Many of our clients have asked us why we don’t invest in emerging markets, and we always tell them the same thing. The world is a big place, and not everybody plays by the same rules that we do. It is hard enough to analyze an industry and a specific company within that industry. Pile on risks having to do with political stability, the rule of law and shareholders’ rights and some countries just are too scary for us. Recent events having to do with Sino-Forest Corporation bring this subject to mind, but there are many other examples of Canadian companies that have come to grief in far off lands.
Crystallex International Corporation, a Canadian gold miner, spent hundreds of millions of dollars developing a promising gold mine in Venezuela. Canadian investors were excited, and even before the price of gold rose, the shares were bid up to $7 from under a dollar. Sadly for the shareholders the mine was expropriated by the left wing government of Hugo Chavez. The company is now seeking relief in the international courts, but in the meantime the stock has gone from over $7 to its current price of $.10. Short of a regime change, shareholders are out of luck.
Hurricane Hydrocarbons, a Canadian listed oil and gas explorer, saw great potential in the break-up of the Soviet Union and directed all of its activities towards Kazakhstan. While there is indeed abundant oil and gas in that country, the politics proved to be as volatile as the petrochemicals the company produced. The official company history describes the situation very well: “Although the potential rewards were large, the intricacies of conducting business in nascent Kazakhstan were foreboding, promising to be fraught with bureaucratic difficulties and a host of other unpredictable problems. Relations with the government deteriorated, sparking acrimony that led to what the Oil Daily, in a December 19, 2000 article, referred to as “scenes of almost total farce.” After a short sharp climb to prominence, the company was forced into receivership in 1999 and shareholders were wiped out. (A later reincarnation of the company was subsequently taken over, and that group of shareholders did well).
Sino-Forest appears to have timber farming and cutting rights over large tracts of land in China. The company, according to its records, has a stellar record of growing production, revenues and profits. However, a short-seller in the United States has called all of the company claims into question, noting that management has refused to produce any documents proving that it does in fact have the land rights it claims, and questioning the quality of the financial reporting. The stock is down about 70% from its high for the year. Whether or not the short-seller’s claims are true will be determined in time but the cloudy state of property rights in China, the difficulty in confirming the company’s activities there and the lack of recourse for shareholders in the event of a real problem were all reasons leading to the quick stampede towards the exit.
It is likely that the fastest growing areas of the world in the next couple of decades will be in Asia, South America and Africa. There is no doubt that important companies will arise and that some shareholders who have invested in these companies will do very well. There will also, however, be any number of disasters on the order of Crystallex and Hurricane Hydrocarbons. As conservative investors, always focused on the preservation of capital, how should we act to optimize our clients’ investments?
We have taken the view that the best way for our clients to participate in these high growth areas is to invest in companies rooted in the developed world, which sell to or have some activities in the rapidly developing emerging markets. Potash Corporation, for example, produces fertilizer in Saskatchewan which is purchased by farmers around the world. It benefits from the intensification of agriculture in the developing world without any of the risks of operating there. Teck Resources produces metallurgical coal which is used to make steel in China, Japan and South Korea. Bombardier makes airplanes and trains which are increasingly in demand to serve the rapidly expanding travel markets in Asia. Kraft Foods has hundreds of consumer products on sale in almost every country in the world, yet operates under the umbrella of American law.
A recent study showed that of all the sales of the five hundred largest companies listed on the US stock markets (the S&P 500) fully 35% is derived from outside the U.S. The comparable number for the TSX 300 is 45%. By investing in North American companies with an international perspective we can gain exposure to quickly growing foreign markets without taking many of the risks of direct investment. In short, the best of both worlds.