Mobius Takes a Swipe at Derivatives
10/28/2011 9:00 am EST
The legendary fund manager says ’out of control’ engineering is to blame for stock volatility, writes David Parkinson, reporter and columnist for The Globe and Mail.
An opaque and bloated derivatives market is ultimately at the root of the volatility roiling stock markets—and investors’ best defence against it is global diversification, argues the man generally recognized as the father of emerging-market investing.
"You’ve got $600 trillion in derivatives out there—that’s ten times more than global GDP," Mark Mobius, the globe-trotting fund manager at Franklin Templeton Investments, said during a rare visit to Toronto Monday.
"One of the things that is making things so unpredictable and difficult in Europe today is that in addition to the debt that Greece, Portugal, Spain, and all these countries have, there are the banks, hedge funds, and others that have taken out credit-default swaps—which in some cases are more than the actual debt.
"Anyone looking at this from a European Central Bank perspective has got to now account for the impact of the credit-default swaps…If the discount on these bonds goes down, their losses multiply.
"This is the crazy situation we’re in now—these derivatives have gotten out of control. And that adds more volatility and more uncertainty to the whole picture."
The 75-year-old Mobius, who has spent 40-plus years investing in emerging markets, believes the derivatives market must be reined in by regulators and made more transparent. But despite the eye-opening experiences in the 2008 financial crisis, he said, too little has changed.
"The legislators globally refused to get a grip on them. They refused to bring back Glass-Steagall, which is what they should do," he said, referring to the Depression-era US law, eventually repealed in 1999, that separated investment banking and commercial banking to shield commercial-bank deposits from risky investment exposure.
"First of all, there has to be listings of derivatives. Secondly, there has to be standardization," said Mobius, executive chairman of the Templeton emerging-markets group, with $40 billion of assets under management.
"Banks and buyers of these derivatives should not be allowed to buy them unless they are very clearly standardized—so they know what they’re buying and the banks know what they’re selling. These things have gotten so complex…and the risks increase dramatically as a result of the complexity."
In the meantime, he believes investors’ best defense against volatility is global diversification. Most investors aren’t doing nearly a good enough job of it, he said.
"I would be surprised if [a typical] Canadian investor has more than 3% to 8% of his portfolio in emerging markets. You know what the market-capitalization weight of emerging markets now is? 32% of the world. So if you want to be diversified globally, at least 30% has got to be in emerging markets."
That might be a scary prospect right now for most investors. Emerging markets have been hit hard by the equity downturn, as investors have fled to traditional safe harbors. The MSCI emerging-markets index has tumbled 24% from its May peak, while the MSCI World index is down just 14%.
But the perception of emerging markets as higher-risk investments is outdated, Mobius argued.
"Their debt-to-GDP levels are lower [than developed markets], their foreign reserves are higher," he said. "And in addition to that, they’re growing faster—their [economy is] growing three times faster than the developed. It’s completely irrational."
That has left many stable, growing, and highly profitable emerging-market stocks looking very attractive, he said.
"We’ve got stocks that are one-sixth of what they were before," he said. "These [sell-offs], we learned at the end of 2008 and beginning of 2009, are temporary—people get panicky, they withdraw to their home country, their home currency, and then after a while they realize, ’Oh, maybe I made a mistake,’ and they get back in. That’s what happened during the end of 2009, beginning of 2010," he said.
"It takes a long view, it takes patience…One of the interesting things about emerging markets is these bear markets tend to be very short and violent downturns, but the recovery takes a long time. And that recovery is where you make money."
|Mark Mobius's Templeton Emerging Market Fund|
|Top holdings (September 30, 2011)|
|Company||Country||% of total fund assets|
|Vale SA preferred A||Brazil||3.18%|
|Banco Bradesco preferred||Brazil||2.66%|
|PT Astra International||Indonesia||2.55%|
|Samsung Electronics||South Korea||2.53%|
|Top country allocations:|