Goldman Sachs coined "BRIC" to sell emerging market sovereign debt, and before that the IFC coined "emerging markets" to sell mutual fund shares.
“Emerging markets” is a descriptor generally used to describe the handful of countries not too rich, and not too poor, and not too closed to foreign capital. They tend to be rapidly growing economies, with aggressively expanding capital markets, putting them in reach of middle-income status with growing global and regional clout.
MSCI Emerging Market Index Annual Performance Since Inception
Third-World to Emerging Market
The term “emerging market” was coined in 1981, at a conference in Thailand, by a deputy director of the IFC named Antione van Agtmael. He coined the term as a rebranding exercise to entice more investors into the new “Third-World Equity Fund” which the IFC had recently launched. The fund planned to invest in shares in stock markets in places like Brazil, India and South Korea.
“People looked down upon the ‘Third World.’ It sounded so distasteful. I thought people with that feeling would never invest… I had lived in Thailand and I knew it was better than people thought. I felt we had to use a more uplifting term.” -Antoine van Agtmael, Former Deputy Director of the IFC
Investor feedback was that the term “third-world” had negative connotations, and that a new name might help get them and other investors over the line. After two days of back-and-forth, “emerging markets” emerged the victorious label, a term evoking imagery of progress, dynamism and potential. The rebranding was a success and capital has been flowing in and out ever since.
By offering a one-stop shop for investors in the promising third-world stock markets, the IFC hoped that those struggling economies would be lifted from obscurity and gain a place in future investor allocations. Today this all sounds obvious, but back then it was a radical idea given how discombobulated and out of reach the undeveloped economies were to international investors.
Six years after the conference in Thailand, in 1986, the first emerging market fund was launched using the “Third-World Equity Fund’s” strategy and targeted investments in four countries. The IFC provided the seed-funding, and made the initial outreach to the Capital Group to be the manager of the fund. The Los Angeles-based manager was founded in 1931 and today manages $75 billion of AUM in emerging market focused strategies, and far more globally.
Incidentally, this origin story rhymes with BRIC’s, which was birthed by Goldman Sachs’ Jim O'Neill in 2001 to sell more emerging market bonds from Brazil, Russia, India and China to its brokerage clients.
Hot Money Trap
Investors invest in emerging markets to realize returns which exceed those available in their home and other readily accessible markets. When the outsized returns are no longer thought to be possible, or when other markets offer a superior risk-adjusted return, the assets are sold and proceeds reinvested elsewhere. These capital outflows tend to happen rapidly and all at once, hence the use of the term “hot money”.
Just how, where and why things can go wrong vary from country to country. In many cases, hot money is fleeing for reasons having nothing to do with what the country has or hasn’t done, but instead on outside forces such as interest rates in another country or moves in global commodity prices. Sudden outflows of hot money tend to deflate asset values as well as the domestic currency making hard money debt obligations harder to meet. A vicious cycle and downward spiral is created, and because the emerging economy is unlikely to have developed capital markets, it has few if any available financial remedies and is thus forced to take the pain and swallow bitter pills.
When capital is cheap too many projects are funded which has a distorting effect on the domestic real estate market taking years to work out of the system. Often, the hangover induced after the capital flight is far worse than the gains achieved when the capital was free-flowing and party in full swing. It’s even worse when the governments are corrupt, such as the Peronists in Argentina, and much of the easy and cheap capital is used to fund everyday expenses rather than investing to improve the country and its infrastructure.
It’s these vicious cycles caused by hot money that have led many observers to regretfully conclude that while it’s true that emerging markets emerge usually because of access to plentiful foreign capital, it’s that same hot money that ultimately causes them to remain emerging or fall back into frontier status. To become emerged, the emerging economies have to master the art of slow and steady growth, a feat few have achieved on a sustained basis.
Comments