Emerging market dilemma

While questions remain for China, Russia and India, emerging markets investor Mark Mobius's belief in the UAE is unshaken.

Companies operating in emerging markets, such as India, can expect to benefit from a projected growth in consumer spending.

Money-supply growth and derivatives are the potentially destructive elephants in the room for investors. But while questions remain for China, Russia and India, one leading analyst's belief in the UAE is unshaken. Emerging markets have historically been fickle bunch, with years of huge booms followed by equally devastating busts. Consequently, investing in places like Brazil, Russia, China and India has traditionally not been for the faint of heart - or the faint of wallet.

Between May and October of last year, the MSCI Emerging Markets index took a 64 per cent tumble, far more severe than the toll the financial crisis took on markets in developed countries. Despite the recent rollercoaster ride, however, Mark Mobius, perhaps the world's best-versed authority on these often-volatile markets, is buoyant about their future. "We expect for the coming year, 2010, the results will be very good," he said on a recent visit to Dubai. "For companies you will see higher earnings. Compare 2008 and 2009 to 2010, and the numbers will look very good, although the 2010 numbers will not be as good as they were in 2007. So we're pretty confident."

Mr Mobius pins his confidence on a number of factors, principal among them the growth in the amount of money sloshing around in the global economy. Central banks lowered interest rates to nearly zero in the wake of the financial crisis to encourage their banks to start lending again. That phenomenon that has led to a lot of new currency in circulation, and those freshly-minted dollars, pounds, rupees and yen need to find a destination.

"The growth of money supply has been quite astounding in the last year," says Mr Mobius, the executive chairman of Franklin Templeton, an American mutual fund firm with about US$33 billion (Dh121.2bn) under management. "In the US, money supply is growing at almost 20 per cent, in China it is more than 20 per cent, and this is being repeated in other parts of the world." While a bunch of extra cash floating around is good for emerging markets investors in the short term, he says, it could be detrimental in the long run.

With more money chasing the same amount of goods and services, prices could move upwards. If that were to happen, investors' inflation-adjusted returns - the only return figures that really matter - could be eroded That is why Mr Mobius calls money-supply growth one of the "elephants in the room". Elephants, he points out, "can be very gentle or they can be very destructive". Derivatives are another of Mr Mobius's elephants. These instruments, which allow investors to hedge away risk by betting on prices to go up, down or sideways, ultimately lead to increased risk-taking - a positive for risky emerging markets but a potentially destructive force in the long run.

Derivatives have been allowed to balloon virtually unchecked by regulators over the past two decades, and one of their more exotic incarnations - collateralised debt obligations backed by mortgage securities - helped touch off the subprime lending crisis in the US two years ago. "Derivatives got us into the subprime mess in the first place, but nothing is being done to curb the derivatives market, and it is now valued at in excess of $600 trillion," Mr Mobius says.

"That's 10 times more than the total GDP of the world." Within emerging markets, Mr Mobius expects companies that piggyback on the growth of consumer spending in China and India to do well in the coming years. He is also bullish about commodities, which he sees as becoming increasingly expensive to extract. Everything from gold to oil is likely to go up in price as emerging economies blossom and demand an ever larger slice of the commodities pie, he says.

"Per capita income is growing at a pretty fast pace in emerging markets in particular," he says. "If you look at a billion people in India, a billion people in China, you will need many of those people to have a higher per capita income to drive an incredible consumption boom." The UAE is an emerging market, but it is currently classed among a subgroup called "frontier" markets. Franklin Templeton manages a frontier markets fund with roughly $200 million under management, Mr Mobius said, and that fund has continued to invest in UAE stocks through the local markets' pronounced downslide earlier this year.

The market declines, he said, had produced attractive buying opportunities in the UAE and across the region. He was relatively unconcerned about Dubai's recent debt drama, begun last month when the Government-owned conglomerate Dubai World said it would seek a delay on debt payments until next May. Dubai World last week received a $10bn relief package from Abu Dhabi Government to handle its debts, including a $3.5bn Islamic bond that was paid off on December 15.

"We were buying during this crisis, because we felt that from a longer-range point of view there were good opportunities," Mr Mobius said. "I would say now is a good environment with prices coming down. And of course the negative views and the problems will not go away." Franklin Templeton's funds invested in finance and property companies both in Abu Dhabi and Dubai, Mr Mobius said. Those included Emaar, the developer of the Burj Dubai, which Mr Mobius praised for its "global diversification". The property giant has operations all over the globe, including in Saudi Arabia, Lebanon, Egypt, China and the UK.

Dubai's current debt problems were not its greatest challenges looking forward, Mr Mobius said, thanks a growing money supply and healthier appetite for risk among international investors. Those trends, he said, would make it easier for the emirate to handle an estimated $85bn debt burden. The bigger uncertainty, he said, was the possibility of protectionism and new restrictions on global trade in the wake of the financial crisis.

"That could lead to of course lower business for the ports, lower tourism, et cetera," he said. "So that's something I would worry about. For Dubai you need an open, a very free flow of goods and people. "The other thing I would say is a worry here is any backtracking on liberalisation. If there's any move to become more restrictive and more conservative, that would discourage investment." @Email:[e-mail]