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Emerging Markets Labor Under Third-World Misconception

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For Marcio Silveira of Pavlov Financial Planning, investing is all about emerging markets.

Well, not all about them, but certainly a large chunk of his clients’ portfolios are devoted to low-cost, index-tracking ETFs that not only offer better diversification, but also take advantage of the imperfect correlations between EMs and the U.S.

Silveira, who was born and raised in Rio de Janiero, Brazil, comes at the investing picture from a different direction than many other advisors. In Brazil he was an equity analyst for a global macro hedge fund, where he got hands-on experience with the difficulties of active management in countries other than his own.

“I was making stock picks in a very active organization,” said Silveira. “They were doing better than others in Brazil, but struggling in international markets—other emerging markets were much harder to trade than local stock.” While a home bias paid off under those circumstances, because “I realized we [did] have an edge at home, but not abroad,” a move to Miami to become a relationship manager in the international private banking world offered fresh insights.

When he made the move to certified financial planner and founded Pavlov, all those varied experiences stood him in good stead, particularly when it came to the home country bias. It’s not as serious for Americans to indulge their bias as it is for foreign nationals, said Silveira, because the American market is widely diversified across types of businesses and because it “already provides a lot of weight in the global economy.” In addition, “many U.S. corporations do business abroad and a big chunk of their revenue comes from international sales. So even the S&P 500 gets big international exposure.”

But it’s a different story for some such as Canadians, who would end up overexposed to mining stock if they followed their own home country bias. And even so, Americans can be determined to keep most of their assets at home.

Silveira keeps between 40% and 50% in U.S. investments, with the rest international. “Many clients are not comfortable [with that], and want more in the U.S.,” he said, even his international clients who “didn’t grow up here but moved here and developed a home country bias for the U.S. and sometimes [also have it] for their home country as well.”

But he explains to them that “The US represents now roughly 50% of global equities, but it is about 20% of global GDP and less than 5% of global population, but the fact is that it doesn’t make sense to have everything here in the U.S. Over the next few decades most of the world’s economic growth is going to happen outside of the U.S. U.S.-based investors are wise to overcome the ‘home country bias’ and benefit from it.”

Client portfolios have “an allocation that’s 45% U.S., then about 25% developed, including Japan, Australia and western Europe, and the 30% remaining is in emerging markets—but not frontier.” Clients don’t have good options for frontier markets, said Silveira, with many being cost prohibitive and liquidity issues abounding. But emerging markets are a different story. Still, despite his efforts to educate his clients, he says one is “a bit uneasy” about any ex-U.S. exposure, despite working on Capitol Hill. “He didn’t want any exposure to emerging markets, and limited developed exposure too. I documented it, and make sure he takes advantage of other opportunities in planning.”

That’s not as easy as it could be, Silveira notes, because the Thrift Savings Plan for federal government employees does not offer an EM investment option. “It has an international developed [option], but not EM.” His client saves through the TSP, so “I have to balance out money in IRAs and taxable investments so that they have bigger exposure elsewhere, because the TSP doesn’t have exposure to EM.”

Silveira believes that part of the reason some people are so wary of international investments, emerging markets in particular, is the old Third World concept.

“Originally, the idea of the Third World was countries not aligned with either the U.S. and NATO or with the Soviets and socialists. The Third World was all the rest,” he explained. “Since then a lot has changed, and some of the former Third World countries, like South Korea and Singapore, are developed rich countries. Some of the Second World countries are off the radar now—Ukraine, Turkmenistan, and so on were part of the Soviet Union and are now frontier if they’re investable at all. And then other countries have grown a lot in importance—India, China, Brazil—and became bigger players in the global economy.”

Now, he says, that global economy could perhaps be divided in four sections: established developed; emerging and more established, such as Mexico, Indonesia, Turkey—“the vast majority of the world population is EM,” he said, with “China, India, Brazil and others making up the bulk of the population.” Then there’s the third group, investable frontier markets such as some sub-Saharan African nations, eastern Europe, and Argentina—which he points out was downgraded to frontier when the formerly rich economy fell apart. And finally, “you have markets that simply don’t invest at all, like many countries in Africa.”

However, Silveira said, “When people think of EM they think that old Third-World mindset, and I don’t think it applies any more.”

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