Emerging Markets in an Upside Down World: Challenging Perceptions in Asset Allocation and Investment

Chapter 7

The Structure of Investment

We have discussed limitations to our understanding of economics and finance, and some of the distortions in how we look at the world. Our current view of the world is out of date and far too static. It would be peculiar if this did not also affect how we invest, and indeed it does. To a large extent, economic theory is not useful in informing investment except for the principle of diversification. Much of the theory we do use does not stand critical scrutiny. Our view of the world has not kept up with the rapid pace of change, and in particular the new prominence of emerging markets.

This chapter looks at how the structure of an investor base impacts market dynamics. This is a topic largely ignored to date both in the literature and in practice but of huge importance for our understanding of markets once we can wean ourselves from fictitious models of how markets should work in theory. By ‘structure’ we mean the populations of different types of investors holding or potentially holding an asset or class of asset. Investor populations may be differentiated by their geographic base, institutional form (private investor, pension fund, central bank, etc.), regulatory framework affecting their objectives and incentives, liabilities and decision processes. Of particular interest is their likely behaviour in future scenarios. We introduce a description of market segmentation and other observations with regard to incentives to describe how investor ...