At the Towson University Investment Group’s International Market Summit, Part 3

More questions not asked:

1        Give us your thoughts on which emerging markets are stars and which are dogs? Will developed outperform developing?

I like emerging markets debt but not the equity.  Governance standards are not up to snuff, but the emerging market governments are running better economic policies than most of the developed countries.

As an aside, a pox on those that use the term BRIC.  Brazil, Russia, India, and China are very different countries with very different problems.  Aside from the fact that they are big, there is no reason to class them together.

2        What are some alternative assets that might be helpful in building out a diversified portfolio and reducing correlation?

Most “alternative assets” are not helpful.  Keep things simple.  If you have to do alternatives, look for things that few are doing.  Those are real alternatives.

Hedge funds and Private Equity are no longer alternative for big investors.  Their returns are highly correlated with stocks and other risk assets.

It is also useful to remember that reducing correlation during the bull phase of the market has little to do with what happens in the bear phase of the market, where all risk assets trade as a group, and the former correlations don’t hold.

Correlation is not a useful concept in investing.  It needs to be abandoned, because it is not stable.

3        What would be a good criterion for determining which asset classes to include in your portfolio and how to allocate these classes relative to each other?

Divide the portfolio into safe assets and risk assets.  Ask what your normal allocation to each would be, and then look at valuations, and adjust to where there is relative advantage.  Invest more in what is relatively cheap.

4        How will the abundance of cheap Natural Gas be used between the competing interests of Big Oil (Export) and Big Chemical (Use internally to make cheap chemicals)?

To the degree that chemical plants are near the places where natural gas and tight oil are produced, they will have cheap feedstocks.  But if the ability to export oil and LNG is expanded, it may not mean so much to the chemical companies, because they will have to pay the global price, net of transportation cost differentials.

5        How will the new health care changes affect and the regular person and how will it affect companies such as: hospitals, insurance companies and pharmaceutical companies?

Time to be controversial.  I think the PPACA [Obamacare] was not designed to provide better healthcare, and certainly not to lower costs, but to destroy the existing healthcare system that worked well, to force the US into socializing healthcare.

It is raising costs dramatically already.  We would be a lot better off dropping the tax deduction for employee healthcare, and moving the healthcare system to a first-party payer system, where stop-losses would kick in at 50% of income.  We need to end the idea that healthcare is a right.

6        Why do you believe that tech companies like Apple and Google have started manufacturing some of their devices in the USA?

Wages in China have risen relative to productivity, to the point where the US is competitive, and what is manufactured in the US is higher quality than what is manufactured in China.  There is a greater degree of control manufacturing here.

7        How does the downgrade of U.S’s credit and the increase in the U.S deficit impact U.S-China relations and trade?

There is no effect.  Better you should look at Fitch’s downgrade of China, and Moody’s moving China from a positive outlook to a stable outlook.  China is in far worse shape than the US.  As it is, the government deficit in the US is troublesome, but the trade deficit is narrowing.  That said, foreigners still want to buy US bonds.  The US is in much better shape than China.  Think of Japan in 1989, or the USSR in the late 1960s: that is China.

8        What is the future of corporate governance for the emerging markets and what advantages or disadvantages have local companies faced through this lack of corporate governance?

There are only disadvantages here.  Good governance would mimic US standards.  Much as we deride them, they are the best game in town.  If I were in a policymaking position, I would eliminate Sarbox, and Dodd-Frank.  Sarbox killed foreign listings in the US.  I would rather have more potential fraud, because I will not get harmed, while foolish people will get harmed.  As for Dodd-Frank, it aims a blunderbuss at a problem that requires a sniper rifle.  The main thing needed is to change capital standards at banks, and make them hold more liquid assets, which will kill ROEs.

Coming from the life insurance industry, where ROEs are lower, I would say to the banks, “Get used to lower ROEs. You took too much risk in the past.”

Back to corporate governance, the US has a Protestant culture in many ways, though it is badly warped.  Other nations do not culturally agree with the ideas of the US, and so control investors have greater advantages in emerging markets versus outside passive minority investors.

More to come…