Making Cents of Emerging Markets - Dispelling myths
about the developing world's economies
By Jonathan Monpetit
When The Economist declared last year that no serious
investor can afford to ignore emerging markets (EMs), Professor Vihang
Errunza bit his tongue.
For more than 30 years, Errunza has been preaching
about the opportunities afforded by developing world economies. In fact,
his 1974 doctoral thesis was among the first to broach the idea that
perhaps investing in countries like China and India wasn't so crazy after
"I came up with the very simple idea that to
have portfolio capital flowing from developed economies to emerging markets
would be beneficial to both sides," says Errunza, a professor in the
Desautels Faculty of Management. "The developed countries share in the
growth prospects of these emerging markets. The emerging markets, in turn,
get a much needed additional source of risk capital, which helps develop
local institutions, increases their economic growth rate and lowers the
cost of capital."
Errunza isn't surprised that three decades of
thinking about EMs has suddenly come to a head. Aging populations and low
growth rates mean the world's developed markets no longer present the
lucrative growth opportunities they once did. At the same time, consumers
and suppliers in the developing world are chomping at the bit; Errunza
estimates that EMs particularly the "BRIC" countries (Brazil,
Russia, India, China) will account for 50 per cent of the global economy
within the next 25 years. BRIC markets are also proving rather responsive
to the environmental warning bells, exploring renewable energy sources such
as wind (India) and solar (China) power. "In the long run, it's in
everybody's best interests to have these economies grow and become part of
mainstream global capital markets."
But while Errunza is credited with helping kick-start
the trend toward EMs, he hasn't rested on his laurels. He recently
completed a major research project that furthers his 1985 study on
international asset management, which established a pricing model for
emerging market securities.
The 1985 study, which has since become required
reading in many PhD programs, established empirically what has been one of
the long-running themes of Errunza's research: although EMs can be volatile
over the short term, they offer significant returns to patient investors.
Errunza's new project doesn't only take into account the traditional
barriers faced by EM investors, but also seeks to explain the risk posed by
fluctuating exchange rates.
The authority Errunza enjoys on the topic comes from
having been able to provide the financial community with reliable
statistics and models for understanding the potential of emerging market
economies. In the early 1980s, for example, he played a lead role in
developing the World Bank's first EM database.
The database has since been sold to Standard and Poor's,
and is an integral tool for fund managers.
By the 1990s, country funds and American depository
receipts (ADRs) had become popular, as investors looked to diversify their
portfolios with offerings from abroad. Globalization was kicking into high
gear, and the dapper management professor from Mumbai had played a quiet
but important role in opening up the world's markets. "A lot of people
that never used to invest in the market have since become stock market
investors," he says from his corner office in the Bronfman Building.
Of course, overturning investment orthodoxies doesn't
happen without a fight, and many have expressed fears that the rise of EMs
spells doom for North American jobs. But Errunza brushes aside such fears,
insisting that the Canadian economy needs the competition. "The fact
is we have to have innovation," he stresses. "If we don't have
innovation we're going to be relegated to a second-rate power status in
Errunza calls the concern over outsourcing
"bogus" because it fails to address the real issues that face our
economy, mainly its ability to adapt to new challenges. Indeed, what
Errunza credits for his own success mirrors in many ways the findings of
his research. "You have to challenge, if you don't challenge you won't
go very far," he says. "You must learn continuously, you must
innovate continuously and keep challenging."
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