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

Introduction

‘Our comforting conviction that the world makes sense rests on a secure foundation: our almost unlimited ability to ignore our ignorance.’

Kahneman (2011, p. 201)

The world is upside down: the emerging market countries are more important than many investors realise. They have been catching up with the West over the past few decades. Greater market freedom has spread since the end of the Cold War, and with it institutional changes which have further assisted emerging economies in becoming more productive, flexible and resilient. The Western financial crisis which began in 2008 has quickened the pace of the relative rise of emerging markets – their relative economic power, and with it political power, but also their financial power as savers, investors and creditors.

The 2008 crisis also revealed intellectual failures in the way we think about the world: in economics, in finance theory and in the practice of investing. We have known about many of these problems for a while, but the 2008 crisis has exposed them more widely and has given impetus to finding alternatives. This book aims to make a contribution to that search.

The credit crunch and then deleveraging are fundamentally due to excess leverage (borrowing) in developed countries. This excess leverage was built up precisely because risk perceptions were artificially low, in part due to emerging market savings being built up excessively by central banks after the Asian crisis of 1997/8 and then invested in the US, ...