Until very recently, Asia Pacific stock markets had been the beneficiaries of vast capital inflows, leading to multi-year gains in every market across the region, from Korea to Sydney, Mumbai to Beijing. All of this seems to have come to a dramatic halt with the recent market corrections. So in response to the growing chorus of questions concerning the present condition and future potential of emerging markets in Asia, I thought I would respond by providing some thoughts on where we are, and where we may be headed.
Google refers to an emerging market as a “term used to refer to markets in newly industrialized or developing countries with capital markets at early stages of institutional development.” A search of ‘emerging market funds’ launched since 2005 overwhelmingly highlights India, China, Korea, Taiwan and Thailand as major constituents of such funds, along with smaller allocations to Eastern Europe and Latin America thrown in for good measure. Now, let us consider the establishment dates of the stock markets of India (1875), China (1995), Korea (1956), Taiwan (1962) and Thailand (1975), the constituent markets of model emerging market funds around the world. I’ll throw in the little known fact that the Bombay Stock Exchange is also the world’s largest exchange representing, over 4,800 listed companies.
The first point that should be made as we consider the present condition of emerging markets in Asia is the fact that almost all the markets considered ‘emerging’ have, in fact, been around for a long time so they certainly cannot claim to be newcomers to the stock market game. From an investment standpoint ‘emerging market funds’ are marketed with the understanding that while economic gains may exceed those of more developed markets, the real known-unknown (in Rumsfeld speak) is the regulatory environment that surrounds these markets that can, and do, alter policies overnight with significant impact on retail and institutional investors within their respective markets.
Are the rewards of such investments worthwhile? If I was to leave the traditional emerging markets of Asia and deviate towards what can truly be described as an emerging market in Asia, I would be brought to the steps of the Ho Chi Minh Stock Exchange, Vietnam which commenced trading in the year 2000. In recent years, the Ho Chi Minh Stock Exchange has been one of the true frontier markets in Asia where returns over a four year period exceeded 240% and foreign institutional investors flocked to the market despite draconian foreign ownership regulations. Daily the market spiralled upwards to record highs. Today the realities are much different, however most market commentators still consider Vietnam a truly emerging market and, henceforward, the record books have plenty of revisions left.
With the risk and reward metrics of emerging markets remaining similar to the way they were in 1875, there remains plenty of interest from global and regional players in the development of investment strategies to enhance returns when, and where, they appear. Today, these investment strategies include interaction with global custodians, investment managers, and regulators in an effort to leverage expertise whilst also remaining aware of market constraints - the emergence of a true strategic partnership between all parties for the benefit of the market.
I will return to my example of the Ho Chi Minh Stock Exchange where traditional investment funds compete with private equity players and alternative funds to secure footholds in pre-IPO companies. This pushes into overdrive the expectations of custodians servicing these institutions. No longer are custodians being asked to simply hold listed assets - they have become participants in innovative processes to support their clients to secure IPO holdings, transfer cash, and report on positions well before they are market eligible. Global market players have no intention of waiting for traditional firms to make their way to the IPO table and have created a dynamic IPO process that pushed the total number of listed firms on the exchange from 2 in 2000 to in excess of 220 in 2008.
The wall of investible cash looking for suitable investments globally has become so large that financial institutions are considering any and all options to gain market entry into emerging markets. The emergence of structured instruments and alternative markets, overlaid with technology, may begin to usurp some of the powers of traditional stock exchanges in Asia as investors attempt to participate in these markets without the currency or regulatory constraints they currently face. Custodian banks will certainly play an important role in these new models, following what the eminent management thinker C.K. Prahalad calls ‘co-creation’ whereby the creation of new products, services and solutions are executed in tandem with their customers. Custodian banks in Asia have already been working with the ‘co-creation’ model to ensure that we remain strategically aligned with our clients, and have begin to push the boundaries of traditional custodial thinking.
The real impact will be with the regulators who may very quickly find themselves less important in their own constituent markets, and therein lies the emerging market conundrum - will they follow the time tested pattern of reacting sharply with the introduction of capital controls, draconian foreign investor limits, or mandatory holding periods for stocks? This was the model undertaken by Malaysia during the Asian Crisis and the market has never fully recovered. Or will they embrace a model of ‘co-creation’ and work with the industry to create the opportunities that every country and market deserves? The next round of growth in Asia will be the most exciting yet, I can assure you.
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