Sri Lanka: You will come back for more

AT Hosking Partners we have no explicit 'mandate' to be invested in emerging markets (EM). But over the past four decades, these markets have regularly presented opportunities to deploy our contrarian 'go anywhere' approach.

- BY JEREMY HOSKING

A learning has been how consistently cyclical the economic and investment returns are from EMs. Financial historian Edward Chancellor recently described EM returns as 'biblical': “seven years of plenty, followed by seven lean years”.

Despite an ever-present bull case, centred on emerging and developed market convergence, demographics, valuation disparities, sovereign fiscal superiority to developed markets (DM) and so on, a sensible rule of thumb is that the trigger for EM investment work should be a country-level crisis. Likewise, any form of heightened valuation based on a 'new era' should be treated sceptically. India, we are watching you carefully!

As global generalists, with the ability to 'go anywhere', we thrive on investment contrast. Whilst the past decade has focused on a narrow set of large-cap stock market winners, the global equity opportunity set is vast, with over 20,000 listed companies. Comparing EM crisis orphan stocks against fully valued DM equities is a great exercise in underwriting existing portfolio positions and in formulating ideas on where to allocate new investment dollars.

Country-level capital cycle

From a capital cycle perspective, economic distress, mixed with currency crises and investor pessimism, work to generate what might be termed 'country-level capital cycles': periods of capital flight, deleveraging and real wage declines which precipitate high forward-looking returns for the remaining capital stock. During such periods, valuations of long established 'country champion' type companies — with strong, structural competitive positions, often built up over multiple decades — can fall well below a conservative 'replacement value' calculation.