The Australian Way, August 2010

On a glorious limestone hillside in Turkey’s Cappadocia, Andrew Rogers is supervising a team of 50 local carvers hewing the steps of an amphitheatre out of the earth. Beneath them, workers with a crane are hoisting a pillar of rock the height of a four-storey building off the back of a groaning truck. These are the final stages of a vast artistic endeavour four and a half years in the making, and you can see it all from the amphitheatre’s steps: 10 stone-wall and basalt sculptures extending two and a half kilometres down the valley, so big you can see them from space.

This is Time and Space, a collection of geoglyphs, or land art, and it is creativity on an epic scale. The installation in Cappadocia is big – 10,500 tons of stone, seven kilometres of rock walls – but not unique, for this is the 12^th location in which Melbourne-based Rogers has worked: 40 sculptures built by 5,500 pairs of hands on five continents, from Iceland to Slovakia, Bolivia to the Gobi Desert, Chile to Geelong. In sum, it is easily the largest contemporary artistic installation in the world.

See this article is it ran here: qa0810_Landscape.indd

When you are an artist on this sort of canvas, the vision is just the start: it’s an exercise in logistics, engineering, staff management and architecture. It requires a character that is not just creative but driven, patient and stubborn. “I’ve basically found out you can build anywhere, in the most difficult situations of terrain and labour, as long as people want it,” Rogers explains as we bounce around the site in a van. “You just have to be very tenacious and driven. Fortunately I’m both of those things.”

The road to this vast undertaking in Cappadocia really began in Israel more than a decade ago, when Rogers was teaching in an architecture faculty there. On a trip to a desert area in the south his colleagues told him they wanted to create something to attract tourism, and he suggested a giant sculpture. A year later, he walked back into the desert to create the first of four artworks there.

“In those days I wasn’t trained as an artist,” he says. “I was trained as an economist.” He had no idea of techniques that might make life easier. “I didn’t realise you could use surveyors. So we used to stand there in 40 degree heat for four weeks at a time and triangulate everything, making points in sand to lay out the sculpture.” Today, the same process takes three to five days.

Next he found himself doing the same thing in the Atacama desert in Chile, the world’s driest, having been inspired by the Nazca lines in Peru. “I thought, what a great idea, why don’t we draw some things across the whole of the earth instead of just one place? That’s the idea behind the whole project. A connected series of drawings on the earth.”

As for Cappadocia, Rogers first visited the region 27 years ago; like anyone who comes here, he was struck by its odd, spiky beauty. He always wanted to come back, and everything about the place suited his purposes. “Each time I decide there should be something of special significance that is inherent to the topography. Here, it’s amazing: the limestone formations that have been caused by nature are quite remarkable and unique. And it is impregnated with thousands of years of history.”

Like any colossal journey it started with a single step – or a phone call, to a sister of a friend in the local travel industry in 2006. “I asked who I could talk to and it went from there.” Then negotiations began. “Getting the permits is always the hardest part,” he says.  How do people feel when approached for something so unusual? “Most of them have never thought about it. It’s like Kleenex tissues: until they were invented nobody thought they needed them. But everybody is interested in preserving their history and heritage and fostering memories for the next generation.”

“You’ve got to find the person that’s interested, or the municipal authority or the elders who believe in the project,” he adds. In Cappadocia this required the support of two successive mayors to chase and approve permits, as well as numerous Turkish and western business leaders to provide funding. People like this need to be free-spirited sorts themselves. “He thinks what I do is quite normal,” says Rogers, impressed, of a local backer, “which is unlike a lot of people.”

For the art itself, Rogers tends to use a mixture of images based around central themes. “We perceive our existence in space and time,” he says. “In this world where technology is constantly advancing, human nature is not; it is often the values of the past that are most relevant today.” This theme, inherent to his work, comes through in many of his sculptures: A Day on Earth features 22 words such as memory, compassion and heritage carved in English and Turkish on basalt columns. Others take forms basic to life and culture – a grinding wheel, a palm tree, a horse – or reflect local myth, such as a Griffin and a double-bodied lion.

Common to every installation he has completed around the world is The Rhythm of Life, which started out as a bronze sculpture 17 years ago and whose original now resides in the National Gallery in Canberra. Rogers describes that original as “a dynamic structure in space, a series of points connected which make a line. It’s like life: all the connected influences we all have, friends, family, activities. It’s an optimistic symbol about life and regeneration.”

Then there’s construction, which began in 2007. Material is key to Rogers. “Stone has been intrinsic to civilisation forever,” he says. “It’s great to touch and feel rock and stone; it brings you back to the fundamentals about the earth, about what’s important.” The stone must be local and where possible nothing foreign is brought onto the site. “In Nepal we used mud with granite. In Chile, bird droppings with clay. Wherever we find a local technique that’s successful and stood the test of time, we use it.”

He has also always insisted on indigenous labour – a rule breached only once, when constructing in the Gobi desert in China, when the authorities decided the best way of getting things done was to give him an army to do the building. (“They don’t normally build sculptures and I don’t normally command an army,” he says.) In Cappadocia, almost a thousand local people were involved. Do they understand what they are working on? “They understand after they’ve worked on it. When they start, it’s a totally abstract concept.”

Relatively speaking, Turkey has been an extremely smooth project; the greatest controversy came with his insistence on paying men and women labours equally, which caused a minor revolt among some of the men. “They’re all challenging for different reasons,” he says. “In Bolivia we worked at 4300 metres, gasping for oxygen all the time. In some of the deserts we’ve been working in 45 degrees. Then you have people issues: too many workers wanting to work in India, and stopping fights between 300 people.”

There’s still a certain rustic approach to producing the art: Rogers judges levels by eye, then marks the pattern each metre with a peg in the ground. But with the workforce engaged, the building is in some sense the easiest part. Unbelievably, the Rhythm of Life sculpture in Cappadocia – whose walls, at the highest point, are two and a half metres high and hundreds of metres in length – was built in just 10 days, by a team of 380 stonemasons. The stones were simply picked up from the ground around the valley, passed hand to hand along lines of people; there’s no cement, no mortar, yet the dry stone walls are pristine three years after their completion.

So why build big? Does it change the meaning of a sculpture to make it writ large? “It doesn’t add anything to its meaning, but scale always adds another dimension,” Rogers says. “It’s more confronting for people. It’s taking the ruins out of being just a material into the realms of speculation.”

‘Visibility from space’ isn’t a casual claim either: Rogers commissions satellites to photograph the sculptures from 280 miles (450km) up. To help with visibility, he coats them, although the material varies with what is local; from place to place it has included cactus juice and bird droppings.

Even as Rogers opened his installation in Turkey on May 29, he was active elsewhere; the next step is Kenya. “It’s all set to go,” he says. “We have 1,000 Masai warriors who will come and camp around the site and build the structure.” It will bring its own challenges and quirks. “They don’t use stone for anything so it will be very interesting. It’s a totally abstract idea for them: they only use thatch.” The structures – which elders have requested include a lion’s paw and traditional markings from a shield, as well as the Rhythms of Life motif – will be made on a volcanic lava plain from deposits around the edges. “It’s going to be fascinating.”

As an installation on a sixth continent, this completes the objectives he originally had for his project. But one senses that it won’t stop here. “I have lots of invitations and if they are interesting places and interesting people I wouldn’t say no. It’s about getting an idea.”

SIDEBAR: Cappadocia

Cappadocia is perfect travel: stunning scenery; history; towns with accommodation and restaurants set up well for tourism without yet being ruinous; and a focus for unusual activities like hot-air ballooning.

The area is filled with curious limestone conical towers that have become known as fairy chimneys, and over the centuries many of them have become homes – or, more recently, hotels. Some have been used to carve churches out of the rock, magnificently painted inside. People have lived here for at least 4,000 years since the Hittites settled the region, followed by the Persians, Romans, Christians, Seljuk and Ottomans.

It is also one of the world’s best places to go hot-air ballooning, blessed with a rare combination of favourable wind and flying conditions and extraordinary topography to see from the air. Skilled pilots can not only navigate the balloons over the region’s most beautiful valleys but descend deep into them, just metres from the rock formations. Other balloons – there may be as many as 40 in the air – add to the extraordinary sight.

In Göreme, Cappadocia’s main travellers’ centre, is the World Heritage-listed Open-Air Museum, a clutch of rock-hewn churches and monasteries. Pay the extra TL8 (A$6) to enter the Karanlık Kilise, or Dark Church, painted inside with vividly colourful biblical scenes.

Elsewhere you can see underground cities, as many as eight levels deep, excavated in the sixth and seventh centuries to give an escape route for Christians fearing Persian and Arabic armies. 10,000 people lived in one of them, Derinkuyu, staying there for months, their air shafts disguised as wells.

More than anything, Cappadocia is a place to walk around, enjoy the scenery, eat well in excellent and friendly restaurants, and sit back with a glass of wine to watch the sunset from a hotel terrace. For many people it is the highlight of a trip to Turkey.

Intheblack magazine, July 2010

In late May, Juan Miranda was in the Afghan town of Mazar-e-Sharif, attending the inauguration of Afghanistan’s first railway. As Director General of the Central and West Asia Department of the Asian Development Bank, Miranda had been involved in the funding and development of this railway, a vital 75-kilometre link to the border with Uzbekistan and the international railway networks beyond. But as he stepped back to take a photo of the train moving slowly backwards and forwards on the tracks, he noticed a huge transmission line in the back of a shot, and a road behind it. He realised he had been involved in the development of all three.

When you are a multilateral banker in this part of the world, the work can be tough, but when it works out there’s the joy of seeing a tangible difference being made. And Miranda’s patch of Asia is all about high challenge and high reward. His department operates in 10 countries most of which few people could successfully locate on a map (and, if they could, it would be for all the wrong reasons): Afghanistan, Armenia, Azerbaijan, Georgia, Kazakhstan, the Kyrgyz Republic, Pakistan, Tajikistan, Turkmenistan and Uzbekistan. It is a patchwork of mostly landlocked countries with sometimes random borders, stubborn bureaucracy, limited commercial laws, dominated by mountains and deserts, into which Miranda must coax international private capital to invest.

The challenge is not just about getting foreigners to come in, but to get these disparate nations to work together too. One might expect the former Soviet states to be kindred spirits, but that’s often far from the truth. “After independence from the Soviet Union, these countries embraced sovereignty like you and I would a long lost brother,” Miranda says. “But as a result of that they created economic structures that were directed towards self-sufficiency and putting up borders.” The ADB is one of six multilaterals that backs the Central Asia Regional Economic Cooperation (CAREC) programme, which seeks to improve efficiencies between Central Asian nations, focusing on connectivity, energy security and trade facilitation. “The nearest port to some of these countries is 2,000 kilometres away,” he says. “Unless people can move from point A to point B efficiently, you’re not going to be very competitive.”

Miranda, CAREC and the ADB have focused their energies on transportation, and have devised six transport corridors, some north-south through Afghanistan and into Pakistan, others traversing Kazakhstan from east to west to link Europe and China. And this speaks to an advantage Central Asia does have: being in the way, separating Europe and China. Becoming an efficient conduit for goods between these states will be to Central Asia’s benefit, and will cement a shift away from reliance on Russia and towards greater integration with China. Other less visible things are no less important: trade facilitation, such as removing tariffs and speeding up the flow of goods across borders, is crucial to the ADB realising its ambition of doubling per capita income within the region within a decade, pulling poverty down from 40% to 25% in the process.

The good news is that when something works, it really has an impact. That transmission line in the back of Miranda’s photo in Afghanistan runs from Uzbekistan to Kabul, and supplies it with constant electricity for the first time. “Delivering electricity 24 hours a day instead of two hours a day is a transformation,” he says. “It’s not a solution in itself, but it’s a means to an end.” By this he means that helping with infrastructure makes it a little easier for Afghanistan to find its footing as a country. “Optimism is something that can come and go, but we have to let it be with us,” he says. “You’ve got to wake up in the morning thinking that you’re doing good. The task is not for the faint-hearted and the security aspects are not getting any easier but I am optimistic this resilient country, these resilient people, can put things together.”

“The political differences between groups across the country are clear, but one thing that binds them together is to reconstruct the nation, and to do that you need development,” he says. “We are part of that agenda, to do projects that will make a little difference to the country.”

Elsewhere in Central Asia, the ADB has been making gradual headway. Talking to IntheBlack at the ADB’s annual meeting in Tashkent, Uzbekistan in May – the first time the bank had held its meeting in Central Asia – Miranda bemoaned the lack of a landmark public-private deal that would get the region truly noticed. “We haven’t had in Central Asia the unique transaction that says: the future looks like this,” he says. “If one happens, we’ve created a message. We convey an opportunity to the international investment community that this place is open for business.”

A month later, over the phone in the ADB’s Manila headquarters, he is able to suggest that such a deal is finally close to the finish line. The $3.2 billion Surgil project in Uzbekistan will involve the construction of a petrochemical plant with a production capacity of more than 500,000 tons of polypropylene and polyethylene, made by converting gas deposits. It will be structured as a PPP (a public-private partnership) and will combine a number of foreign investors – who have not yet gone public in their involvement – with the Uzbek state oil and gas company, with the management and the exports run by international shareholders. “In turning gas into chemicals it moves a commodity into a value-added product with an international market ready-made,” Miranda says. “If it works well, instead of just exporting their gas they can get foreign investment into the country and generate jobs.”

Getting foreigners in requires more than just a visible opportunity. What’s also lacking is the legal infrastructure to protect and encourage an investor. “In Central Asia we have the big ticket projects waiting for the private sector to invest, but unlike other parts of Asia the upstream work lags behind,” he says. There are places where concession laws do exist – Kazakhstan has gone so far as to build a dedicated PPP unit within its government and has an approved list of projects for it to pursue – but few foreigners have so far been willing to jump in. “There is a comfort zone that is not that huge here, and we need to expand that comfort zone.”

Uzbek landmarks apart, he thinks it’s important to be reasonable in expectations. “Would you be able to have an all-singing, all-dancing concession and BOT [build-operate-transfer, the classic public-private model in more developed markets]? Maybe not right now. Maybe you go in more realistically and expect a management contract to start with. If you go from zero to something that’s no longer zero, that still represents success.”

Miranda himself, who is Spanish-born and English educated with a degree in agricultural economics from Reading University, first visited Central Asia in 1992 after the Soviet Union was dismantled. Back then he was working at the European Bank for Reconstruction and Development. When he took over his current department for the ADB in 2006, he felt that he had “a longer memory of the region” thanks to his earlier role, and he remembered its potential. “They have the things that everybody should want: a growing market, investment opportunities for regional and international players, and an area strategically as important as most. It is an area with rich traditions but is landlocked and needs to be integrated into the world economic system.”

Miranda’s career has involved plenty of private sector work between the multilaterals: at once stage he set up and managed his own project finance boutique investment bank that he later sold to Morgan Stanley, becoming a senior executive at the US powerhouse as well as a stint in a Spanish investment bank. People who have sold their own banks to Morgan Stanley don’t generally need more money, and one suspects he is drawn to this ADB role, with its dismal flights and endless visa queues, out of a sense of duty. “Central Asia has the importance and that thrill where things are yet to be done,” he says. “As a development bank we like to be involved with change.”

And, once in a while, there’s a visible reward. That Afghan railway, the first in the country’s history, built across unforgiving topography in a nation at war? It was finished ahead of schedule.

BOX: Out of Hours

What are your interests?

Lots of them – music, sports; I play golf well enough to beat most of my colleagues. I like classical and jazz music and I like to watch football – I’m a long-standing fan of a team called Deportivo La Coruna. I’m happy to report to you that we beat Manchester United twice.

What words do you live by?

Accountability and responsibility.

What keeps you awake at night?

The happiness and health of my healthy and happy children.

What are you reading?

Henry Kamen’s Spanish Empire. It argues that the empire could well have been the first big example of globalization and outsourcing!

ROADTEST

Hastings Yield Fund

Who runs the fund? Hastings Funds Management, a Melbourne-based specialist in infrastructure and yield investments, and since 2005 a Westpac subsidiary.

The basics: Invests in high yield securities including loans and hybrids. High yield means the payout is greater than in mainstream bonds, but with a greater credit risk too. It aims to beat the UBS Australian Bank Bill Index by 3% per year.

The process: Looks at senior, subordinated and mezzanine loans – these terms tell you in what order creditors get paid if a company runs into trouble. Subordinated ranks behind senior but pays better. Also looks at bonds and hybrids and can invest in structured products like collateralised debt obligations, though in practice it doesn’t seem to.

The bottom line: Good over the longer term: Morningstar says its 7.14% per year return over three years and 8.18% over five is among the best of all yield funds in Australia. 12.42% over the past 12 months is weaker than many peers, however.

Fees: 0.4% plus a 10% performance fee on returns above its benchmark, but retail investors will only be able to reach it through a platform, so add on the platform administration fee too. Alternatively a listed fund with similar holdings, Hastings High Yield Fund, can be bought and sold like any share.

Verdict: High yield is one of the buzzing areas of world capital markets, and Hastings has shown it can be successful in this complex area.

NEW FUND

Climate Advocacy Fund

What is it?

A new ethical fund which not only aims to deliver a decent return – similar to the overall share market – but to do so while improving corporate behaviour, performance and sustainability. It will do this by actively engaging with companies about environmental, social and governance issues related to climate change.

Is that a good investment?

In performance terms it doesn’t claim to be any more than an index fund and will use passive management to try to at least equal the S&P/ASX 200. It charges 1.1% a year (0.85% if you invest over US$50,000) which is more expensive than some ways of getting index exposure, but less than most actively managed funds. You’d really be buying it in the hope of effecting an environmental difference.

Well who’s doing the advocacy?

Australian Ethical, which has been running ethical managed funds and superannuation since 1986. Its Balanced Trust flagship fund, for example, has A$237.5 million under management.

If it’s an index fund how can it pick only ethical stocks?

Its portfolio will be built using an economic footprint weighting. But it differs from most ethical funds in that rather than selecting the best companies environmentally, it will use its clout as an investor to try to change practices at companies generally.

GIZMO

The iLuv iPhone iMM190 App Station

If you are an iPhone junkie you have probably already surrendered most of your daily functions to your gadget bar eating it. So you might as well add another: as well as using it for your email, address book, music, video, and even perhaps as a phone, why not make it your bedside alarm clock?

This so-called App station is a cross between a charger and a speaker. You attach your iPhone to it, add the alarm clock application from iTunes, and away you go: it turns into a big-display bedsides clock and you can program it to wake you up with your favourite iTunes songs, or with weather information, for example. It works equally well as a desktop speaker for an iPhone or iPod, and it charges the gadget while it plays. It can run on batteries so can be used outside too.

FUND WATCH

EQT SGH Absolute Return

The idea of an absolute return fund is to see a benchmark and plunge beneath it. Well, that’s not the theory, but a look at this fund’s returns might lead you to believe so, with comprehensive underperformance of the stock market over one, three and five years.

In fairness, it’s not meant to track stock market returns exactly: 75% of the portfolio goes into equities and 25% into absolute return strategies. This theoretically insulates investors during market declines, but it’s not showing up in the numbers.

Gold is at a record high and it’s easier than ever to get exposure. But should you?

1. Are you worried about traditional safe assets like bonds crashing? Yes/No

 One of the main reasons people invest in gold is as insulation against problems in other asset classes. In particular, since the problems set in with sovereign bonds in Europe, investors have started to think twice about what they used to consider safe haven assets. In an environment like that, gold shines: it’s at an all-time high in US dollar terms. That said, it’s very wrong to think that just because Greece might default on its bonds, you shouldn’t trust sovereign bonds anywhere else: some, including the US and Australia, remain pretty much bulletproof.

 2. Are you worried about inflation?

 Another reason people buy gold is as a hedge against inflation. Over the very long term it tends to move in the same way as inflation, so if you hold it, you won’t be left behind by the economy. That said, in recent years its performance has dramatically outstripped inflation, causing some to think it’s due a decline.

 3. Do you need diversification?

 Gold, like all commodities, tends to behave in a different way to stock and bond markets, and some advisors think that’s a good reason to include it in a diversified portfolio.

 4. Do you believe in gold’s outlook?

 Apart from the macro factors about the state of Europe and so on, there are simpler themes that impact the gold price. One is that there’s a finite amount of it in the ground – also that, once out, it is there forever in one form or another. It is affected by things like India’s growing wealth, given its popularity as jewellery there; by the difficulty of gold mining at increasing depths; and by central banks around the world wanting to hold it in national reserves. Most think the outlook, for the medium term at least, is good.

 5. Do you think the Australian dollar is due to weaken against the US dollar?

 In truth, few people do think this, but if it happened it would be good for Australians holding gold. Gold has performed sensationally in US dollar terms, but much of that gain has been wiped out for Aussies by the strong performance of their own currency.

 6. Are you comfortable buying something that’s already at a record high?

 An important question: some feel the great rise in gold has already happened and that we might even be heading for a bubble; others think that there is plenty of headroom. Gold trades at more than US$1,200 an ounce today; the most bullish believe it could hit US$2,000.

 7. Are you comfortable holding exchange-traded funds?

 There are several ways of owning gold: one is to buy an exchange-traded fund (ETF), like buying any share, which trades on the ASX and reflects the value of gold. Some ETFs around the world are backed by genuine allocated gold; others are just derivatives reflecting the price.

 8. Or do you prefer the security of owning something you can physically hold?

 If you’re so inclined you can get good old Goldfinger-style bullion or gold coins from the Perth Mint, who can also hold it for you or give you certificates reflecting ownership.

 9. How about gold miners?

 Some choose to play the gold price by buying the stocks of miners. There’s an awful lot more variables at work when you do this – you’re relying on their success to find gold and mine it, and a host of other issues common to any company – but they sometimes do better than the gold price itself. Some managed funds focus on gold miners and other ways of playing the gold price.

 10. Do you understand the dangers with gold?

 Gold can be volatile, unpredictable, and it will never pay you a dividend or earnings like a company does.

 The verdict

Mostly yes: There’s a place in your portfolio for gold, as a diversifier, a hedge against difficult times, and a plain old good investment

Mostly no: It’s not for you. Perhaps you doubt the outlook of something at a record high or think the Aussie dollar is going to wipe out any gains you might make.

Fancy a Mongolian mining company? No? How about a nice Lithuanian bank, or a Kazakhstan gas utility? OK, my final offer: KenGen. What do you mean you don’t know KenGen? It’s Kenya’s most successful electricity company. Durr.

Frontier markets, as stock markets like these are known, require greater savvy and experience than dealing with the most grizzled of used-car salesmen. This is, no doubt, where some of the most extraordinary gains will be made: the emerging star companies of tomorrow in the emerging star countries of tomorrow. But they take the idea of risk and reward to a whole new level – particularly on the risk side of the ledger.

You may not know it, but the countries you are exposed to are dictated more than anything by a group of people sitting in an office on Pine Street, New York. This is MSCI, and it is one of the leading providers worldwide of stock market indices. One of its most well-known ones is the MSCI Emerging Markets, and it is against this index that most emerging market fund managers – including those selling such funds in Australia – are benchmarked.

Consequently, most emerging market funds tend to mirror the geographical allocations of the MSCI index fund quite closely; when a market enters or leaves the index, a lot of capital tends to flow in or out with it as emerging market portfolio managers rebalance their holdings accordingly. The table below shows the 26 nations that make up the index today; even if you don’t hold an emerging markets fund yourself, the chances are your super fund will have at least a modest allocation to it, and it is because of MSCI’s decisions that you probably have an exposure to Brazil but not Argentina, to Hungary but not Croatia, and to Morocco but not Tunisia.

“The definitions to a large extent are given to us as fund managers by the index providers, particularly MSCI,” says Peter Taylor, investment manager for Asian equities at Aberdeen Asset Management in Singapore. (Taylor’s investment decisions affect the emerging market and Asia funds sold by Aberdeen in Australia.) “They have a process and criteria, and under those, some markets are defined as developed, some as emerging, and some as frontier.”

Frontier is actually quite an odd term, because it doesn’t always mean what you might think it means: poorer countries with no established stock markets. In fact, if you look at the table showing the constituents of the frontier markets, it includes some of the richest countries in the world, such as Kuwait, Bahrain and the United Arab Emirates; these have not been promoted to more widely tracked indices mainly because of a lack of easy access to their stock markets, or a lack of maturity or depth within those markets. Also, some frontier markets have stock exchanges almost as old as Australia’s: the Colombo Stock Exchange in Sri Lanka traces its history back to 1896.

“The term ‘frontier markets’ captures a broad universe,” says Taylor. “There are things that you might consider real frontier markets – Central Asia, Mongolia, Papua New Guinea, Pacific islands – where there is an insignificant stock market or sometimes no stock market at all, with the bigger companies listed elsewhere. Then there are what you might think of as the emerging markets of tomorrow: places like Vietnam, Sri Lanka, Bangladesh, Pakistan, and outside Asia places like Nigeria, Kenya or Romania. They may have their difficulties but are sizable countries with a decent number of listed stocks already that could potentially make the leap in the next few years.” And a third category is the wealthy Gulf states. “’Frontier markets’ is not strictly an income level cut-off. If a market has certain types of controls or access problems, it won’t meet MSCI’s criteria to be in the emerging market index. That’s why you have a country like Kuwait defined as a frontier market where it is far richer per capita than, say, India.”

Frontier funds covering all these bases do exist, but they are rare and little marketed in Australia. Franklin Templeton, for example, whose fund manager Mark Mobius has long been a standard-bearer for unloved markets, runs the Templeton Frontier Markets Fund out of Singapore and has so far garnered US$299.13 million under management tracking the MSCI Frontier Markets Index. Its biggest geographical positions are, in this order, Nigera, Qatar, the UAE, Vietnam, Saudi Arabia and Kazakhstan. Its biggest picks, while household names in their own countries, are little known outside them: MTN Group, a South African telco; Kazmunaigas Exploration Production, a Kazakhstan gas company; Saudi Basic Industries, a chemical, fertilizer, plastic and metals producer; Industries Qatar; and United Bank for Africa, which is headquartered in Lagos, Nigeria.

Other funds might pursue a specialist opportunity. In Australia, AMP Capital developed the Vietnam Real Estate Opportunity Fund, for example, investing in direct property there, although funds like this tend to limit access to sophisticated or institutional buyers rather than general retail.

Since few pure frontier funds exist, investors are more likely to get exposure to the frontiers when emerging market fund managers decide to dip their toes in the water of markets outside their benchmark, whether in expectation that those countries will eventually be promoted into true emerging markets and hence become part of their mandate, or simply because they think there are good returns there. In this respect, emerging markets fund managers are most interested in the chunk Taylor labelled the emerging markets of tomorrow, and this is perhaps where the biggest opportunities might lie for bold investors too. “We are quite bullish on prospects for both Vietnam and Sri Lanka long-term,” says Peter Sartori, founder of Treasury Asia Asset Management. “We think it will take longer than many people expect for both markets to become more mainstream or institutional – we expect it is five years away rather than one to three years – but it will likely happen.”

Managers differ on which markets they think offer the real opportunities. “There are a decent number of interesting stocks, particularly in markets like Sri Lanka and Kenya, which have a very long tradition of equity markets,” says Taylor.  “We find more interesting companies in Nigeria and Sri Lanka than we find in Vietnam. Vietnam is everybody’s favourite exotic market, but it’s not a place we find a lot of good companies, whereas places like Nigeria and Sri Lanka have had listed companies forever, with subsidiaries of multinationals listed there, and the local banks.” Aberdeen pursues these opportunities particularly through an Asian small caps fund – this holds stocks in places including Sri Lanka and Pakistan – and to a lesser extent in its broader emerging market funds too.

If you’ve noticed Sri Lanka keeps popping up in this story, that’s a useful point to consider. What’s really changed in Sri Lanka for everyone to be talking about it? It’s not that its companies, which have been around for more than a century in many cases, have become suddenly better – it’s because a crippling civil war has ended. Fund managers with a really long-term view will look at macro considerations like this in deciding whether exposure to a market might eventually make sense. “There has been a tremendous increase of interest in Sri Lanka but it’s got nothing to do with it graduating [to an emerging market definition – which, by MSCI, it still hasn’t],” says Taylor. “People were dismissive of it because of civil war, and suddenly it’s become exciting. We’ve been invested in Sri Lanka forever and that was not a set of investments that have performed very well for many years but suddenly it’s come good: all our stocks have been two or three baggers in the last 18 months.” That is, they’ve doubled or trebled.

Correctly calling the end of a civil war with any accuracy is clearly beyond most of us, but there are other similar factors that are easier to see coming: the world is getting more interested in Mongolia as transformative mining deals (including a vast mine backed by Rio Tinto) get closer to completion, which should lead to greater foreign involvement, faster economic growth and a more developed stock market, for example.

Still, in unpredictable places, these transformative economic moments can go both ways. “People think of emerging markets as a one way bet, but that’s not the case: you do have some emerging markets that go in the wrong direction.” The two key examples at the moment are Pakistan and Argentina, both of which in the recent past have been investment darlings – Pakistan in particular, which for a brief time was a poster child of foreign investment and privatisation before the political and security situation worsened. Both those markets now languish in the frontier indices rather than the emerging market ones, with a consequent loss of interest from international capital. Similarly Kazakhstan was for several years considered a barometer for the emergence of Central Asia, and attracted a lot of attention as it liberalised its banking sector – which pretty much went broke in the financial crisis, taking a lot of foreign money with it.

No Australia-based investor in their right mind would seek to buy a stock listed in Ulaanbaatar or Lagos without a great deal of prior knowledge, but there are other ways of getting exposure to odd parts of the world through a single stock. To stick with the Mongolia example, more and more of the world’s most powerful investors – such as Temasek, Singapore’s sovereign wealth fund, and China Investment Corporation, its equivalent in Beijing – are trying to get a foothold in companies and mining interests there in expectation of growth. One of the companies that sovereign funds have bought into, South Gobi Resources, has since been listed in Hong Kong, which can be easily reached by Australian investors and is a well-governed exchange. (It’s worth noting, though, that the stock has crashed 30% since listing, although the rest of the market is well down too.) You don’t even have to go that far to get exposure to some frontier markets: here in Australia, Lihir Gold gets most of its revenue from a gold mine in Papua New Guinea, and much of the remainder from Cote d’Ivoire. A great many mining companies, BHP Billiton and Rio Tinto included, have some exposure to the frontier mining idea.

It’s also very easy for Australian investors to invest in the USA, and doing so gives you access to the greatest range of exchange-traded funds (ETFs). These behave like buying a single share, but they reflect the performance of an entire index. Providers in the US such as Vectors, PowerShares and Claymores offer frontier ETFs, or ETFs tracking particular areas such as the MENA area, which means Middle East and North Africa. Examples are the Claymore Frontier Markets ETF (whose New York Stock Exchange symbol is FRN), PowerShares MENA Frontier Countries ETF (on Nasdaq, code PMNA) or Market Vectors Africa ETF (NYSE, NFK). Be aware that an ETF gets you exposure to the dross as well as any diamonds that might be found, and also that buying an ETF in America from Australia also exposes you to currency movements. iShares, the biggest provider of international ETFs sold in Australia, covers several individual Asian emerging markets in its Australia-listed products (Taiwan and Korea, for example), but for more far-flung stuff you have to go to their New York-listed products too: they have ETFs for Peru, Chile and South Africa, for example.

Otherwise, real frontier investing tends to be the preserve of private equity players who bring chunks of daring institutional money together to put into very new markets with a long-term timeframe. Examples are Altima Partners, the former Deutsche bank equity special situations group which peeled off from the bank in 2004 and has since launched funds including the Central Asia Fund, covering Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Tajikistan, Turkmenistan and Kazakhstan; the Dubai-based private equity specialists Abraaj Capital, which runs the Abraaj/BMA Pakistan Buyout Fund alongside a local Pakistan bank; and a group called Acap Partners, run by a former McKinsey staffer called Pierre van Hoeylandt, who runs a truly frontier-spirited entity, the Afghanistan Reconstruction Fund. It takes big money and immeasurable patience and risk appetite to participate in these sorts of ventures.

Generally, though, the idea of wanting to get in early to markets that will grow in importance, liquidity and influence is sound enough, and allied to the broader trend of Asian or emerging market growth. “Asia ex-Japan has only been on the radar for most Australian institutions for the last five years,” says Sartori. “It will definitely remain on the radar and will continue to grow in importance as the region continues to grow relatively stronger than elsewhere in the world and Asia gets larger in global indices. The frontier markets will contribute to this, but are a few years away from being more meaningful.”

BOX: The Middle East

The Middle East, which for investors is chiefly the big oil-rich markets of the Gulf Cooperation Council (GCC), is an odd case. Massively wealthy, their stock markets do not appear in global indices because by and large their markets either lack suitable access for foreign money, or because they are too small or immature. Saudi Arabia’s market doesn’t even make it into the frontier index because foreigners cannot buy Saudi shares (although they can create the effect of doing so synthetically with new investment structures).

There are funds that do invest exclusively in these markets: one of the biggest is the Schroder Middle East Fund, sold within its International Selection range, whose biggest positions are in Turkey, Saudi Arabia, Kuwait, the UAE and Qatar. “The long-term case for investing in the region remains strong,” says Rami Sidani, fund manager at Schroders in Dubai. “Middle Eastern countries are at a relatively early stage in their development and have strong growth potential. While many of these countries continue to benefit from oil and gas riches, they are investing in new products and skills to diversify away from reliance on energy exports. The region has a young, fast-growing population which should also contribute to a more rapid economic development.”

But emerging markets managers often consider the Gulf’s position in frontier indices an anomaly given that, as highly wealthy states, their future growth profile is likely to be quite different to a Vietnam or Sri Lanka.

In any event, MSCI has been talking for some years about adding some Gulf markets to the emerging markets index; Kuwait, the UAE and Bahrain are the ones that are most frequently mentioned, even though Saudi Arabia has much the biggest market in the region by market capitalization. It will be an interesting day when it happens, because calling Kuwait an emerging market – with its high performance luxury cars, bounteous oil revenue and soaring per capita income – seems just as odd as calling it a frontier.

Australia’s financial services industry has been awash with inquiries, reviews, commissions and responses for the last two years, and their impact is finally beginning to be felt. They could lead to a change of the remuneration models commonplace in investment platforms, with a knock-on effect on the ability of smaller fund managers to get access to investment menus.

Australia has had three separate reviews running in tandem: the Parliamentary Joint Committee on Corporations and Financial Services, also known as the Ripoll report, which has mainly looked at the payment structures around financial advice; the Henry Review, a comprehensive analysis of the tax system; and the Cooper review, which is a study of the superannuation (pension) industry. Each of those, once issued, then prompts a government response, and it’s on the back of that response that policy will be formulated.

From the perspective of the platform industry, it’s the first of these which has the biggest consequences, and now that the government has issued a formal response to it – a policy called The Future of Financial Advice, announced by Minister for Financial Services Chris Bowen – we can finally start to draw some conclusions about what the impact will be.

First, a summary of how investment management links from the consumer to the fund manager might be useful. Australia is an extraordinarily intermediated market: financial planners, their dealer groups, and investment platforms (known as mastertrusts and wraps) are all exceptionally important. It is comparatively rare these days that anyone invests in a fund by contacting a fund manager directly. Instead, the more common model is that people seek advice from financial planners, who are usually part of collectives called dealer groups; and based on the advice of these planners they invest in particular funds through platforms, which offer menus of hundreds of different funds people can invest in.

Investors come out of this arrangement well because they pay only a wholesale rather than a retail fee to the fund manager and gain other administrative benefits; on top of the fund manager fee they pay a platform administrative fee, which is the main source of the platform’s own revenue. The financial planner and dealer group (historically, anyway) get their money in commissions that come back down the line from the fund manager and, sometimes, rebates from the platform itself. Fund managers don’t have a lot of choice in this arrangement since the power of platforms is so absolute, but in theory they gain access to a great deal more potential volume then they would be able to reach individually.

However within this elaborate set of connections, the fee structures, commissions and rebates can be muddy, and there has been a growing feeling that the existing model creates conflicts of interest. This was a key area of focus of the Ripoll report and the government’s response to it.

The keystone of the review and the government response is a package of three reforms on financial advice that will come into effect from July 1 2012. These are a ban on conflicted remuneration structures, including commissions and any form of volume-based payment; a statutory fiduciary duty for financial advisers requiring them to act in the best interest of their client, placing those interests ahead of their own; and the introduction of an adviser charging regime, bringing flexible options for consumers paying for advice.

What does this mean for the powerful platform industry in Australia? It depends on how the platform has been structured. It has been widespread practice in Australia for funds to secure space on investment platforms (also known as mastertrusts and wraps) by paying what is known as a shelf space fee; there is frequently also a complex system of rebates which are linked to the volume of business the funds or dealer groups bring to the platform. This whole system is likely to be changed.

Some platforms have been preparing for this for some time, most notably MLC, which since at least 2006 has been not only expecting this shift but lobbying for it. Under the MLC approach, which is now likely to become much more widespread, there is no payment from a fund manager to get onto a platform. The management expense ratio charged by a fund manager on the platform goes in its entirety to the manager; the whole platform administration fee goes to the platform administrator (MLC). This system, in which the intra-payments between various players from the financial planner to the fund manager and platform have been removed, may well become a template after 2012. A system like this only really works if financial planners move to a model where they make their money not from commissions, but by charging fee for service; this approach, little used a few years ago, is rapidly catching on and with the banning of commissions from 2012 should now become the norm.

For other platforms, and for those in the value chain who deal with them from the fund manager to the planner and the client, there is going to be a serious period of adjustment. The reason Bowen did not attempt to bring the changes into effect from 2011 was partly because of a recognition of just how much of a shift is going to need to take place. It will affect arrangements and relationships between platforms and everyone who deals with them; may have a significant IT cost; and will require detailed modelling of how the new rules will affect their business model and profitability.

The government recommendation is not to get rid of shelf space fees entirely, however. There is a distinction made between shelf space fee payments based on volume – which will be banned – and those that are not (including product access payments), which will be permitted. It’s the volume part that the government wants to eradicate.

Going further, the changes should, in theory, mean more of a meritocracy in funds getting access to end clients. In the past it has been possible for fund managers to acquire distribution and size without necessarily having matched it with ability: they could, in a sense, buy exposure. With volume payments and commissions removed, it should be more of a level playing field for fund managers. This should, in turn, be to the benefit of smaller fund managers and boutiques.

Additionally, these trends are likely to increase the consolidation of Australian investment platforms among a few select leaders. According to Plan for Life data, as of December 2009 the top five providers (National Australia Bank/MLC, AMP, Commonwealth/Colonial, BT Financial and ING) controlled 64.3% of funds under management in what Plan for Life calls Masterfunds (wraps, platforms and mastertrusts). This trend has been gathering momentum for years anyway: at the end of 2007 20.8% of the industry was held by names outside the top 10, but that figure has now fallen to 13.8%. It is likely that the structural changes that come with this government review will make it harder still for new or weak institutions to penetrate the top level, which could lead to a period of greater consolidation.

Is it likely to change the dominance of platforms themselves? After all, platforms have become dominant partly because they suit financial advisors, and the advisory industry is being changed dramatically by these reviews. But most in the industry think platforms are now so entrenched that their power will not be undermined.

The government response is still up for discussion: stakeholders have time to lodge their own submissions, although the reforms themselves have not been presented as proposals so much as absolute changes. They must still be navigated through parliament, but the mood in the industry today is not to wait for that to happen but to start changing practices now.

Australia’s market for new initial public offerings, already moribund, has been further dented by an Australian Taxation Office (ATO) attempt to levy a tax on foreign private equity exits.

 The transaction that triggered the ATO’s stance, and has rattled potential issuers, was the IPO of Myer in November 2009, which raised A$2.4 billion in a deal led by Credit Suisse, Goldman Sachs JBWere and Macquarie Bank. One of the groups that sold its stake in the IPO was the foreign private equity group TPG, which alongside minority partner Blum Capital owned Myer through a Cayman Islands-based entity called TPG Newbridge Myer. The partners gained A$1.58 billion from the IPO.

Shortly after the IPO, the ATO said it was pursuing TPG for a A$452 million tax bill related to the cash from the float – it went so far as to freeze a National Australia Bank account TPG held in Australia in expectation that the money was going to flee offshore (which, indeed, it reportedly already had).

 At issue is where tax on income should be paid. The ATO believes the gains TPG made from the Myer listing constituted Australian-generated income, and that income tax should therefore be paid in Australia by TPG Newbridge Myer (and another offshore TPG company, NB Queen). It is understood to be pursuing TPG for a further A$226 million in penalties for tax avoidance.

At the time of writing, the ATO had not published its final conclusions on the TPG tax situation, and was expecting to do so in late May along with final rulings on tax proceeds of private equity sales generally. The resolution of the case one way or another will have a big impact on foreign private equity appetite for Australia, and in turn for IPO volumes.

“I speak to a lot of private equity majors who are looking at Australia but I can tell you for a fact this is bothering them,” says one M&A banker at an Australian institution. “At the moment, it’s not just the question of the tax, it’s the uncertainty they really don’t like.”

Quite apart from the tax issues, the performance of recent IPOs has been miserable. After announcing an uninspiring third quarter sales result in May, the Myer share price was down more than 25% from its IPO. Another IPO late last year, for outdoor supplies retailer Kathmandu, has also fared badly. The only major IPO in Australia this year has been a A$516 million float from Miclyn Express, the marine services group; at the time of writing that was down 10% from its listing price.

Consequently private equity firms in Australia seeking an exit are believed to be looking for trade sales instead of IPOs. For example Study Group, a university programme provider owned by CHAMP and expected to raise A$600 million, and pallet maker Loscam, owned by Affinity Equity Partners and expected to raise up to A$700 million, have been reported to be heading for trade sales rather than floats. Since the real boom in private equity activity in Australia began in 2006, and firms normally hope to hold their companies for three to five years, there ought to be a host of forthcoming exits. But in this stock market environment, a number of expected floats may never happen.

Nevertheless there is a reasonably robust pipeline of equity capital markets deals expected in Australia when conditions suit, among them listings for Ascendia Retail, which operates the Rebel Sports chain of sporting equipment shops, and is believed to have appointed Bank of America Merrill Lynch, Goldman Sachs JB Were and UBS; the coal and freight business of Queensland Rail, which has been valued at A$7 billion; and Bilfinger Berger’s Australian operations.

The Myer situation fits within the context of a broader conflict in Australian commerce today: a desire to increase tax revenues (also evident in the proposed super-tax to be levied on exceptional earnings by miners in Australia) while also appearing to be business friendly and attractive for foreign investment. “The tax office and the markets don’t always appear to be coming from the same direction,” says an ECM banker in Sydney.

Nevertheless, there are already signs that foreign private equity interest in Australia will persist even if there is uncertainty about where they will be taxed on the proceeds. TPG itself, alongside Carlyle, launched a A$1.7 billion bid for Healthscope in May.

 You will have read about the boom in contracts for difference, or CFDs. But if you join the crowd, what exactly should you do with these versatile and powerful investment tools? It’s all very well having the ability to leverage, to go long and short, and to take positions not just on stocks but indices, currencies and a host of other assets – but without a trading plan, you’re unlikely to get too far.

 “After 17 years trading financial markets I have learned that the one thing all consistently winning traders have in common is a strategy,” says Andy Richardson, founder of www.contracts-for-difference.com, a UK financial trading site that offers free advice on CFD trading. “They all stick to a strict set of rules, taking the emotion out of their decision-making.”

 LONG AND SHORT

In its simplest form, you can just use a CFD in the same way you would buy a share – by going long. Doing so means you benefit if the price of that share, or whatever other asset you have invested in, goes up.

 But one of the main reasons people choose to set up CFD accounts is they make it easy to do something that is otherwise quite tricky: going short. This means you benefit from a fall in the share price.

 This brings us to our first real trading strategy: how you use a short. Most obviously, you can use a short position to express a view that there is a fall coming in something’s value. If you were one of those bright people who took short positions on US bank stocks in 2008, or on an index representing them, then you are probably wealthy enough not to need to read on. In circumstances like that, there is just as much return to be made from something falling in value as rising.

 Many professional fund managers find the ability to go short enormously useful, and argue that being constrained to long-only positions is an illogical limitation of their skills. If they have a view on stocks that are going to go up, surely they should also have a view on stocks that are going to go down? And why shouldn’t they be able to take a position that reflects those views and make money if they’re right? CFDs allow you to do exactly that.

 But there are other uses for shorts too. The main one is hedging. This means you offset one position with an opposite one in order to reduce the risk you have. You can do this in varying degrees: you might take a modest short position that doesn’t complete balance out a long position but does provide a bit of insurance to dampen the blow if the share price falls. Or, in some circumstances, you might choose to negate your positions entirely – if, for example, you have acquired a lot of stock that you can’t sell (most commonly through a share option plan with your employer which requires you to hold the stock for a certain period of time), you could take a short position which means that no matter what happens to the share price you will not have lost or made money.

 “Recently, when we’ve seen activity in our market driven by what’s happening in Europe, clients have been adjusting their strategy a bit,” says James Leplaw at Macquarie. “We are seeing more people use CFDs to hedge their portfolios. If you’ve got 10,000 BHP and you don’t want to be exposed to potentially losing the stock, and what you really want to do is protect your investment, you can short or sell a CFD for the same number of units. You’re then not getting any downside risk, but are also losing any upside exposure to what BHP might do in the short term.”

 RULES TO LIVE BY

 But a trading strategy doesn’t just mean following a theme like this. When many traders talk about strategies, they mean a hard and fast set of rules they apply to themselves when trading as a form of risk management. This might include when to sell out of a losing position; when to sell out of a winning one; and how much leverage they are comfortable with.

 Vital in implementing these strategies are instruments like the stop loss.

 There are all sorts of variations of these conditional order tools, but the principle is simple. A stop loss defines a level at which your broker will sell out of your position if the market moves against you.

 The most obvious example of a stop loss is in a long position, when you’ve bought something in the hope that it will go up in value. If you set a stop loss sell order at, say, 10% below the market price when you place the order, then your broker will bail you out after your position has lost 10% of its value. Deciding exactly where to put the order is tricky: too close to the share price and you’re likely to trigger it in everyday volatility, too far below and you’re exposing yourself to a lot of risk.

 A variation on this theme is the stop entry: that means you’d like to buy a stock, but only if it falls a bit. By buying a stop entry position, your broker will automatically buy in if the stock falls to that level.

 With some providers you can also put a stop loss on a short position, meaning you get out of it if the share price rises too far.

 It’s important to understand a distinction between different stop loss products. “The mechanism for how it is triggered is important,” says Leplaw. “With a stop loss, if a stock trades at a certain price, the order will be executed – but in order for that to happen it has to trade at that exact price. What can happen is, in a falling market, a price step can be jumped” – going straight from $19.05 to $18.95 without hitting your stop loss level of $19, for example – “and with a normal stop loss that will mean the order is not triggered.”

 This is called gapping, and is particularly dangerous in the gap between the market closing and opening again, when the behaviour of other markets around the world will have a big impact on the share price in the meantime. It is quite common for a stock to close at one price and then open the next day much lower or higher.

 To get around gapping, many providers offer a guaranteed stop loss, meaning that even if the share price jumps over your stop loss level without hitting it, the broker takes on that risk and guarantees to get you out at that level. “Think of it as an insurance policy,” says Leplaw. Stop losses cost money and guaranteed stop losses cost more, but many traders swear by them for peace of mind.

 KNOWING YOUR LIMITS

 Another vital part of a trading strategy is to make sure you absolutely understand how leveraged you are, how much you can lose, and whether you are comfortable with that. If you are too highly leveraged, you can sell some of your position, or commit more money as margin against share price movements. But it is impossible to overstate the importance of understanding this simple fact: leverage allows you to make a lot of money, but it potentially loses you a lot too – perhaps more than you actually have. You must understand how to mitigate this risk, and be comfortable with it, before trading with CFDs.

 What do we know about how people really behave when it comes to these risk systems?

 A useful study is the 2009 CFD report by the consultants and researchers Investment Trends in Sydney. They got responses from 7,500 investors, including 2,000 current CFD traders, so their findings are quite representative.

 “Risk management plays an important role in current traders’ strategies, but they are unlikely to switch providers for improved risk management tools,” explains Pawel Rokicki, analyst at Investment Trends.

 58% of current traders in the survey said that contingent or stop loss orders would be important if they were choosing a CFD provider today, and of those respondents who aren’t yet traders but plan to do so, 42% said the availability of guaranteed stop losses was the single most important catalyst to prompt them to start using CFDs.

 More than anything the key with CFDs is to know what you can do and understand what tools you have at your disposal. “Traders should stack the odds in their favour before making a trade,” notes Richardson. “That means spending some time analysing their trading style and mindset, as well as the markets. Some CFD firms offer investors a free suite of tools and seminars designed to assist. Only once these crucial elements are conquered is an investor ready to trade.”

 BREAKOUT: STRATEGIES THE PROFESSIONALS USE

There are several other specific strategies that traders talk about. Here are a few examples:

• Index constituent changes. This involves trying to take positions when indexes are being reweighted in order to try to take advantage of movements in the share prices of companies that are added or removed from an index, or reweighted within it.
• Trading on news. Some CFD providers provide ready access to news about companies – directors selling shares, maybe, or corporate activity – that could affect the share price. Doing this, though, means taking on the professionals, who will be doing much the same thing but probably with faster news sources than you.
• Arbitrage means trying to make a profit from what you see as a price discrepancy – this might be a company trading out of line with its peer group, or even the same company’s stock appearing to trade at different levels on different exchanges. Some professional traders try to exploit these discrepancies by taking one long and one short position, hoping that the discrepancy will eventually resolve itself, making them money.
• An example of an arbitrage technique is pairs trading. This can take a number of forms. One could pair trade with companies in the same sector, such as buying Rio Tinto while selling BHP Billiton because you believe Rio Tinto will rise relative to BHP. One advantage of this is you’re not exposed to what’s happening in the broader market: if the whole ASX 200 crashed, the two shares would presumably crash together, and your exposure is simply the convergence or divergence of the two share prices, not the drop in the market. A more aggressive approach might be to pair trade on stocks in different sectors – even different exchanges – or to pair trade the markets themselves. For example, quite often traders will take a view on the relative merits of the Australian versus the American stock markets, and they can express that by, say, buying the ASX200 and selling the Dow Jones Industrial Average, or vice versa. Getting the best out of trades like this really does require you to watch the markets like a hawk, though, and is better suited for professionals.
• Tax management. This is a way of making some money out of a stock without selling it, since selling would trigger a tax event. A typical approach is called a capital cash release, where the stock you don’t want to sell is used as security to enable you to access more funds for other investments.
• CFDs lend themselves well to technical analysis or charting – a whole other investment discipline, and beyond the scope of this article.

For the second time in two years, one of the engines of the developed world economy is in trouble, this time Europe. And also for the second time in two years, the countries we call emerging markets – those in the developing world in Asia, Latin America and Eastern Europe, for example – look much stronger than their supposedly emerged peers in the west.

At first glance, it looks like a reason to divert your international equity exposure away from places like the US and Europe, and towards places like Asia. The truth is, Asian economies – the ones we have patronised with the emerging label all these years – look in far better fiscal condition than any of the richer counterparts in the west, with the possible exception of Australia itself. “Asia is in better financial shape than it has ever been, and also relative to the world,” says Peter Sartori, who runs Treasury Asia Asset Management, which offers Asian equity funds to Australian investors. Most emerging Asian nations don’t have deficits of any note; they are in a demographic sweet spot in which the bulk of the population are working, and not entering retirement as in places like Japan; and in many cases their biggest challenge is keeping growth in check to avoid inflation, not wallowing out of recession.

The problem is, we’ve been here before. During the global financial crisis, there was a lot of talk that Asian countries had become so strong, they would not be affected by problems in the US. Unfortunately this turned out to be rubbish – although Asian economies stood up pretty well, foreign money fled emerging markets and most stock markets in Asia did even worse than those in the west (although they subsequently rebounded much more vigorously too). So with another crisis in Europe, should we expect contagion again?

Economists generally think not: only 20% of Asian exports go to continental Europe, and most of those to relatively unscathed Germany, meaning a European slowdown should have a modest impact. “While the sovereign debt crisis has increased the downside risks to EU growth, we do not think that it represents a large risk to emerging market Asian growth for now,” says Prakriti Sofat at Barclays Capital in Singapore, who also stresses that exports aren’t as vital to Asia as they used to be because of the growth in domestic demand.

Money managers familiar with Asia are wary. “Having been living in Hong Kong in 1997 and 1998, managing Asian money and witnessing how contagion spread, I’ll never underestimate what contagion could do across Europe,” adds Sartori. “But I find it quite hard to believe that contagion could spread to Asia. My general hope and view would be that Asia would come out of this in a much strong relative position.”

A look at performance numbers does suggest that, for all the volatility, emerging markets funds have been doing better than developed world equities, particularly in the rebound since the global financial crisis. According to data from Mercer, the median emerging markets equity fund sold in Australia delivered a 39% return in the year to March 31, 1.6% a year over three years (a period which includes the whole financial crisis) and 11.5% a year over five years. For overseas shares funds generally, those figures are 17.9%, -7.8% and -0.3% – considerably inferior on all counts, although the picture is much brighter for hedged overseas funds (those that neutralise currency movements).

In fact, much discussion in Asia has focused not on threats to growth, but worries that growth is getting out of hand. The IMF recently warned about the volumes of inflows into Asia, and the creation of asset bubbles, particularly in Chinese property.

Is this a worry? “There are various bubbles in Asia,” says Hugh Young, managing director for Asia at Aberdeen Asset Management. “But they are largely property-related, not really stock markets, although they are due a fall after rapid rises. Famous last words, but there are no huge excesses in most of Asia, though markets are far from cheap.”

That’s another important point: after such terrific rises in most Asian markets in the last year, is it a good time to buy? Even long-standing Asia bulls like Sartori will only say: “Overall, we think Asian stocks can end the year higher than where they are at the moment”; he is actively avoiding India and Indonesia, finding them overvalued.

Credit Suisse Asset Management starting pulling out its emerging Asia equity exposure last November, feeling valuations were getting stretched, and instead getting its exposure by buying developed world companies which get most of their revenues from emerging markets (another popular approach – many people buy stocks such as Coca-Cola, Nestle or even BHP Billiton for exactly this reason). But, according to senior advisor Robert Parker, valuations are “starting to look more reasonable. My view is after the next two to three months we will want to go back into emerging market equity.” He favours Korea, Taiwan and – despite valuations – Indonesia.

It’s important to note that different Asian markets appear to offer different opportunities at different times. Sartori is overweight Taiwan, for example, which in recent years has thawed its previously hostile relations with China, a thawing that ought to have considerable benefits to Taiwanese industry and banking. Also, he notes that China – despite what you read about its phenomenal growth – has been a hopeless stock market performer; its CBN 600 index was down 21.8% in 2010 up to May 17. “Chinese stocks have underperformed for three quarters now and have de-rated. But we’re in the camp that is not overly concerned about China: we think the weakness is throwing up a lot of buying opportunities. Although, saying that, we’re not even close to buying a real estate stock there.”

This raises the question of how to invest in Asian or emerging markets. There are a number of ways.

The most obvious is to buy an emerging market or Asia mutual fund. Morningstar tracks 76 separate emerging market equity managed funds sold in Australia, although many of them are different sales classes of the same fund; they vary from covering all emerging markets (such as the Russell Emerging Markets Fund, up 32.36% in the year to April 30); ex-Japan Asia (such as the T Rowe Price Asia ex-Japan Fund, up 41.91%); BRICs – that handy acronym covering Brazil, Russia, India and China (such as the Macquarie Globalis BRIC Fund, hedged, up 42.23%); or country-specific (such as the Fidelity Indian Fund, at 62.97% the best-performing emerging markets fund over 12 months in Morningstar’s coverage by a mile, and the Premium China Fund, up 33.66%). Each individual fund will have its own allocation overweights and themes, and their views and successes will make a quite a difference to returns: Morningstar tracks some emerging market products that made only single figure returns in the same year that Fidelity was shooting the lights out with its India fund.

Emerging markets is the broadest approach. To take the Templeton Emerging Markets Fund as an example – probably the most famous in the world, thanks to its iconic manager Mark Mobius – as of March 31 this would have put 22.2% of your money into Brazil, 15.8% into Russia, 15.3% into India, 11.3% into China, and then smaller chunks into places like South Korea, Turkey, Hungary, Mexico and Indonesia.

At the other extreme, country specific funds are offered in Australia on China (by Aberdeen, AMP, Fidelity, Premium and Challenger), and India (Fidelity and Fiducian). These allow you to take a view on a particular Asian market, but don’t offer a lot of diversification.

It’s also possible to go it alone. Many Australian brokers allow you to buy securities on the New York Stock Exchange, which allows you access to the many Asian countries that have listed forms of their shares (called American Depositary Receipt listings) there – among them Chinese banks, oil companies, telcos, and a host of other regional blue chips such as Taiwan Semiconductor Manufacturing or Samsung Electronics. Some brokers let you buy shares in Hong Kong and Singapore too. Alternatively iShares offers exchange-traded funds in Australia, bought and sold like any other local share, which replicate the performance of indices including China, Taiwan and Korea, as well as ‘emerged’ Asian markets Singapore and Hong Kong.

Doing your own investing in Asia, though, is not to be taken lightly. It’s hard enough to keep track of what Australian companies are doing without seeing your way through companies in different countries, time zones and corporate cultures.

One thing that has severely damaged the benefits of international share investing for Australian investors in recent years has been the outstanding performance of the Australian dollar against dollar, euro, sterling – you name it. But how about Asia? “We think Asian currencies will appreciate, particularly against the Australian dollar, which is crucial for Australian investors,” says Sartori. Judging currency movements, though, is exceptionally difficult, and many managers hedge it out altogether.

In future, perhaps we won’t talk of emerging markets; everything about the performance of world economies in the last few years has supported the sense that the West is certainly no smarter than the East, and in a much worse financial state. “I don’t particularly like this categorisation of developed market, emerging market, frontier market,” says Parker. “There are many economies categorised as developed which frankly I would call emerging, and likewise some emerging markets I think are developed. The classification is just plain wrong.” But whatever you call it, it’s where the money is going. “You’ve got a quantum change in investor attitudes towards emerging markets,” he says.

BOX: Emerging debt

It’s not just in equities that many people see emerging markets as the best option. Many global fund managers are looking here for the best options in debt too.

“We are long emerging debt,” says Robert Parker, senior advisor for Credit Suisse Asset Management, which manages SFr1.3 trillion worldwide. CSAM starting pulling money out of G3 sovereign debt – in currencies like dollars, euros and yen – and putting it into emerging markets in late 2008 and continues to do so.

At Goldman Sachs Asset Management Asia, Oliver Bolitho, who heads the business, has a similar view. “Given the uncertainties about the ratings and fiscal positions of many OECD countries, there is a strong case to be made that the debt of emerging economies is an extremely attractive proposition,” he says. When Asia’s corporate bond markets develop further, Bolitho expects opportunities to increase, “and those opportunities will remain very attractive, possibly for decades.”

Australia does not, though, offer many ways of buying emerging market bonds in managed funds sold there. Instead, they can opt for funds which allocate more than most towards emerging markets while balancing it with some more stable developed-world government debt or with broader global high yield. A good example of this is the Pimco Extended Markets Fund, sold in Australia to retail through Equity Trustees, which is benchmarked half against an emerging markets bond index, a quarter against an emerging market government debt index and one quarter against a global high yield index. As of March 31 its top holdings were debt in Brazil, Russia, Mexico, Indonesia and the Philippines, and its total net return (distribution plus growth) in the year to that date was a remarkable 39.51%, although the five year average of 8.59% a year is probably a more realistic reflection of how a fund like this ought to return.

Remember, though, that returns come with risks; and while many feel that risk-reward ratio has tilted in favour of emerging market debt, it’s still nothing like owning a Commonwealth bond in Australia.

It used to be that government bonds were considered the ultimate safe haven investment. What could be safer than a government? If they run out of money they can always get their central bank to print some more. For many years, investors have looked to sovereign debt – bonds issued by governments and states rather than banks or companies – as a safe, steady, secure backstop to their portfolios.

But events in Southern Europe are changing people’s attitudes towards what government debt actually represents. This crisis – and it is a crisis, threatening the euro itself – is not about cash-strapped American homeowners, or weirdly repackaged bundles of indecipherable debt, or the failure of risk-stretched banks. It is about countries themselves – governments that have borrowed too much, can’t pay it back, and are now on the brink of default.

So what does this mean for investors and the way we use government debt in a portfolio?

“If we go back in time to before the global financial crisis, there was very much a view among investors that sovereign debt, if investment grade, was basically generic,” says Clive Smith at Russell Investments. “You could buy sovereign debt and it was set and forget: it didn’t have to be actively managed like corporate credit.” That’s what’s changed. “The events around Greece and other countries have highlighted that you can’t just assume sovereign debt is all the same. These exposures have to be actively managed within portfolios.”

Smith’s is a widely held view, particularly among fund managers who have long considered governments on their own merits just like carmakers or miners. “We’ve long believed there was complacency among global investors about risk,” says John Wilson, CEO of PIMCO Australia, one of the world’s biggest debt investment specialists. “Not every stock is the same and not every government bond is the same. That perception was not universally shared by the investment community, who tend to see assets in blocks.” David Bryant, head of Australian Unity Investments, adds: “The first thing that surprises me is that people are surprised. Greece didn’t wake up to a debt problem today. One problem has been an assumption that sovereign entities can’t fail: we have a history in Asia, Russia, Latin America where that isn’t the case.”

And analysts agree too. “In European nations this concept of risk-free is starting to be challenged by investors,” says Mark Reade, credit analyst at Citigroup. “What it has shown is that government bonds really should be assessed like any corporate bond or other investment opportunity in terms of the risk and the reward.”

It’s hard to put a figure to how much exposure Australians have to sovereign debt around the world. The biggest exposure will be through super funds. Most people go for the balanced option in their fund, in which fixed interest (or fixed income as it is called elsewhere in the world) is typically about 30% of the portfolio. “Depending on the strategy, anywhere up to half that could be in sovereign debt,” says Smith. “It wouldn’t be difficult to imagine an exposure of around 15% for sovereign debt for many super fund type options.” That would suggest at least A$150 billion of Australian assets in sovereign bonds and potentially significantly more.

On top of that there’s managed funds: Morningstar tracks 43 global bond funds with a combined A$7.29 billion under management, in addition to several more “high-octane” funds that invest in higher yielding securities; these 43 don’t invest exclusively in sovereign bonds but will certainly include them. One trend in the last year, when sovereign debt seemed to be one of the best performing asset classes, was to opt for a passive international bond fund such as those offered by Vanguard, in order to capture the performance of the whole market.

That said, most super and managed funds aren’t putting their money anywhere near Greece, or not in significant volumes anyway. Much sovereign debt holding in Australia will be domestic, and Commonwealth bonds are considered among the most secure in the world. Plenty more will be in US treasuries, which, despite the US’s economic woes in recent years, are still considered safe. The broader problem is not so much people having money in Greek bonds – a tiny proportion even of European Union debt, never mind on a global scale – but the knock-on effects of the Southern European problems on sentiment towards sovereign bonds worldwide. “The contagion effect is one of sentiment, not one of substance,” says Bryant.

And this will take a while to resolve. “This is not a two month issue,” Smith says. “How countries deal with debt levels, and the impact for investors on their sovereign debt holdings, is something that is going to be unclear in the near term. They may only realise what the ultimate impact is years down the track.”

But for shrewd bond funds, what’s happening in Europe isn’t all bad news. “In every crisis there is an opportunity,” says Wilson at Pimco. As pricing varies widely on bonds around the world because of uncertainty about Southern Europe, managers are trying to take a view on the investments that have become could value because they’ve been wrongly caught up in the panic. For each possible investment, they will weigh up the risk with the potential reward and make a call. Wilson is not a fan of index funds at a time of crisis, feeling that: “Passive investment is an incredibly dangerous thing” at times like this.

The lesson of the crisis is certainly not to abandon sovereign debt as an asset class – although the surge in the gold price in recent months suggests some investors have been doing exactly that, abandoning treasuries and other government bonds in favour of the precious metal – but to understand its role. “I think there is a lot of merit in investing in fixed income securities, and that very much includes sovereign debt,” says Bryant. “The safest place in fixed income is sovereign debt but there’s good counterparties and not so good.”

Since most Australians don’t buy bonds directly in their own right, the key thing for them to consider is manager selection. When buying an international bond fund, how diversified are they? Look at the most recent portfolio update you can find and see how it is spread across credit rating, type of issuer, and geography. This will give you an indication of the manager’s approach to risk, and how you should fit the product in your portfolio accordingly. There’s nothing wrong with taking a risk to get a return; just be sure you know what level of risk is being taken on your behalf, especially in a product you’re relying on never to lose value.