News Column

Move over BRICs: Investing in the N-11

January 23, 2014

Growth in Emerging Markets is going to drive the vast majority of growth and return opportunities in the world. That's the opinion of Kathryn Koch Senior Portfolio Strategist and Chief of Staff for the Office of the Chairman , Goldman Sachs Asset Management (GSAM). "We are right now in the moment of the most dramatic shift in the gravitational force of the economic landscape ever in the history of the world, we're in the process of that happening right now," Koch says. "There are over 200 countries in the world. Of those 200 countries, we call 33 Developed Market countries because they meet the International Monetary Fund (IMF) definition of a mature economy. Then there are another 170 countries in the world that are considered developing markets and a lot of people group them all up together in one bucket called Emerging Markets or maybe Emerging Markets and Frontier Markets. "Of those 170 developing countries, we've elevated eight to something that we call 'growth market' status," Koch says. These eight countries are Brazil , Russia , India , China , South Korea , Mexico , Indonesia and Turkey . GSAM calls them 'growth market' because they believe calling them Emerging Markets is a misclassification. "It's kind of insulting to refer to some of these countries as Emerging Markets. If China is the world's second largest economy and the biggest buyer of flat-screen TVs and mobile phones and autos and eventually, in the next couple of years, it'll be the world's largest luxury goods market, then it has emerged already and we have to think about it in a new paradigm," Koch says. These eight countries are the only ones in the developing world that have a one per cent share of the GDP, says Koch. "One per cent might not sound that much to you but it's three times larger than the individual share of any of the Nordic countries, so it's pretty big. "The other thing to mention about these countries is they are home to 25 per cent of the Fortune 500 countries, they're going to be eight out of the top 10 contributors to global growth and all eight of them now have investment grade sovereign balance sheets. So again, thinking about these in a new paradigm, this leaves 160 plus countries in the world that can still be thought of as Emerging Markets," Koch says. WHO ARE THE NEXT 11? "Everyone's heard of the BRICs but you may be less familiar with the concept of N-11. There's an easy explanation, it's the next set of interesting Emerging Market economies after the BRICs but if you want to think of it in the growth market framework and add a little more sophistication to the concept, the N11 is comprised of four growth markets after the BRICs: Mexico , Indonesia , South Korea and Turkey and then a set of other countries that, if they continue to do some stuff right, may actually become growth markets, namely, Nigeria , Vietnam , Philippines , Iran , Egypt , Pakistan and Bangladesh . Why those seven out of 160? We think these countries have the potential, the demographic and the growth conditions to one day become a growth market, so they are aspiring growth markets or future growth markets." An investment approach to this group of countries depends on your view of where the world is going in the next decade, Koch says. "At GSAM, we believe very strongly that the world is capable of delivering more growth over the next decade than it has over the past decade, we're optimists. We see the BRICs and N11 continuing to be the engines of global growth. We think the countries that we identify as growth market countries are going to contribute now more than 60 per cent of global growth. So let me be clear, this isn't because we are overly optimistic about Europe , we're not, we're actually relatively cautious about Europe it's just because these countries have already become bigger and we're positive on their growth prospects and they have the ability to change the global economic landscape. "So let's look at a couple of countries, China for example. Last year, 2012, China created the equivalent of two South Africas. That's not just a figurative statement, it's somewhat literal because they took a lot of stuff out of the ground in South Africa and shipped it to China and built many things with it. "Another way of thinking about this is Cyprus . China creates a new Cyprus every two weeks. So it is big and it's growing fast and that is impacting global growth. "As far as how much the Euro zone is going to contribute to the world economy, we think Russia on its own will contribute more than the Euro zone over the next decade.We believe the UK's contribution to global growth will be in line with Turkey's . Maybe something to highlight about Turkey is that its number one trading partner is Germany . Its second trading partner is Iraq . The world is changing very fast and I don't think anyone would have guessed five years ago that Turkey would be a major trading partner for Iraq but those countries that are nimble and are able to pivot quickly to this changing world can dramatically improve their prospects. RAPID WEALTH CREATION The world is creating wealth at an unprecedented and dramatic rate, says Koch. "If you look back on the UK after industrialisation, it took 155 years for them to double GDP per capita, the most basic measure of wealth. Right now China is doubling GDP per capita at a rate of every 12 years and India , despite having a lot of pockets of dysfunction right now, is still doubling GDP per capita at a rate of 16 years. From an infrastr ucture perspective, as this growth continues to move forward, a major driver of growth is urbanisation. When you look across the cities in the developing world, the floor space needed to build these cities is equivalent to 85 per cent of the current building stock. To put it another way, all that floor space would be equivalent to the size of Austria . So there's a lot to be built and valuations matter in accessing this, the story is large and impressive in scope. Koch says this growth is driven by large, young, educated populations. The bottom line is that 85 per cent of the world's population lives in developing countries and 60 per cent of them live in the N-11 countries. "If you have a lot of people and they're old, that's bad. That's what Japan looks like. You want a lot of people and you want them to be young." But you also want them to be well educated, says Koch. You may have a large, young population but if they're illiterate and they die early, that's not good for growth. "We want them to be educated and we want them to live a long time. "I'm extremely excited about prospects of the BRICs and N-11 but if I had to pick a theme within the theme that I was most excited about, it is the rise of the domestic consumer. We think by the end of this decade, we'll have over one billion individuals entering the Emerging Market middle class. It is going to have a dramatic impact on the fortunes of both developing and developed market companies," Koch says. For the investor, this demographic shift throws up many consumer opportunities within the N11 portfolio. Take for example the Mexican health care industry. It's a 100 billion dollar industry but it's only 20 per cent of where the healthcare industry is in the US on a per capita basis so it has huge potential for growth. Koch gives the example of basic health care supplies like painkillers and shampoo, deodorant, etc. The company producing these products doesn't spend much money on research and development but it does spend a lot of money on advertising and as wealth rises for consumers in Mexico , they move up the wealth cycle and start to spend a lot more money on these basic healthcare supplies. A second example is Nigeria , which has a population of over 150 million with a median age of 19. The average person in Nigeria still lives on a couple of dollars a day unlike Mexico with $10,000 plus per annum per capita so Nigeria is a very early stage consumer. Take a Maggi chicken stock cube. Every day, 60 million of these are sold in Nigeria . In West Africa , that figure is 100 million. As wealth rises in Nigeria , imagine if the average consumer started pushing two cubes a day instead of one. In addition, Nigerian men are big beer drinkers. More Guinness beer is drunk in Nigeria per year than in all the US and in Ireland . What this all adds up to is a huge amount of opportunities for investors, Koch says. In sum, the big story coming out of Emerging Markets is the rise of the middle class consumer, Koch says. "By the year 2030, we think about half the world's equity market capitalisation will be dominated by what are now considered developing markets. The fastest growing part of that pie is the BRIC and N11 countries, which will account for about 40 per cent of market cap in 2030. Obviously as an investor what you want to do is anticipate that, access it at the right entry point and put it in your portfolio now. We are right now in the moment of the most dramatic shift in the gravitational force of the economic landscape ever in the history of the world, we're in the process of that happening right now the floor space needed to build these cities is equivalent to 85 per cent of the current building stock. To put it another way, all that floor space would be equivalent to the size of Austria REDEFINING EMERGING MARKETS: INTRODUCTION TO GROWTH MARKETS ~200 countries in the world1 Developed Markets2 High average income per capita Advanced stages of economic developement Open and transparent financial markets 33 countries2 For example; US, Japan , Germany , UK and other G7 countries Growth Markets Current share of global GDP = 1% Favourable demographics and rising productivity going forward Adequate market size and depth to achieve scale and liquidity 8 countries BRICs ( Brazil , Russia , India & China South Korea , Mexico , Indonesia and Turkey N-11 Emerging Markets Current share of global GDP < 1% Generally low GDP and incomes per capita, but rapidly increasing in places Scope for improvement of investment environment 160+ countries For example; Nigeria , Vietnam , Philippines , Iran , Egypt , Pakistan and Bangladesh N-11 Source: GSAM, "It is Time to Re-define Emerging Markets", 31-Jan-11. 1 Source: CIA World Factbook, as at 31-Mar-12. 2 Consistent with the IMF's definition of advanced economies, ex Korea . World Economic Outlook, Sep-12. This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see additional disclosures.

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Source: Wealth Magazine (United Arab Emirates)

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