Investment report: Where to go for growth

There are no safe havens, but eight countries will drive global recovery. Prospect looks at how to gain access to them
January 25, 2012

During the past three and a half years, any notion of an investment safe haven—a place where money can be put with little or no risk—has disappeared.

At Goldman Sachs Asset Management, we commissioned the Economist Intelligence Unit in 2010 to conduct a survey among European investors to gauge thinking following the crisis. The survey, “Assessing and Explaining Risk,” posed questions to 289 private and corporate investors and financial advisers across Europe.

The results showed that respondents’ perception of risk had increased in all asset classes. The status of those such as cash and fixed income—normally assumed to be safe—had been challenged. At the same time, 61 per cent of British investors expected a mix of strong growth in emerging markets and low growth in developed markets.

Yet here’s the paradox: most investors still have a huge home market bias in their investment strategies, meaning they prefer to buy securities listed in their own country. But the sovereign debt crisis in Europe has exposed the dangers of such traditional thinking. With risks and opportunities surfacing in unexpected places, there is now a powerful case for investors to adopt more flexible and opportunistic strategies.

Bond portfolios with a global span are increasingly attractive. An unconstrained approach is appropriate now that markets are shaped by global forces including sovereign debt risk, global fiscal imbalances, and concerns about inflation and interest rates.

Most new opportunities can be found in the emerging world—but the term “emerging” is as outdated as “safe haven.” If a country already constitutes 1 per cent or more of global gross domestic product, should it really be called “emerging”? Currently, there are eight such countries: Brazil, Russia, India, China, Mexico, South Korea, Turkey and Indonesia. Jim O’Neill, the chairman of Goldman Sachs Asset Management, is now arguing for these countries to be classified as “growth markets.”

Not only are growth markets already powering a big part of the world economy, but their size and macroeconomic prospects also offer the potential for transformational growth in the coming decades. We believe that they will be eight out of the top ten contributors to global growth in the current decade, potentially adding about $16 trillion to global GDP, which is at least three times the potential GDP contribution from the US and Europe combined.

There are many ways for investors to access growth markets, both through buying stocks or bonds. One obvious route is through investment in regional or “composite” funds, which hold assets from companies in a wide range of markets; but there are also numerous country specific strategies focusing on countries such as Brazil, China, India and Korea. Increasingly, investors are looking at emerging market debt funds, given the strong economic positions of many of the growth market economies.

There are also less obvious ways of investing in growth markets. For investors who consider them an unknown quantity or as being too risky, investments in European or US equities funds can give indirect exposure to the growth markets. Amid the gloom and doom in the developed world, it should be remembered that Europe and the US are about more than just the sovereign debt crisis. In Europe and the US, many established companies make money from Asia and Latin America in particular, and derive an increasing proportion of their revenues from them.

But how can the value and performance of companies in different countries be compared? Most indices use a methodology based on the total value of all the outstanding shares in a company—the “market capitalisation.” There are some problems with this. Historically, this method has tended to increase the risk of bubbles. In the late 1980s, this happened with Japanese stocks in the MSCI World Index and again, in the late 1990s, a bubble formed in IT stocks within the S&P 500 Index. The asset management industry needs to consider new methods of valuing companies, which pay more attention to the GDP growth of the host country. This would take into account the rising influence and importance of the world’s new growth markets in particular and would help investors get a more appropriate level of exposure to the long-term sources of return.

Whether in bonds or equity investment, the danger to investment portfolios lies in the illusion that there are safe havens in either particular asset classes or individual countries. The realisation that there are not shouldn’t paralyse investors, however. The investment world offers plenty of new opportunities, but to find them we might have to look overseas, to places that we have not paid attention to before. That is the challenge for 2012 and beyond.