COMMENT: Vertical vs horizontal diversity in EM portfolio diversification

By bne IntelliNews August 12, 2008

Daniel Demytrie of Jones Lang LaSalle, Singapore -

Almost half the world's population live in China and India. Business magazines and newspapers love writing about the various "tigers" and "dragons," which have been fashionable in the financial world for a couple of years now. But the hype distracts from the more important question of whether there is now a trend toward favouring bigger, deeper markets elsewhere in the world.

In Central and Eastern Europe, there are some similarities between late EU entrants such as Poland, Hungary and the Czech Republic to the Asian and sub-Continental markets, but as they mature they have ceased to sizzle, thanks to greater transparency and falling risks. These markets have stabilized, they're more liquid, more familiar, and investment yields are about as low as some Western European markets. While a stable, low risk environment is often top of the list for institutional investors, we shouldn't forget just how important diversity is.

A mellowing eastern frontier has meant that, increasingly, investors' interests are being drawn to Russia - to be more specific, Russia's regional markets: an incomplete list of which includes places like Novosibirsk, Samara, Rostov and Chelyabinsk. It's still some time away before we're closing $500m investment deals in places like Tver, but we might be witnessing a trend of "market re-discovery" and a shift to multi-layered, "super markets" like China, India and Russia.

RIC with a silent 'B'

Few regions in the world offer similar scenarios to what we see in Russia, India and China. A very striking feature, at least in terms of commercial real estate investment, doesn't conveniently fit into an economic model alongside, as the most unique and exciting feature of markets like these is their depth, scale and internal consistency - points we can call the basic tenets of a "super market."

Investors, whether they are highly risk-averse listed funds or private and opportunistic, generally regard a well-diversified portfolio as a high priority. This isn't just because this works to mitigate the risk factors frequently found in emerging markets; but largely because a variety of markets presents new options and investment alternatives. This, of course, isn't anything new, and largely has accounted for the geographic expansionism that real estate investment has undertaken across CEE, Southeast Asia and Latin America over the last 15 years. This informal yet effective strategy of "a little bit here, a little bit there" continues to be a dominant means of capturing global real estate opportunities and remaining diversified. This brand of portfolio management, however, comes with hefty price tag. Managing a portfolio of real estate assets across four or five (or more) markets within a geographic region can be exceedingly difficult. The level of local knowledge and experience needed to ensure that your options work out in each of the markets is not easy to come by.

Markets like China, India and Russia however, have a comparative advantage over many other markets - and we can call that advantage their "super market" status. This is to say, that because these countries are so large and possess a seemingly endless network of smaller fledgling markets reflecting a broad range of market maturity levels, they remain predominantly similar in terms of due diligence and risk concerns.

While this probably won't lead to some kind of renaissance or rediscovery of regional markets, it does suggest that many investors are likely to stay put for a second round of harvesting investment opportunities - going "deeper" as opposed to going "further" (abroad). A tactic like this not only exposes investors to new opportunities, it also sheds many of the concerns and deterrents of entering new markets, like having to learn the ropes, again.

Many readers have heard phrases like "secondary" and "tertiary markets," or "tier II" and "tier III" cities by now. It seems that this is now becoming a preferred method of categorising the fledgling markets found in our super markets. So what does this mean for contemporary expansionism, portfolio management, and asset diversification? As emerging economies try to flatten out their evolutionary differences between regional markets, investors are poised with the question of how to make the most with the time they have left. Markets like France, the UK, the US are also considered large-scale and rich with opportunities, but for an opportunistic, value-added point of view, they don't have the same differential from investment grade, core assets in increasingly liquid markets (for example Delhi, Shanghai and Moscow), to highly opportunistic, largely undiscovered, private equity driven markets like Chengdu, Chennai and Chelyabinsk!

Over the long term, these markets will flatten out just as others have and we will likely see the "Moscow-Minsk differential" shrink to almost nothing. But before then, one would expect these three regional giants to remain in the headlines.

Daniel Demytrie is Associate Director, Asia Capital Markets at Jones Lang LaSalle, Singapore and was formerly Head of Capital Markets Research, Jones Lang LaSalle, Moscow

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