Kyoto. Think of Katsushika Hokusai’s famous woodcut of a gigantic curling wave made not of water - but of money - and poised in that split second before it gives way to gravity and pounds the decks of three fishing boats. The image serves as an apt metaphor for the ‘wall of money’ and tsunami predictions being cast about these days in the debate about the sustainability of emerging markets globally.

So it seemed natural that a panel of international headliners would turn their focus to the implications of this wall of money with tsunami effects for emerging markets in Asia. The panel was convened in May as an institutional investors’ roundtable, the featured segment in the Asian Development Bank’s 40th anniversary meeting, held in Japan’s cultural heartland. The roundtable was organised by the Pacific Pension Institute jointly with the ADB’s Private Sector Operations Department, directed by Robert Bestani.

The question that is central to the global debate - to which no one can claim, at least convincingly, to have the answer - held true for the roundtable participants as well: What factors might temper the force of the wave before it crashes on the beach - or will the wall of money continue to build until, forced downward by gravity’s pull, it smashes everything in its path?

Additionally, these panellists wondered about the effect of record capital inflows on Asia’s traditional bank-centric cultures and longstanding practices around capital intermediation; the emergence of a bond or debt market in Asia; the ability of domestic exchanges to align the pace of reforms with demand for capital as well as access; and the reliable assessment of political/country as well as economic/financial risk.

Diana Farrell, director of McKinsey’s Global Institute, set the stage with a penetrating presentation on the scope of - and activity within global capital markets. Think in terms of a pie chart: total world equity market capitalisation is $43.5trn (€32bn); total private debt securities equal $35.4trn; global trade flows are $12trn; Asian central bank reserves total $3.1trn; and private equity assets under management equal $500bn.

If the Chinese government, for example, signals that it wants to recycle $3bn of its reserves away from US Treasury bonds and into the heart of a private equity firm in the world’s most sophisticated capital market, then that single activity has significant ripple potential. In other words, the wall of money can continue to change velocity by taking on new instruments, a new direction in capital flows as well as new risks.

There are many unique aspects about the
Chinese government’s first-time investment of reserves in a commercial transaction, including the fact that Beijing now wants to join the pantheon of those seeking greater return on investment despite a higher degree of risk.

North American and European institutional investors, including pension funds, also want higher returns. In recent years, they have shown a willingness to look beyond the potential for volatility and to act on the basis of what they perceive as underlying growth in emerging markets, particularly in Asia. Indeed, Asia’s emerging markets have demonstrated marked improvement in their fiscal and monetary positions over the past decade.

According to Emerging Portfolio Fund Research and Bloomberg.com, fund managers are contributing to more than a doubling of invested assets in dedicated emerging market funds globally. As of June 2006, assets invested by institutional fund managers totalled $357.7bn, up from $146bn at the start of 2004. ABP has doubled its allocation to emerging markets and has recently opened an office in Hong Kong to be closer to the Asia market.

CalPERS, the world’s third largest fund, recently authorised a $500m allocation to corporate governance funds investing in emerging markets. At the end of May 2006, the California-based public fund had $4.54bn in emerging market equities - up from $3.6bn at the start of 2005.

The other side of the coin is that the addition of large chunks of institutional money is contributing to a higher price of assets. This poses a distinct vulnerability, particularly in the event of an unravelling triggered by an adverse macro-economic event like a global health scare or a destabilising terrorist attack.

In other words, the pressure remains on, even with a modest decline in overall emerging market investment forecast for 2007. The Institute for International Finance expects investment into emerging markets to drop from $502bn in 2006 to $468bn this year.

Deep-pocketed investors will continue to apply pressure to deepen and broaden the markets and in the process, improve sustainability. In addition to institutional investors, there are financiers from oil-producing regions, hedge funds, and private and public equity investors, all of whom are seeking returns, minimal risk and the ability to walk away if policy demands or unregulated practices don’t translate into satisfactory rates of return.

Ta-Lin Hsu, roundtable panellist and chairman of H&Q Asia Pacific, noted for the audience in Kyoto the range of positive outcomes as a result of foreign private investment into emerging markets. Private equity creates jobs and opportunities, encourages innovation and repatriation of talent and builds linkages between the emerging market and rest of the world, Hsu said.

Additionally, private equity inflows contribute to the general upgrading of economies in emerging markets which in turn, can have a spillover effect for neighboring or regional emerging economies.

Mark Mobius, another panellist and managing director of Templeton Asset Management, addressed the issue of volatility as an aspect of emerging markets that has to be addressed via an emphasis on asset allocation. China or India may be the flavour of the day but that can change. (Note that Asia accounts for more than half of MSCI Emerging Markets Index while Latin America, which includes two of the 10 largest economies in the world, accounts for only one-fifth.)

Just prior to the Kyoto Roundtable, it was reported that Templeton was about to cash out of its first private equity emerging markets fund, which had invested in listed and unlisted emerging market companies with a focus on China, India and the former Soviet Union. The firm reported that targets were achieved and that 2.2 times its initial capital commitment was to be disbursed.

 

Emerging markets around the world have seen the best and worst of times in the past 15 years. Starting with the Mexico crisis in 1994 and the Asian financial crisis of 1997-98, followed by the Russian calamity and its contagion to Brazil, emerging markets endured a series of crises. There has been no major turmoil since 2002 and indeed, much success in the past three or so years. The chief economics commentator of the Financial Times, Martin Wolf, offered the concluding word to the wide-ranging discussion in Kyoto. The global economy expanded 5.4% last year, he noted. The world’s advanced economies grew by 3.1% while the emerging economies pegged an astonishing 7.9% growth.

When times are good, no one wants to think about shocks. Wolf then listed the market shocks in his adult lifetime: the oil crisis of the 1970s; inflation in the US in the 1980s; the Mexican crises of 1982 and 1994-95, the stock market crash of 1987, the Asian and Russian debacles of 1997 and 1998 and of course, 11 September 2001.

These were the “ignored unknowns” that when they hit, were like the proverbial tsunami.

Marsha Vande Berg is chief executive of the Pacific Pension Institute, an educational non-profit whose members include H&Q Asia Pacific and the Asian Development Bank