risks and opportunities are fairly well understood. If anything, I would argue that market weights of world indices under-represent emerging markets equity because of substantial insider ownership (most indices are based on market caps that take into account only free float, not total shares outstanding). So even if we take global equity market caps as a starting point, I think emerging markets are probably closer to 15-20% of global market cap than the 10-12% in most world indices. My main gripe with emerging market indices is that India is way under-represented. However, I have compensated by holding the WisdomTree India ETF in addition to the MSCI based emerging market index.
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Post by Lbill »

From Bernstein's article:
Developing countries are, after all, expected to lead us out of this global recession. And in the long run, countries like China and India will almost certainly leave economies in the U.S., Europe, and Japan in the dust.
Come on, now. Nobody would put a dime into these countries if they didn't believe this "story" just a little bit would they? In fact, nobody did put a dime into them back when you could have actually made some money - before the "story" became an investment mantra.

Here's the bottom line from Bernstein:
There's just one glitch: Economic growth and stock returns don't always move in sync
translation: the "story" doesn't always result in more money in your pocket even if the story is true.
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Post by Adrian Nenu »

Makes sense, right? Developing countries are, after all, expected to lead us out of this global recession. And in the long run, countries like China and India will almost certainly leave economies in the U.S., Europe, and Japan in the dust. There's just one glitch: Economic growth and stock returns don't always move in sync.

If they did, your S&P 500 fund would have made you money this past decade. And Chinese shares should have been the top performers, since GDP in China grew nearly double digits annually between 1998 and 2008. But the MSCI China index rose just 3% a year, vs. nearly 20% for stocks in Russia, where the economy grew a third slower.

Maybe a decade is too short. Okay, let's consider the past 20 years. U.S. equities gained 8% a year at a time when our economy grew less than 3% annually. By comparison, China's economy soared 9% a year, but its stocks didn't do nearly as well.
Vanguard Total Stock Market Index - (1.34%) last 10 years' average annual return.

Vanguard Emerging Markets Index - 8.99% last 10 years' annual average return.

You decide if stock market performance doesn't follow economic growth (not exactly but close).

Adrian
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Post by Kenster1 »

Interestingly, the bond market has done quite well in Emerging Markets.

Fidelity New Markets Income Fund has a 15-yr annualized return of 12.3%. Some Emerging Market countries have substantially big bond markets relative to their stock market.

Bernstein raised an interesting point about the MSCI China index -- but I would also say this....if you're worried about heated growth in these countries then possibly a Value version of these indexes can help. In the 10 years between 1998 - 1997, the MSCI China Value Index way outperformed the MSCI China Growth Index.

Notice also that Bernstein uses Russia as an example of a market that grew slower than China but their stocks outperformed over the longer term. Siegal in his book also used Brazil as an example versus China. Since China had the hottest growth but not the hottest stock performance, it doesn't then mean you can then say to avoid all EM exposure because China doesn't represent the EM index entirely -- Russia and Brazil were used as examples of slower growth countries than China but still outperformed and these happen to be EM countries used in these examples. So basically the lesson is to use a diversified EM basket instead of chasing after the hottest single growth country -- makes sense to me. And note that Russia and Brazil are no slouches either -- they've had much higher GDP growth than most or all of the developed countries and have outperformed for quite some time now.

Emerging Markets Value Index anyone? Anyone here using an interesting EM allocation such as PXH (Powershares RAFI EM) + DGS (Wisdomtree EM Smallcap Dividend) to give some Large + Small value tilt?
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Post by caklim00 »

Kenster1 wrote:Emerging Markets Value Index anyone? Anyone here using an interesting EM allocation such as PXH (Powershares RAFI EM) + DGS (Wisdomtree EM Smallcap Dividend) to give some Large + Small value tilt?
I tilt with DGS, not with PXH...
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Post by Jack »

Lbill wrote: Here's the bottom line from Bernstein:
There's just one glitch: Economic growth and stock returns don't always move in sync
translation: the "story" doesn't always result in more money in your pocket even if the story is true.
In fact the evidence is that fast economic growth and equity returns have an inverse relationship.

Here is Bill Bernstein's expanded take on emerging markets from back in 2006 when BRIC funds were the new fad. Thick as a BRIC
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Post by Lbill »

Jack - Thanks much for that link to the Bernstein article. That adds a lot of additional insight and also provided further cautions about chasing EM. Share dilution probably explains a lot of why investors in "story" equity ideas are likely to end up getting their head handed to them. You gotta remember that the producers and purveyors of "stocks" have an endless inventory with no carrying costs, so they have little difficulty, or moral reservations, in ginning up plenty of supply to meet (and exceed) demand.
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Post by SmallHi »

Adrian Nenu wrote:
Makes sense, right? Developing countries are, after all, expected to lead us out of this global recession. And in the long run, countries like China and India will almost certainly leave economies in the U.S., Europe, and Japan in the dust. There's just one glitch: Economic growth and stock returns don't always move in sync.

If they did, your S&P 500 fund would have made you money this past decade. And Chinese shares should have been the top performers, since GDP in China grew nearly double digits annually between 1998 and 2008. But the MSCI China index rose just 3% a year, vs. nearly 20% for stocks in Russia, where the economy grew a third slower.

Maybe a decade is too short. Okay, let's consider the past 20 years. U.S. equities gained 8% a year at a time when our economy grew less than 3% annually. By comparison, China's economy soared 9% a year, but its stocks didn't do nearly as well.
Vanguard Total Stock Market Index - (1.34%) last 10 years' average annual return.

Vanguard Emerging Markets Index - 8.99% last 10 years' annual average return.

You decide if stock market performance doesn't follow economic growth (not exactly but close).

Adrian
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Uh, ok:

1994*-6/08

Russell 3000 = +6.4%
MSCI EAFE = +4.3%
60/40 = +5.7%

MSCI EM Index = +4.7%

*Inception year of Vanguard EM Index

Double the risk of developed markets with investable returns of 1% or more less than developed country returns. Oh, and for 7 of the first 9 years the Vanguard Emerging Markets Index was around, it lost money.

sh
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Post by Kenster1 »

Jack wrote:In fact the evidence is that fast economic growth and equity returns have an inverse relationship.
Well at least not in the past 10 years.

Yeah I can just see it -- there are those sitting there on the edge hoping the day comes when EM starts underperforming the US market over the 3-5 year trailing period. Hey I don't mind either as I'm diversified.

YTD
VTSMX: 5.88% (VG Total Stock Market)
VEIEX: 37.38% (VG Emerging Markets)

Past 5 years
VTSMX: -0.78%
VEIEX: +15.04%

Past 10 years:
VTSMX: -1.34%
VEIEX: +9.04%

VIVAX: -0.92% (VG Value Index)
AEMGX: +12.41% (Acadian EM - Value)

Yeah - the higher growth countries have really been underperforming. :lol: One day they will underperform but that's what diversification and rebalancing is for. Hey I also see some nice rebalancing benefit and potential here.
Last edited by Kenster1 on Thu Jul 16, 2009 5:14 pm, edited 1 time in total.
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Post by Kenster1 »

Ok - let's go back a little further to the inception year of AEMGX (Acadian EM) to cover a 16-17 yr span....

Value of $10k invested on 9/30/93 to 7/15/09:

VIVAX: $26,029 (VG Large Value)
DFLVX: $30,210 (DFA US LV)
AEMGX: $33,792 (Acadian Emerging Markets - Value tilted)
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Post by slick_dealer_05 »

What gives? For starters, politics often gets in the way of equity market performance, as it did in China 20 years ago after the Tiananmen Square crackdown.
What the hell is he talking about ?
What's the link between the performance of Chinese stock market with Tiananmen Square crackdown?
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Post by AzRunner »

slick_dealer_05 wrote:
What gives? For starters, politics often gets in the way of equity market performance, as it did in China 20 years ago after the Tiananmen Square crackdown.
What the hell is he talking about ?
What's the link between the performance of Chinese stock market with Tiananmen Square crackdown?
Political risk. Overall, investors will pay more for a stock in a stable political climate and conversely less where the political situation is unstable and they might fear never seeing their money again.

Norm
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Post by Triple digit golfer »

Adrian Nenu wrote:
Makes sense, right? Developing countries are, after all, expected to lead us out of this global recession. And in the long run, countries like China and India will almost certainly leave economies in the U.S., Europe, and Japan in the dust. There's just one glitch: Economic growth and stock returns don't always move in sync.

If they did, your S&P 500 fund would have made you money this past decade. And Chinese shares should have been the top performers, since GDP in China grew nearly double digits annually between 1998 and 2008. But the MSCI China index rose just 3% a year, vs. nearly 20% for stocks in Russia, where the economy grew a third slower.

Maybe a decade is too short. Okay, let's consider the past 20 years. U.S. equities gained 8% a year at a time when our economy grew less than 3% annually. By comparison, China's economy soared 9% a year, but its stocks didn't do nearly as well.
Vanguard Total Stock Market Index - (1.34%) last 10 years' average annual return.

Vanguard Emerging Markets Index - 8.99% last 10 years' annual average return.

You decide if stock market performance doesn't follow economic growth (not exactly but close).

Adrian
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Post by bmb »

Did Bernstein really write this?
For an investor in his early years, an EM index is the place to be for at least 20% of his equity allocation. Stocks are about taking risks to get rewards. If value matters, in the long term equities reflect the degree of growth in the underlying entities. So where do you think the greatest percentage growth is going to be over the next 25 to 50 years? In economies that are growing rapidly, or in those that are already mature?
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Post by SmallHi »

Kenster1 wrote:Ok - let's go back a little further to the inception year of AEMGX (Acadian EM) to cover a 16-17 yr span....

Value of $10k invested on 9/30/93 to 7/15/09:

VIVAX: $26,029 (VG Large Value)
DFLVX: $30,210 (DFA US LV)
AEMGX: $33,792 (Acadian Emerging Markets - Value tilted)
From October of 1993 through June of 2009, a comparison of the highest expectation, best companies in the fastest growing emerging economies (MSCI EM Index) with the slowest growing, most unsuccessful low priced/expectation companies in the most fully developed world (US Large and Small Value):

$1 in MSCI EM Index = $1.57
$1 in US Value co's = $3.87

Going forward, we must also contend with the fact that the market seems certain of a rather high level of sustained economic growth from these emerging economies (as reflected by premium valuations on EM stocks):

Price to Book Ratios:
Vanguard Total World Index = 1.6
Vanguard Emerging Mkts Index = 1.9
US Value = 0.8

Earnings Growth Rates:
Vanguard Total World Index = 14.5%
Vanguard Emerging Mkts Index = 22.2%
US Value = 5.2%

What happens to the riskiest region of the world when it trades at the highest valuations around reflecting an ability to sustain 50% higher growth rates than the rest of the world?

A better title for the article would have been: Should You Bet on Emerging Markets at All?

sh
Last edited by SmallHi on Thu Jul 16, 2009 6:37 pm, edited 3 times in total.
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Post by slick_dealer_05 »

AzRunner wrote:
slick_dealer_05 wrote:
What gives? For starters, politics often gets in the way of equity market performance, as it did in China 20 years ago after the Tiananmen Square crackdown.
What the hell is he talking about ?
What's the link between the performance of Chinese stock market with Tiananmen Square crackdown?
Political risk. Overall, investors will pay more for a stock in a stable political climate and conversely less where the political situation is unstable and they might fear never seeing their money again.

Norm
Didn't the crackdown lead to more political stability?
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Post by SmallHi »

bmb wrote:Did Bernstein really write this?
For an investor in his early years, an EM index is the place to be for at least 20% of his equity allocation. Stocks are about taking risks to get rewards. If value matters, in the long term equities reflect the degree of growth in the underlying entities. So where do you think the greatest percentage growth is going to be over the next 25 to 50 years? In economies that are growing rapidly, or in those that are already mature?
Totally, totally false. Only if realized growth exceeds the growth expectations already imbedded in share prices. And, as my post above showed, everybody and their dog already shares your opinion.

sh
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Post by Sammy_M »

Robert T wrote:.
A similar take by Jeff Troutner http://www.capitalspectator.com/WM/2007 ... ill_1.html

My earlier take: Risk, not GDP, is priced into EM equity. EM “flight-to-quality” shows up in US Treasury returns. The latter has been a good diversifier for EM equity.

Robert
.
Robert, for diversification, why is it that you chose Int. Treas. rather than TIPS?
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Post by Lbill »

I tapped my finger and a beautiful woman appeared at my doorstep in her underwear.
TDG - How do I know that you're not a beautiful woman and will show up on my doorstep in your underwear if I tap my fingers? (I will wait for your reply before tapping anything). :oops:
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Post by Robert T »

.
The first part of the table below is what I had in my earlier linked post (as of June 2008), the second part is an update as of today. The current price of $1 of expected earnings in EM is lower than in US LV and LG markets, with higher expected earnings growth. Still sounds to me like a risk story, and EM still looks priced like a 'value stock' than growth stock. Obviously no guarantees.

Code: Select all

June 2008                                                 Historical 
                                 Price/Prospective         Earnings 
                                     Earnings               Growth                                                

Vanguard Emerging Markets              11.9                  20.4 
iShares Russell 1000 Value             11.9                   4.5 
iShares Russell 1000 Growth            15.8                  18.9 

M* data 
-------------------------------------------------------------------------------

July 2009                                                                           Historical        Projected     
                                 Price/Trailing      Price/Forward      Price/       Earnings          Earnings
                                     Earnings          Earnings          Book         Growth            Growth                                     
Vanguard Emerging Markets              9.2              10.7              1.6          12.6              15.5       
iShares Russell 1000 Value            11.8              13.3              1.3          -6.2               8.5             
iShares Russell 1000 Growth           15.7              15.1              3.3          10.6              11.7 

M* data

Code: Select all

Or using Vanguard data - a similar story IMO

                         P/E       P/B         Earnings Growth

Vanguard EM             15.0       1.9              22.2
 
Vanguard US Value       12.7       1.4               9.6
Vanguard TSM            18.5       1.9              13.8
Vanguard US Growth      19.3       2.5              27.5    

Robert, for diversification, why is it that you chose Int. Treas. rather than TIPS?
I use a blend of both.

Robert
.
Last edited by Robert T on Thu Jul 16, 2009 7:58 pm, edited 1 time in total.
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Post by yobria »

Lbill wrote:
I see no reason to underweight EM. As Bernstein alludes to in the article, markets are pretty efficient these days, so believing developed markets are a free lunch (the only reason you'd overweight) doesn't make sense
EM is about 12% of the world equity index. Bernstein suggests no more than 5-10%, so he's not much underweight at the top end of his recommended range. He makes a good point about investing in the EM "story." As a example, most people who invested in auto stocks at the beginning of that story lost money, even though the industry itself was massively successful. I'm sure the same was true for investors who might have piled into the U.S. emerging market story at the beginning. There are smarter ways to play these stories than by piling directly in, along with everyone else. If it looks like a great story and you don't know who the greater fool is - it is you. :D
Yes, he's not far from 12%, but I was thinking of general tone of the article. Bernstein seems to criticize the "story" of EM while building one of his own! And the "piling in" theory works both ways - "piling out" is no more rational.

The market is one of the few things I trust more than the great Dr. Bill.

Nick
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Re: Emerging Markets Article by bill Bernstein

Post by Sunny Sarkar »

Chuck T wrote:I found this article by Bill Bernstein very interesting. It was posted on the Money website.

http://money.cnn.com/2009/07/15/markets ... 2009071606
This article from some time ago warned about the same problem with the BRIC countries, viz. Brazil, Russia, India, and China...

http://www.efficientfrontier.com/ef/0adhoc/bric.htm
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Post by Kenster1 »

SmallHi wrote: What happens to the riskiest region of the world when it trades at the highest valuations around reflecting an ability to sustain 50% higher growth rates than the rest of the world?
Then look into EM Value. This is the same issue years ago when Jeff Troutner berated the US S&P 500 and TSM as nothing but growth traps or roach motels. Though the US was burning up in 1999 with super high valuations that would make Brazil, Taiwan and S.Korea today look like bargains -- the solution was to invest in value stocks even in an overheated US market.

Why can't the same be said of EM? Why not promote EM Value to help dissipate that roach motel effect?

Secondly -- I can understand you in not being too interested in EM because you would rather take the international risk in International Smallcap Value. Ok so that seems plausible in taking on a sizable allocation here in lieu of little EM exposure. So we could be looking at a sizable US SV and International SV tilt instead to reach into the FF3 SV higher expected returns which is fine. But that's not the case for a lot of investors who 5 years ago here were TSM investors and may have had a little sprinkle of the MSCI EAFE Index.

So again -- I can understand the perspective from the US + International Value & Small tilters in not having much EM exposure and just basing their higher expected returns on the increased Global SV exposure and I can agree with this if this is where you're coming from. However, most investors aren't coming from that same premise or value-style of investing and in fact don't even believe in implementing a SV tilt.
Last edited by Kenster1 on Thu Jul 16, 2009 9:22 pm, edited 1 time in total.
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Post by Chas »

Kenster1 wrote:
SmallHi wrote: What happens to the riskiest region of the world when it trades at the highest valuations around reflecting an ability to sustain 50% higher growth rates than the rest of the world?
Then look into EM Value. This is the same issue years ago when Jeff Troutner berated the US S&P 500 and TSM as nothing but growth traps or roach motels. Though the US was burning up in 1999 with super high valuations that would make Brazil, Taiwan and S.Korea today look like bargains -- the solution was to invest in value stocks even in an overheated US market.

Why can't the same be said of EM? Why not promote EM Value to help dissipate that roach motel effect?

Secondly -- I can understand you in not being too interested in EM because you would rather take the international risk in International Smallcap Value. Ok so that seems plausible in taking on a sizable allocation here in lieu of little EM exposure. So we could be looking at a sizable US SV and International SV tilt instead which is fine. But that's not the case for a lot of investors who 5 years ago here were TSM investors and may have had a little sprinkle of the MSCI EAFE Index.

So again -- I can understand the perspective from the US + International Value & Small tilters in not having much EM exposure and just basing their higher expected returns on the increased Global SV exposure and I can agree with this if this is where you're coming from. However, most investors aren't coming from that same premise or value-style of investing and in fact don't even believe in implementing a SV tilt.
I am viewing tilting to EM, i.e. in addition to that already present in VGTSX, or perhaps Int'l Value, as similar to a dash of hot sauce in a portfolio. Livens it up! Just need to keep the water glass full and ready! :lol:
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SmallHi
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EM looks awful growthy

Post by SmallHi »

Looking to iShares and DFA websites for independent verification:

iShares Emerging Markets Index BtM = 0.36
iShares EAFE Growth Index BtM = 0.33
iShares EAFE Value Index BtM = 0.71

DFA Emerging Markets Fund BtM = 0.49
DFA International LC (EAFE) BtM = 0.68
DFA International LV BtM = 1.05
DFA International SV BtM = 1.41

Regardless of which site you use (iShares or DFA), the more stable measure of book value/price shows Emerging Markets trading almost at the level of developed growth stocks, telling you that investors are paying a significant glamour premium for future expected growth. Its fine to pay that for very large, stable and established companies in developed markets because they have very low risk. Emerging Markets, OTOH, should trade at a discount because of their excessive risks, much like they did in the 90s and early 00s, when the BtM of Emerging Markets were around 1.0 -- similar to that of developed Large and Small Value stocks and 1/5 that of growth stocks.

Since that time, Emerging Markets economic growth has accelerated significantly, but Bernstein's comment about dilution has held. Valuations on Emerging Markets have risen by almost 50% (from a BtM of about 1.0 in 2000 to about 0.5 today using DFA as a guide), while Int'l Large and Small Value stock valuations actually have fallen. During a period where Emerging Markets valuations more than doubled relative to developed Int'l Value stocks, you'd expect a significant return premium (similar to the S&P 500 in the late 90s relative to US Large/Small Value). This was not the case:

2000-2009
Emerging Markets = +7.2%
Int'l Developed Value = +7.2%

Unless you are counting on valuations again doubling from here, I shudder to think whats coming. Just imagine if Emerging Markets don't live up to these expectations, and we unexpectedly enter another Emerging Markets centric panic/bust, which has happened like clockwork every few years for decades. Look out!

Most don't realize, the long term record of Emerging Markets is not good. The Emerging Stock Market Factbook reports Emerging Markets underperformed both the S&P 500 and EAFE from 1975 to 1995 with much higher risk, and we know that 96-99 was also painful for Emerging Stocks relative to developed markets -- so for the 25 years leading up to this 00-09 period above (where EM only matched Developed Int'l Large/Small Value) Emerging Markets would have offered a great combination of ultra high risk and disappointing returns.

Adding more developed size/value, and/or increasing stock allocation relative to bonds is a better way for even Vanguard/iShare investors to increase expected portfolio returns, IMO.

sh
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Re: EM looks awful growthy

Post by Chas »

SmallHi wrote:Looking to iShares and DFA websites for independent verification:

iShares Emerging Markets Index BtM = 0.36
iShares EAFE Growth Index BtM = 0.33
iShares EAFE Value Index BtM = 0.71

DFA Emerging Markets Fund BtM = 0.49
DFA International LC (EAFE) BtM = 0.68
DFA International LV BtM = 1.05
DFA International SV BtM = 1.41

Regardless of which site you use (iShares or DFA), the more stable measure of book value/price shows Emerging Markets trading almost at the level of developed growth stocks, telling you that investors are paying a significant glamour premium for future expected growth. Its fine to pay that for very large, stable and established companies in developed markets because they have very low risk. Emerging Markets, OTOH, should trade at a discount because of their excessive risks, much like they did in the 90s and early 00s, when the BtM of Emerging Markets were around 1.0 -- similar to that of developed Large and Small Value stocks and 1/5 that of growth stocks.

Since that time, Emerging Markets economic growth has accelerated significantly, but Bernstein's comment about dilution has held. Valuations on Emerging Markets have risen by almost 50% (from a BtM of about 1.0 in 2000 to about 0.5 today using DFA as a guide), while Int'l Large and Small Value stock valuations actually have fallen. During a period where Emerging Markets valuations more than doubled relative to developed Int'l Value stocks, you'd expect a significant return premium (similar to the S&P 500 in the late 90s relative to US Large/Small Value). This was not the case:

2000-2009
Emerging Markets = +7.2%
Int'l Developed Value = +7.2%

Unless you are counting on valuations again doubling from here, I shudder to think whats coming. Just imagine if Emerging Markets don't live up to these expectations, and we unexpectedly enter another Emerging Markets centric panic/bust, which has happened like clockwork every few years for decades. Look out!

Most don't realize, the long term record of Emerging Markets is not good. The Emerging Stock Market Factbook reports Emerging Markets underperformed both the S&P 500 and EAFE from 1975 to 1995 with much higher risk, and we know that 96-99 was also painful for Emerging Stocks relative to developed markets -- so for the 25 years leading up to this 00-09 period above (where EM only matched Developed Int'l Large/Small Value) Emerging Markets would have offered a great combination of ultra high risk and disappointing returns.

Adding more developed size/value, and/or increasing stock allocation relative to bonds is a better way for even Vanguard/iShare investors to increase expected portfolio returns, IMO.

sh
Hi Small,

Using Simba's spreadsheet:

1975-1995
VFINX (S&P500) CAGR=15%
VDMIX (Int'l Developed) CAGR=15%
VEIEX (Emg. Mkts.) CAGR=27%

2000-2008
VEIEX (Emg. Mkts.) CAGR=4%
VTRIX (Int'l Value) CAGR=1%

The 2000-2008 period is the latest data Simba has, but the numbers don't come close to matching your data. What's up?
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Post by Robert T »

.
I posted some of the M* iShares numbers earlier. Here they are from the iShares website.

Code: Select all

                                                                                
                                Price/Earnings     Price/Book

iShares Russell 1000 Value         16.9               1.9
iShares EAFE Value                 16.6               1.4

iShares Russell 1000 Growth        19.3               4.9
iShares EAFE Growth                19.0               3.0

iShares MSCI EM                    18.0               2.8

Not a hugely dissimilar story to the M* or Vanguard numbers IMO. Investors are paying a higher “glamor premium” for growth in the US and Non-US developed whether using P/E or P/B. i.e. EM less of a growth stock (more of a risk story IMO). And irrespective of valuation, I’m don’t think making marketing-timing moves in asset allocation is a prudent approach. If there is another EM “bust” my bond allocation will likely do okay. Obviously no guarantees.

Robert
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Re: EM looks awful growthy

Post by yobria »

Betting everything on an unexplained historical pattern like the SV premium is a narrow, risky investment strategy.

And trying to compare the B/M ratios across countries -where local accounting rules and industry mixes vary widely- is going way, way out on a dubious limb to exploit this pattern.

There are plenty of investing ideas out there beyond SV, such as the fact that higher risk EM stocks should outperform lower risk developed stocks.

Nick
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Post by minesweep »

Triple digit golfer wrote:I tapped my finger and a beautiful woman appeared at my doorstep in her underwear.
I don’t know about your doorstep but you can make beautiful women appear on your computer (with or without underwear) by tapping your finger on the keyboard. :)

Mike
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Re: EM looks awful growthy

Post by Chas »

yobria wrote:Betting everything on an unexplained historical pattern like the SV premium is a narrow, risky investment strategy.

And trying to compare the B/M ratios across countries -where local accounting rules and industry mixes vary widely- is going way, way out on a dubious limb to exploit this pattern.

There are plenty of investing ideas out there beyond SV, such as the fact that higher risk EM stocks should outperform lower risk developed stocks.

Nick
Nick,

Most int'l index funds now include about a 20% slice for emerging markets. The question is, "Does it pay off in risk adjusted returns to tilt to EM by including it in a portfolio in a larger proportion than its cap weight?" My Simba spreadsheet analysis indicates that it does over periods 1972-2009, 1985-2009 and many other periods. In fact, it is hard to find a period when extra tilting to EM doesn't pay off.
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Post by Kenster1 »

Well - looks like no definitive answers here but we are talking about only a 5-15% allocation in most portfolios. In fact a 70/30 investor with 30% allocated to Total International has probably only around 4% allocated to EM.

Looks like we have 5 major international investing groups:

1. Invest in Total International/FTSE All-World ex-US and let EM allocation ride up & down per market-cap weighting.

2. Invest in the Developed Markets Index and avoid EM altogether.

3. We have those that are going to use the MSCI EM Index in a separate & more static allocation and take advantage of the rebalancing effect -- especially in looking at the past 5-10 years where EM and US have performed remarkedly very different.

4. Then we also have those who also like EM allocation but agree with being a bit wary of the super growth, heated overvaluation and potential downfall of EM stocks and therefore use EM Value and/or EM Small-Value to hopefully help mitigate some of that problem (e.g. similar to US S&P500 & TSM issue in the late 90's). And this EMV allocation would be an extension to an Int'l Developed Value allocation. So these investors are doing an Int'l Developed Value + EM Value allocation.

5. Then it looks like we have those who will just stick with the FF3 SV risk factors and higher expected returns in a US + International SV tilt across developed markets.

Here's also something to consider -- while some of the EM market were poor performers in the distant past, I wonder if some structural changes have made them more efficient recently. They're still going to be quite risky, volatile and growthy but I wonder if we'll see some improvements in their stock markets because of increased global coverage and improved liquidity and global accessibility.

Interestingly, the ADRE ETF (EM 50 ADR ETF) has outperformed VEIEX (VG EM Index) since the beginning of 2003. This could be an option for gun-shy investors because ADRE invests in the top 50 EM companies available as ADRs -- meaning stocks trading here in the US and giving much greater efficiency, liquidity and global accessibility.
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Post by Valuethinker »

Kenster1 wrote:
Here's also something to consider -- while some of the EM market were poor performers in the distant past, I wonder if some structural changes have made them more efficient recently. They're still going to be quite risky, volatile and growthy but I wonder if we'll see some improvements in their stock markets because of increased global coverage and improved liquidity and global accessibility..
It used to be EM that had bad financial crises and we laughed at them.

Now developed markets (Japan, US, UK, Ireland etc.) have bad financial crises and they tisk tisk at us.

Some EM have most definitely not emerged: Russia, Argentina, Venezuela (all of which were 'hot' at one time) have all the same political practices which made us hate them before.

Mexico has emerged and is getting close to a developed market. So has Poland.

By contrast Ukraine, Hungary etc. are in crisis. Don't even mention Latvia.

So the whole question of 'Emerging Markets' is fuzzy in my mind: Brasil has world-leading natural resources companies. Taiwan has world-leading semiconductor companies. Israel has world-leading technology companies.

By contrast Canada and Australia have banks, and natural resource companies. Relatively few world-leading companies.

My bet is trying to time/ call who 'emerges' is not going to be a successful strategy generally. Index to the world weights, and so be it.
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Post by Lbill »

Most int'l index funds now include about a 20% slice for emerging markets. The question is, "Does it pay off in risk adjusted returns to tilt to EM by including it in a portfolio in a larger proportion than its cap weight?" My Simba spreadsheet analysis indicates that it does over periods 1972-2009, 1985-2009 and many other periods. In fact, it is hard to find a period when extra tilting to EM doesn't pay off
Chas - I'm a heavy user of Simba's spreadsheet myself. Don't know how I did without it before discovering. In this paper Coaker concludes that EM and International are better long-run diversifiers of U.S. LC than U.S. SCV because the average correlations are lower with lower variability. Something to think about.
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concluding thoughts

Post by SmallHi »

Hi Small,

Using Simba's spreadsheet:

1975-1995
VFINX (S&P500) CAGR=15%
VDMIX (Int'l Developed) CAGR=15%
VEIEX (Emg. Mkts.) CAGR=27%

2000-2008
VEIEX (Emg. Mkts.) CAGR=4%
VTRIX (Int'l Value) CAGR=1%

The 2000-2008 period is the latest data Simba has, but the numbers don't come close to matching your data. What's up?
Whats up is that Simba's spreadsheet is wrong, or just misguided. First of all, there is no standardized Emerging Markets data prior to 1988 when MSCI and Dimensional Indexes begin. People have (incorectly) used Int'l Small Cap (actually, UK Small and Japan Small) as a plug for emerging markets from 1970-1987. I sincerely hope no one is using this information to make decisions about emerging markets. 27% from 75-95? C'mon...I am inclined to follow the IFC book/study on emerging markets before I believe UK/Japan Small was a close proxy over this period.

Secondly, my 2000-2009 (through June) numbers use the MSCI Emerging Markets Index and a 50/50 allocation of DFA Int'l LV/SV as the closest approximation of the asset classes. EAFE doesn't have an Int'l SV index I have data on, and I am sure not going to use an active Vanguard mutual fund to study the asset class!

Careful with these spreadsheets, if the inputs are poor (as these are), then the outputs will be misleading at best.

Robert,
Not a hugely dissimilar story to the M* or Vanguard numbers IMO. Investors are paying a higher “glamor premium” for growth in the US and Non-US developed whether using P/E or P/B. i.e. EM less of a growth stock (more of a risk story IMO). And irrespective of valuation, I’m don’t think making marketing-timing moves in asset allocation is a prudent approach. If there is another EM “bust” my bond allocation will likely do okay. Obviously no guarantees.
I think we would all agree with Nick, cross border valuation comparisons are difficult. But if we are looking at Price/Book, I am more inclined to compare EM to the developed non-US world than I am just or mostly US stocks -- just one country vs. 20+. From that viewpoint, relative to most of the rest of the world, emerging prices are quite lofty.

Also, I am not advocating market timing emerging markets. I am just questioning theory vs. reality on a permanent allocation or exclusion (clearly a controversal consideration in the face of good returns over the last 3-5 years).

Nick,
Betting everything on an unexplained historical pattern like the SV premium is a narrow, risky investment strategy.

And trying to compare the B/M ratios across countries -where local accounting rules and industry mixes vary widely- is going way, way out on a dubious limb to exploit this pattern.

There are plenty of investing ideas out there beyond SV, such as the fact that higher risk EM stocks should outperform lower risk developed stocks.
I would say that the developed country size/value premiums that FF studied are as well explained as any asset pricing theory concept we have, certainly better than the CAPM. And yes, in a marketing driven industry, there are plenty of ideas out there to make money. With the very real risks Bernstein documented about dilution, and the limited available track record with spotty results using IFCs EM stock guide as a reference, I'd say emerging markets investing deserves more critical thinking than Bogleheads have committed to the subject.

sh
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Post by Kenster1 »

Interesting articles from the Brandes Institute:

[2005] New Insights Into the Case for Emerging Market Equities

http://www.brandes.com/Institute/Docume ... 071105.pdf

[June 30, 1980 - June 30, 2004]
Our results for emerging market stocks are similar to the country-specific findings of Professors Dimson, Marsh, and Staunton. Emerging market value stocks (in the upper deciles) have tended to outperform glamour stocks over the long term. At the extremes, the average annualized return for "glamour" stocks in decile 1 was 4.1% vs. 16.2% for "value" stocks in decile 10.
After debunking the notion that powerful stock market returns generally are found in countries with robust economic growth, the professors answer the question of whether investors should avoid emerging markets. They assert, "That is not an implication that should be drawn from our research." Instead, they emphasize diversification as the primary reason for allocating assets to developing markets, suggesting investors maintain "a strategic exposure."
==========


[2008] Value Investing: Has It Worked In Emerging Markets?

http://www.brandes.com/Institute/Docume ... 200708.pdf
To value investors, this research may confirm more clearly the opportunities available in emerging market investing. These results show it is possible to generate competitive returns by focusing on companies selling at attractive valuation levels, and by avoiding the temptation to chase after investments in glamourous companies in prosperous and fast-growing economies, regardless of their valuations.
Last edited by Kenster1 on Fri Jul 17, 2009 9:44 pm, edited 2 times in total.
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Re: concluding thoughts

Post by saurabhec »

SmallHi wrote: I'd say emerging markets investing deserves more critical thinking than Bogleheads have committed to the subject.
I know you like to tweak Bogleheads now and then especially given their mistrust of small and value premiums, but on emerging markets if anything Bogleheads seem to be even bigger skeptics, so not sure if your aside was merited. If anything, I suspect the average Boglehead has far less exposure to emerging markets than investors as a whole.
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Post by Robert T »

.
Not without thought, for what its worth some earlier views ...

On: Submerging markets?: My take

On: Asset Pricing in Emerging Markets: My take

On: Thick as a BRIC: My partial take (a)

Second partial take (b): on Dilution:

The argument: High growth countries, often have a high growth in the number of companies issuing new stock (from either new or existing companies) to raise capital for further growth. These new issues “dilute” existing ‘country’ shareholders, widening the gap between growth in market capitalization and stock price appreciation (where market cap is simply price x number of shares). The difference between the market cap growth and price appreciate is often call the “dilution” effect (as refered to in Bernstein's article).

The evidence: E.g. What’s the source of a 30% stock dilution in China? From 1992 to 2003 China’s equity markets increased from $18bn to $681bn -> 39% annualized growth. Over the same period the number of listed companies in China rose from 52 to 1,296 or by 34% per year. The S&P/IFC price index of Chinese equities increased by 3.5% => so a dilution of 30%+ (using the measurement definition above).*

Does it matter? Was the 39% growth in market cap ever attainable in actual returns? i.e. what’s the real counterfactual. IMO the example above does not mean an investor lost 30% return due to dilution (not that its implied by Bill Bernstein - but just to clarify). Or put another way, the $681 bn in equity financing for 1,296 companies in 2003 would not have all gone to the 52 companies had there been no issue of new stock since 1992*. It would have very likely gone to companies in other countries and the market cap in China would be much smaller. Finance is global, and if we believe the allocation of capital reflects risk in US and non-US developed markets, how can we not conclude the same for EM (after all its often the same investors).

*The results above draw on the paper Speidell, Stein, Owsley and Kreuter (2005): Dilution is a Drag…The Impact of Financings in Emerging Markets. Journal of Investing.

Again just may take - we each has to decide for ourselves. I am certainly not 100% EM, but also not 0%.
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Post by Triple digit golfer »

Lbill wrote:
I tapped my finger and a beautiful woman appeared at my doorstep in her underwear.
TDG - How do I know that you're not a beautiful woman and will show up on my doorstep in your underwear if I tap my fingers? (I will wait for your reply before tapping anything). :oops:
Please don't tap your finger!
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Post by Triple digit golfer »

minesweep wrote:
Triple digit golfer wrote:I tapped my finger and a beautiful woman appeared at my doorstep in her underwear.
I don’t know about your doorstep but you can make beautiful women appear on your computer (with or without underwear) by tapping your finger on the keyboard. :)

Mike
Haha, that's very true. And free!
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Post by BlueEars »

Much of this tread is about investing in a Total International index versus spicing it up with Emerging Mkt. Wouldn't it be wiser to get more exposure to international midcaps + smallcaps first? From M* VGSTX has only about 11% midcap+smallcap.

For instance, using VG funds one could mix in some International Explorer VINEX. I know it's active (bad?) but the ER=0.42 so not too bad and also some may not like that it is a blended midcap+smallcap so no real value tilt there.

Some chart history:
Image
Last edited by BlueEars on Fri Jul 17, 2009 7:03 pm, edited 1 time in total.
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Re: concluding thoughts

Post by SmallHi »

saurabhec wrote:
SmallHi wrote: I'd say emerging markets investing deserves more critical thinking than Bogleheads have committed to the subject.
I know you like to tweak Bogleheads now and then especially given their mistrust of small and value premiums, but on emerging markets if anything Bogleheads seem to be even bigger skeptics, so not sure if your aside was merited. If anything, I suspect the average Boglehead has far less exposure to emerging markets than investors as a whole.
If you mean I point out my perceived flaws in the boglehead rationale, then yes, I do. Not reading much here lately, maybe I should stay away from generalizations. Although, I do note that I am the one dissenting voice on emerging markets on this entire 40+ post thread...so maybe my comments weren't so much of a stretch.

sh

PS -- I don't care who tilts and who doesn't, as long as their conclusions aren't based on active fund performance, survivorship biased studies, or a Morningstar article from 10 years ago that proves the conclusion they had already come to
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Re: concluding thoughts

Post by stratton »

SmallHi wrote:Whats up is that Simba's spreadsheet is wrong, or just misguided. First of all, there is no standardized Emerging Markets data prior to 1988 when MSCI and Dimensional Indexes begin. People have (incorectly) used Int'l Small Cap (actually, UK Small and Japan Small) as a plug for emerging markets from 1970-1987. I sincerely hope no one is using this information to make decisions about emerging markets. 27% from 75-95? C'mon...I am inclined to follow the IFC book/study on emerging markets before I believe UK/Japan Small was a close proxy over this period.

Secondly, my 2000-2009 (through June) numbers use the MSCI Emerging Markets Index and a 50/50 allocation of DFA Int'l LV/SV as the closest approximation of the asset classes. EAFE doesn't have an Int'l SV index I have data on, and I am sure not going to use an active Vanguard mutual fund to study the asset class!

Careful with these spreadsheets, if the inputs are poor (as these are), then the outputs will be misleading at best.
I agree. The spreadsheet is dangerous before about 1988. Before that the only thing you can count on is the US funds and EAFE foreign stuff. And I'm commenting without examing the sources.

Hmmm. Might be worth a thread to "audit" the spreadsheet data.

Paul
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