Concentration in Emerging Markets

Market concentration tends to distort the efficiency of markets, which negates the accuracy of analytic tools. To successfully invest in these markets requires different tools to understand the different rules

Last week I read an article about the IMF’s (International Monetary Fund) latest forecast. Confirming my most recent suspicions, the IMF was forecasting that China’s economic growth in 2012 would slow to 8.25% from the 9% projected in September. Although in most countries a growth rate over 8% would be considered to be highly inflationary, the IMF advised that China could inject additional stimulus into its economy via its weekly open market operations.

Normally a central bank uses open market operations as the primary means of implementing monetary policy. The usual aim of open market operations is to control the short-term interest rate and indirectly control the total money supply. But in China this is not necessarily the case. Interest rates may make little difference in China. Few Chinese use debt to buy homes and fewer still use credit cards. Loans at the controlled interest rates go to state-owned industries and private companies are forced into the huge shadow banking system where interest rates have nothing to do with the money supply.

The IMF’s recommendation tells more about how economists and analysts from developed markets look at China and other emerging markets than about the economic situation in China. The IMF looks at China through the lens of developed markets, where its recommendations would make a lot of sense. In emerging markets things are different. One of the most important differences has to do with market concentration.

Emerging markets are dominated by two types of companies: state-owned firms and family-owned firms. Each emerging market is dominated by one or the other and sometimes both. In either case each market is made up of a few whales and a bunch of minnows. So the diversification that investors expect by investing in emerging markets is often simply an illusion.

For example in Russia about 45% of the market is dominated by five companies. They include three enormous state-owned companies: Gazprom, the world’s largest gas producer, Sberbank, the largest Russian bank, and Rosneft, the company that ‘inherited’ the assets of Yukos. Together these three make up 35% of the market by capitalization. If you include two private companies, Lukoil, and Norilsk, the total market capitalization of just these five makes up over 45% of the Russian market. Gazprom and Sberbank make up over half the turnover. In addition the state also owns large chunks of other large listed companies including Transneft, a pipeline company; Sukhoi, an aircraft-maker; Rosneft; Unified Energy Systems, an electricity giant; and Aeroflot among others. 

 China is a little better. Its top five companies make up a bit less than 30% of the market. They include PetroChina, ICBC, Bank of China, China Construction Bank and the Agricultural Bank of China. It is not only the concentration of a few large companies that dominate emerging stock markets, the companies are overwhelmingly concentrated in either finance or commodities, usually oil. It is not only former communist countries like China and Russia where state-owned companies dominate markets, the 179 listed companies in the Gulf are at least partially owned by 51 government entities. Governments controlled almost 30% of the region’s total market capitalization.

Brazil at least has a mostly private firm, the mining giant Vale, dominating its stock market, but the combination of Vale and the state-owned Petrobras make up 30% of the Bovespa alone. If you add the shares of Vale and Petrobras with the other three in the top five, which include two banks, Itau Unibanco and Bradesco, and, refreshingly, a brewer, Ambev, you end up with the most concentrated stock market in the world at 48%.

In contrast to the other BRICs, India is the model of diversification. The top five companies make up only 23% of the market capitalisation. Still almost three quarters of the economy is in the hands of either state-owned or large family-owned firms like the two Reliance firms controlled by the Ambanis and various bits of the Tata empire. India is hardly unique. Carlos Slim is the richest man in the world. His companies account for more than a third of the Mexican stock market. Even in Israel the market is controlled by a few oligarchs.

Investors around the world are advised of the wisdom of diversification including diversifying internationally and into emerging as well as developed markets. But there is hardly any diversification by investing in markets concentrated in state or family-owned commodities and financial firms. This type of diversification also misses investing in the more dynamic firms that are supposed to make up the emerging market growth story. 

Finally, market concentration tends to distort the efficiency of markets, which negates the accuracy of analytic tools. To successfully invest in these markets requires different tools to understand the different rules.

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected])


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