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Executive Times |
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2008 Book Reviews |
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When
Markets Collide: Investment Strategies for the Age of Global Economic Change
by Mohamed El-Erian |
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Rating: |
**** |
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(Highly Recommended) |
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Click
on title or picture to buy from amazon.com |
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Transformations PIMCO’s
co-CEO and co-CIO Mohamed El-Erian’s new book, When
Markets Collide: Investment Strategies for the Age of Global Economic Change,
describes the structural changes transforming the world’s economies. Readers
can come to appreciate and understand the impact of these changes and
consider some ways to mitigate the merging risks of these transformations. There’s
great insight on these pages into the bewildering world of finance that has
been under great pressure. Here’s an excerpt, pp. 130-133: Phase 3. Liability and Asset Management This type of "liability
management" has two distinct advantages. First, the operations
extinguish debt in foreign currency that trades at higher yields than what
was earned on the investment of the reserves, thereby reducing the overall
negative carry. Second, it helps the country deal with what has been labeled
in the literature as "the original sin problem." Coined by Barry
Eichengreen of the University of California, Berkeley, and Ricardo Hausmann
of Harvard University,19 this concept refers to the inherent
financial instability of emerging economies that comes with the currency
mismatch that has often (although less so today) been associated with a
composition of debt issuance that has favored instruments denominated in
foreign currency. The tendency to issue foreign
currency debt reflects not only cost considerations but also a basic reality
of development: Initial risk factors are perceived to be so elevated in some
developing countries that there are few buyers out there willing to assume
the combination of risks that come bundled in local currency instruments,
including credit, liquidity, and currency components. Accordingly, countries
face both price and quantity constraints. As such, they are led to issue debt
denominated in "hard" currency (specifically, U.S. dollars, euros,
Japanese yen, and British pounds). The issuance of debt in foreign
currency provides access to a larger pool of potential investors. It also
results in most bonds being traded under U.K. or New York legal jurisdiction,
which is viewed as more predictable than local laws-although the experience
with Argentina's December 2001 default gives some cause to pause. 20 As countries start to run out
of debt to buy back, they also focus on "asset management." The
objective is to directly increase the returns on the holdings of reserves,
thereby again reducing the negative carry. This step is usually associated
with a change in mindset: As the reserve holdings increase beyond what is
deemed needed for precautionary balance-ofpayments purposes, the increment
is viewed as de facto constituting "national financial wealth." This phase is usually
associated with institutional changes. Most notably, some countries start
setting up sovereign wealth funds (SWFs). The seed capital for the SWF comes
from part of the reserve holdings at the central bank that are viewed to be
well in excess of what would be deemed necessary for prudential
balance-of-payments purposes. As these SWFs extend their footings, both the
media and the politicians pick up on their activities. As an illustration, consider
the recent spike in attention given to SWFs. You would think that the
phenomenon was totally new—which is not the case. And you would think that
the magnitudes are already gigantic, which they are not (currently amounting
to around 2 percent of global financial assets under management). Yet the
attention is such as to have SWFs included in the group of "the new
power brokers"—a term coined by McKinsey & Company in an October
2007 report describing the growing influence of "petrodollars, Asian central
banks, hedge funds and private equity." 21 Interestingly,
the focus of the newly wealthy economies goes beyond assets in the advanced economies.
There is also considerable interest in investing in other emerging economies.
For example, the SWFs of oil producers have also been exploring opportunities
in the Middle East and North Africa, India, Pakistan, and the Far East. As
noted in the previous paragraph, Chinese entities have also been pursuing
investments in Africa and Latin America, including the October 2007
announcement of a $5 billion investment by the ICBC (Industrial and
Commercial Bank of China) to acquire 20 percent ownership of South Africa's
Standard Bank. These three phases provide
close to a win-win situation for investors in emerging market assets.
Virtually any exposure there benefits from the reduction in country risk
(associated with the higher holdings of international reserves), the decline
in domestic real and nominal interest rates (assisted by the greater
availability of capital), and the possible appreciation in the exchange rate.
Moreover, the process opens up investment segments that were previously
inaccessible, providing investors with the ability to make even larger
returns through first-mover advantages. Finally, investors are able to
capture the investment premiums associated with the completion of markets and
the application of modern portfolio management techniques. These
considerations will be highlighted further in Chapter 6 when I discuss how
investors can benefit from this age of economic and financial change. Investors
in industrial countries also benefit. The deployment of SWF assets overseas
supports valuations in many market segments. And the willingness, indeed
necessity, for SWFs to operate in the context of a long-term investment
horizon gives them a value orientation when they invest in the more risky
segments in the financial system. This was clearly illustrated in the second
half of 2007 when several SWFs stepped in to provide capital to ailing
industrial country banks and brokerage companies—a phenomenon that attracted
significant attention and controversy, which I will address further below. Some
readers are likely to go over the 300 pages of When
Markets Collide more than once. Steve
Hopkins, November 20, 2008 |
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The recommendation rating for
this book appeared in the December 2008 issue of Executive Times URL for this review: http://www.hopkinsandcompany.com/Books/When Markets Collide.htm For Reprint Permission,
Contact: Hopkins & Company, LLC • E-mail: books@hopkinsandcompany.com |
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