Wealth gaps lead investors to rethink risk in emerging markets
LONDON - Middle-class anger at not seeing enough of the fruits of economic growth is growing in developing economies, and that anger is forcing the world's biggest investors to rethink how they rank emerging markets.
Political risk has always been a fact of life for investors focused on the developing world, but many money managers are now assessing which countries have institutions and governments robust enough to stop the kind of anger boiling over into the chaos seen after the Arab Spring uprisings.
The emergence of what one investor called 'the Facebook Middle Class' - aspirational but frustrated as elites soak up the gains from economic growth - is creating a potentially explosive environment in key economies such as Brazil and China, they say.
"This middle class is waking up to the fact that the government does not offer you the schools, the roads, healthcare system, the housing that the middle class around the world gets," said Jorge Mariscal, UBS Wealth Management's chief investment officer of emerging markets. "It is this phenomenon that is creating enormous amounts of resentment."
The insurance market is showing clear signs that companies with international operations are becoming more and more anxious about social discontent in particular.
Insurers are seeing a spike in demand from companies looking for policies to cover "soft" political risks - such as heavy handed policy responses to civil disorder that damage business prospects - as opposed to hard political risks like war, said Andrew van den Born, the executive director in the political and trade credit risk practice at insurance broker Willis.
"We're seeing growth in soft risks - income disparity, poverty, food prices," van den Born. "There's been an upward trajectory in demand for this product since the Arab Spring."
Credit insurer Coface, which covers companies against default by their clients, has placed its ratings of Turkey and Venezuela on 'negative watch' reflecting "political fragility". Both have seen civil unrest.
Global managers of stocks and bonds are also growing more aware of the roots and results of such social tension. They see the extent to which it depresses economic growth over time and undercuts long-term returns.
Some of them are increasingly looking at which governments are capable of reforming fast enough to defuse political tensions. Among them is Andrew Milligan, head of strategy at Standard Life Investments (SLI), the Edinburgh-based asset manager.
He reckons Mexican bonds remain highly investable. But SLI has a 'zero weight' on credit from Brazil, the scene of street protests, where the results of an upcoming election are difficult to call.
"Political unrest is another reason for us to be cautious... These issues often lead to outflows, or insufficient inflows. They often are associated with currency problems and that's not very helpful," he said.
Rapid growth in the developing world has drawn millions out of poverty and created a new middle class, but inequality has simultaneously increased in countries such as China and India, the Organisation for Economic Cooperation and Development said in a report published earlier in July.
The resulting social tensions threaten to "hamper growth and lead to instability," the OECD said.
Carl Dahlman, the head of global research at the OECD's Development Centre, warns the rising tensions endanger the flow of foreign investment, jeopardising economic growth further still.
"When (investors) begin to see social tensions rising you do see a fallback in investment ... There's a lot of animal spirit in these things," he told Reuters.
Investors also note that qualitative factors such as institutional or government stability must be taken into account. Quantitative measures of inequality are not enough in isolation.
The most closely watched measure of equality used by economists - the Gini Coefficient used by bodies such as the World Bank and OECD - show income inequality is wider in Nigeria than in France, for example. But it also shows Belarus and Japan have among the most even distributions of income in the world, although they offer very different investment prospects.
"It is a part of the mosaic, certainly... But there are a lot of factors at play here," said Morgan Harting, portfolio manager for emerging markets at AllianceBernstein.
The world's biggest asset manager, Blackrock, produces a Sovereign Credit Risk Index for investors, 30 percent of which is made up of the category 'willingness to pay' - an assessment of a government's effectiveness and stability - alongside conventional quantitative measures.
Alastair Newton, a senior political analyst at Nomura, identifies civil unrest seen over the past year in a long list of countries, including Brazil, Chile, Egypt, Thailand and Turkey as "a quasi-systemic threat," and places it high on a list of "issues which keep me awake at night."
"You know that something bad could happen in any number of countries, but you don't know what and you don't know when," he told Reuters. "And even if you did, you'd probably struggle to price it in."
Not all investors are so gloomy Some argue that this middle class agitation in Turkey, Brazil or Chile should be seen as growing pains associated with a process that is overwhelmingly positive.
Masha Gordon, London-based Head of Emerging Market Equities at PIMCO, argues investors should also be heartened by events in India, where the election in May of a reform-minded government, has shows the new middle classes can spur change for the better.
"This should give hope. Places stuck in a middle-income transition need to do structural, difficult reforms ... The externality of a so-called demographic dividend is a generation that is looking to vote out policy makers who failed to deliver the benefits from economic expansion."
May's election result has driven sharp rises in Indian asset prices. Mumbai's benchmark BSE equities index reached record highs this month, after rising more than 15 percent since the election.
The resentment that UBS Wealth Management's Mariscal saw also represents an opportunity, he said - an opportunity to invest in the infrastructure projects, hospitals and healthcare facilities protesters are demanding.
"It's an interesting theme for us ... a medium-term investment theme that needs to be explored," he said.