Shareholder Activism Drivers in Emerging Markets

The Shareholder Activist - Shareholder Activism Drivers in Emerging MarketsMorality should always be a core component of your investing portfolio, and not only for the sake of integrity.

It makes good business sense. This is especially the case when investing in companies that operate in emerging markets. Emerging markets—nations or regions experiencing rapid growth and industrialization—are more susceptible to porous corporate governance than more established markets.

In an emerging market, ethical and moral standards are often pushed aside to make way for short-term growth and stability. Yet such dysfunction actually breeds long-term instability.

Therefore, the principles of responsible shareholder activism are even more essential when investing in emerging markets.

Emerging markets create the opportunity to do it right from inception, which is rarely the case in terms of corporate governance. Greed and corruption, combined with ineptitude and inexperience, make for quite the toxic brew when it comes to nation-building.

Immediately, sustainability and responsibility are key factors. It’s almost as if emerging markets are creating their own financial constitution in utero. During these periods, it’s crucial that shareholders assume a vigilant posture because their portfolios are invested in markets (and countries) struggling to define themselves and their standards.

Consider the context. Developing nations are faced with severe capital inflow issues, legal conflicts, environmental problems, government control manias, and a myriad of cultural and other internal issues.

A white paper written in 2011 for the Oikos Foundation for Economy and Ecology, founded in Switzerland in 1990, addresses the determinants of shareholder activism in emerging markets. In these markets, sustainability is the goal. However, first things first: Viability. Life itself!

Sustainability is a sophisticated luxury reserved for NYSE listed companies. In emerging markets, there must be “proof of life.” Investors must have confidence that their monies are reasonably secure.

Emerging market economies constitute more than 80% of the global population, but represent about 20% of the world’s economies, and 75% of the world’s land mass and resources.

According to Blackrock, they are indeed an established asset class (“The Growing Importance of Emerging Markets,” Blackrock, March 2010). It’s a kind of reverse paradoxical Pareto Principle. In Pareto’s time, 80% of the land in Italy was owned by 20% of the populace. These economies are investment targets for wealthier, industrialized societies.

There is no denying there is short-term profitability to be had. Generally, emerging markets are in the process of rapid growth and industrialization which create rich opportunities for outside investors.

But as an investor (socially responsible or otherwise), you need to grasp how those profits are generated. For instance, is it through responsible investments in infrastructure and sound business development practices? Or is a company more competitive because its labor costs are artificially through exploitive employment and abusive practices?

For the latter, when it’s good, it’s really good, and when it’s not it’s not. The swings are more rapid than a bipolar episode. When corruption reigns, rapid boom-bust cycles are the norm. In emerging economies, there is so much room for improvement that good ideas and new businesses can surge like commodities prices.

Lacking a moral compass, these characteristics can manipulate the human psyche with abandon creating hope and euphoria. But fear and depression can be just around the corner. Investors get excited, and then they crash based on the actual data. The emotional roller coaster of irresponsible investing in emerging markets can be wild and unpredictable; the returns can soar or dissipate seemingly from moment to moment.

Emotionally, investors can become disoriented, angry, bewildered, panicky, and sell at the bottom after they’ve had many opportunities to get out.

Overseas investors who espouse to be socially responsible must be aware of the fact that many emerging market political regimes are volatile, potentially corrupt, morally tenuous, and unstable. Profits can be extraordinary in these situations but simultaneously smack of “blood money.” Russia, Brazil, India and China are economic powerhouses fraught with myriad dysfunction across basic human rights dimensions.

Most investors I treat are quite concerned with control and predictability within reasonable parameters. Emerging markets have a “Wild West” flavor.

Even in America we can certainly understand the emotional power of this phenomenon. We became an equity culture slowly but surely after “our West” was won.

Take the profit blinders off. Socially responsible investing in emerging markets just makes good business sense.

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