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OPINION

The Carlsberg way

The Carlsberg way
November 27, 2014
The Carlsberg way

Why the Carlsberg way? Because in mid-October, as I breezed into Sihanoukville, Cambodia's only deepwater port, the shiniest thing in an otherwise scruffy city was the brewery. It was the one piece of real estate that would not have looked out of place in Manchester or Melbourne and it is a joint venture between Cambrew and Denmark's Carlsberg (COP:CARL B).

This nicely illustrates the extent to which some truly global companies are making an impact in emerging markets. The names that crop up most are fast-moving consumer goods producers that have a 'repeatable model' - an easy-to-understand operation that can be replicated in one market after another, with just a few tweaks to products and distribution, while retaining the simplicity and focus that made it successful in the first place. Easier said than done, but clearly the world's best drinks companies are good at this, as are the likes of Nestlé (SIX:NESN), Procter & Gamble (NYSE:PG) and Unilever (ULVR).

Obviously, there are other ways of getting exposure to emerging markets. Exchange traded funds (ETFs) are cheap and usually simple. Actively managed funds are neither as cheap nor as simple and often end up holding a bunch of assets that, before costs, follow the market anyway; yet, like ETFs, they offer diversity and convenience. But putting capital directly into the sort of companies just mentioned sidesteps the governance issues that are a hazard of investing in markets where regulations can be honoured more in theory than in practice.

There is another important factor that favours consumer companies, but we'll reach that in a moment. Meanwhile, it's still necessary to ask: to what extent should we be investing in developing markets in the first place? This familiar question got a new twist in last week's magazine when Chris Dillow showed that, from the perspective of investment returns, "miners and emerging markets are, for practical purposes, pretty much the same asset".

This prompts some questions: why should it be? What does it tell us about investors' perceptions of both mining shares and emerging markets? And which way does causality run? Do investors cut the value of mining shares when they perceive that the world's great manufacturing workshops in China and south-east Asia are slowing and that, therefore, demand for commodities will soften? Alternatively, do they assume that emerging markets rely heavily on strong commodities prices for their growth and therefore mark down the value of emerging markets when they see global demand for commodities slipping?

Both questions are valid, but neither gets to the truth and that's because different emerging economies march to the beat of different drums. What favours raw materials exporters, such as Brazil and Russia, has a different effect on raw materials users, such as China and India. Yet the divide between exporters and users is fuzzy. Brazil is a major exporter of iron ore, soya and coffee, but it still runs up a $78bn (£49bn) current-account deficit (an amount exceeded only by the UK and the US). Meanwhile, Russia runs a $75bn surplus. Similarly, it's awkward to lump China and India under the same heading. China runs the world's second biggest current-account surplus (at $183bn, it is smaller than Germany's), but India's deficit - at $75bn - is barely lower than Brazil's.

This indicates that, whatever the current correlation of their returns, emerging markets and mining shares aren't the same asset. More important, it also means that all 'emerging markets' can't be lumped into a single asset. That also tells us it's sensible to be fussy about which emerging markets to be exposed to.

For example, over the long haul, or even the short one, I would not want capital tied up in Russian assets. How Russia ever got the moniker 'emerging market' is a bit of a mystery. Emerging from one sort of autocracy to be replaced by another, true; as for emerging economically, only the strength of the oil price fostered that illusion temporarily. Increasingly, something similar might be said of Brazil, which shows signs of slipping back into bad old ways.

Granted, with peace and stability even those countries will become wealthier. But, given that assumption, China and India still look better bets. And not just any old bits of China's and India's economies. This is where we return to the importance of consumer companies because it will be the consumers - the burgeoning middle classes of those countries - who will drive growth. This will be true even of India's much less developed economy. For UK investors, the challenge will be to get exposure to this trend without being sucked into the quite possibly lousy investment returns of the state-controlled champions whose shares clog up emerging country stock markets.

In a small way, I have steered the Bearbull Global Portfolio in this direction via investments in two ETFs - iShares MSCI Emerging Markets SmallCap UCITS ETF (SEMS) and Lyxor UCITS ETF CSI 300 A-share C-USD £ (CSIL), which tracks an index that has higher-than-average exposure to consumer sectors. These efforts may be inadequate, although they may be the best I can manage within the global portfolio's terms. However, it might still be good to put together a portfolio of western companies that tackle the developing world the 'Carlsberg way'.