Emerging Markets...

In last few years emerging markets investments proved to be extremely fruitful and everyone on the street wanted to be invested in the emerging markets..why not? Between 2003 and 2007 MSCI Emerging Market index annualized 48% in returns. However at the begining of 2008, when we were deciding our allocations to long short managers we had done a small study if emerging markets were gonna continue to do well or not? In hindsight not increasing our emerging market exposure seemed to be fruitful this year to date.

The study done was really simple..we analyzed the significance of the Emerging Market Index against the World Index. The ratio of price between the world index and the emerging market index touched a low of 0.2446 in 1998 after hitting a high of 0.92 in 1994. This ratio stood at 0.8 at the begining of the year and things weren't looking that good fundamentally (I will explain this in the fundamentals sections)

Also, when we looked at the Alpha generated by the emerging markets over the world index we found that this alpha was never significant in the long run. The 20 years weekly data gave an alpha of 0.016 and the standard error of alpha was 0.011 (0.016 +/- 0.011*1.96 would include 0). However during the period between 2003 and 2007 this alpha was actually significant and emerging market index did produce excess returns over world index.


Fundametals:



So when do emerging markets tend to perform better?

1. Commodity boom: Commodity boom explains the most significant factor contributing to the positive excess performance of the emerging markets. If we look at all the emerging markets; they have one thing in common..excess commodity .. may it be minerals, oil & gas, agro commodities or most importantly labour

2. Global Liquidity: Global liquidity is another major reason for the emerging markets to do well. Liquidity drives consumption which drives demand for emerging market commodities. Hence, now when the global liquidity is drying up we see dwindling growth rates for the emerging markets.


At the begining of 2008 both of these factors seemed to had ran out of steam, however we did see a final frenzy rally for commodities till the middle of 2008. The ratio of emerging market index to the world index now stands at 0.60; a decline of 20% YTD. Emerging Market Index has declined 52% YTD against a decline of 37% for the world index. I believe this ratio will fall further; emerging markets would underperform the developed markets for some time to come. I wont be surprised if we see this ratio going down to 0.40 in the coming months. Long term mean of the ratio is at 0.48 with std dev of 0.16 and I am sure we are going to see one std.dev move on the downside. We shall all wait for the global liquidity to come back with a bang for emerging markets to do well in future.


(P.S. World Index does include a proportion of Emerging Market Index in its composition)

The big slide ...

For past few days, as every other analyst on the financial street, I am trying to figure out when this turmoil going to come to end .. or whether there is some steam left in the sell off's we have witnessed globally ..

Incidentally I pulled up the charts of S&P and Dow Jones since 1990 and tried to figure if one could draw any conclusions from these weekly charts ... .

So here's the chart for S&P 500. It has seen two major falls in the past 18 years ... one was when the S&P peaked in 1998 and we had the russian bond crisis and the crisis of asian currency. The fall had lasted for nearly 4 years ... obviously this peiod had 9/11 happening as well dampening the spirits in the market. Interestingly look at the recent fall on the extreme right you may see the the velocity of the fall has been far more striking .. in just one year (from July 2007 to Sept 2008) we have had a fall similar to 4 years during 1998 to 2002. S&P is now approaching a very important support level of 800 ... if this support gets taken out ... the double top suggest that we may fall another 700 points...

Similiar is the story for the dow jones index as . The index had a trend upwards since the begining of Dec 1993 till 1998 and then a consolidation during 1998 to 2002. A strong trend again from 2003 to 2007 before finally reversing in July of last year. I fear based on the chart that INDU may go down to 7300 levels and may be there's a big support waiting for us then ..
These two charts indicate that we are very close to important supports and if we break these ... may be thats gonna be the end of the finance world!!

Doom strikes ...

Last few days in office have not been less than sheer disaster and this day, 13th October 2008, I see one of the hedge funds being the scapegoted purely because of whats going on in the financial markets world-wide.

This incidentally is (was) the first fund (and only till date) that I created by myself. Right from deciding on the capital allocation to checking the custody agreements and blah blah was done by me when we had launched this fund in August 2007. Wasn't perfect timing; however, everything we could do to protect our capital was done....infact the fund outperforms its benchmark by more than 10% YTD.

Sometimes I wonder what financial sense is? .. is to redeem out of relatively better performing positions or is it staying away from the bad one's. Incidentally whats been happening off late is that investors are selling good positions to fund some of the bad one's. How is that logical... when the market is at peak every one wants to be a part of it and when it turns bad everyone wants to leave ... bizzaaare isn't it ... however that behavioral finance. It feels disgusting to the fund manager though when peer's lose more than you do and you are bashed because you were better than the rest .... I am always gonna keep this email from my boss which said that investors are redeeming all their money from our fund and we have to close it down.... and most f*$%king thing of all we had to prepare the proposal ourselves.

Sometimes when you get up in the morning you feel there is something not right .. this has clearly been a bad day ... right from 9AM (when I saw this mail) the mood's just been terrible ...

Just as I write this blog ..my boss walked into my office ... and I said ... 'what a dis-appointing day ... we are left with only one fund ... I fail my driving license final test ...' and my boss told me strikingly ...'atleast you have a job' (pun intended)