Hey Reader,
The world's most profound structural mismatch creates the greatest investment opportunity of our generation
It’s been a hectic month with over 30 meetings with primarily European family offices discussing asset allocations and emerging markets. I’ve been positively surprised that there is an increasing realization that the (extreme) under-allocation to emerging market equities is neither healthy nor sustainable.
With this 2nd part in this newsletter series, I want to continue the story from where we left off by going into a set of additional under-appreciated reasons for why I myself have allocated 77% of my net worth to emerging markets.
Yale’s legendary CIO, David Swensen:
Market inefficiencies are a core outperformance generator
In David Swensen’s (Yale endowment’s legendary CIO from 1985-2021) portfolio management classic “Pioneering Portfolio Management” he writes:
The second pillar of my thesis rests on this insight regarding how market structure dictates the ability for active investors to outperform. Emerging market public equities offer inefficiencies that simply don't exist in developed markets anymore.
In New York or London, thousands and thousands of analysts and fund mangers armed with a range of data terminals and machine learning algorithms scrutinize every 10-K filing, every management call, every industry development. The result is ruthlessly efficient pricing where genuine alpha (i.e. performance above the market) opportunities are scarce and fleeting. Davis Swensen knew this to be true already in the year 2000, and it remains even more true today.
Contrast that with frontier and emerging markets, where research coverage is sparse, information flows are uneven, institutional infrastructure remains underdeveloped and world-class portfolio managers are few and far in between.
A Vietnamese bank trading at 0.7x book value while having grown earnings at 20% annually for the past 20 years. An Indonesian consumer goods company dominating local markets but ignored by global investors because it's not in the MSCI index. An Indian logistics company that's critical infrastructure for e-commerce growth but trades at single-digit multiples. These are all classic features of less mature and less efficient capital markets.
For active managers willing to put in the work required to dig up and create first-hand fundamental research, emerging markets remain a target-rich environment for generating alpha through superior stock selection and valuation discipline. We are not allocated to emerging markets to make bets on average index performance; we are here to pick a handful of the very best local champions at some of the world’s most attractive valuation multiples and then let them compound structurally from there, in turn leveraging some of the world’s fastest-growing end-markets.
The alpha opportunity in emerging markets today is comparable to what value investors found in the US markets 50-100 years ago.
Active ownership leverage
Listening to the wise words of David Swensen, we can read further regarding his view on the main sources of investing outperformance (on the same page as the previous quote above):
This brings us to the third reason for allocating significantly into emerging markets - the return boost that active ownership can provide in these markets is much more significant than in developed markets.
Even listed companies in developing economies need substantial help to keep pace with their respective end-market growth. Corporate governance standards are improving, but remain inconsistent. Management teams are often first-generation entrepreneurs who have built successful businesses, but lack experience in optimizing equity value for public market shareholders. Strategic planning can often be opportunistic rather than systematic.
This creates tremendous upside for investors who can (and are willing/set up to invest the time and resources to) provide genuine long-term value-add through board participation, strategic guidance, and operational expertise. The same active ownership approach that might generate 10-20% performance improvement in a mature European company can drive 50-100% value creation in an emerging market setting.
The Singaporean sovereign wealth fund, Temasek, exemplifies this approach with multi-billion USD allocations to emerging markets. Temasek not only provides capital to its portfolio companies, instead they partner with their portfolio companies through board participation and strategic initiatives. This active ownership is either executed directly or via a long range of emerging market fund managers that they have invested in as the anchor LP over the years. Furthermore, it’s interesting to note that Singapore’s geographical location (surrounded by emerging markets) helps alleviate the massive home bias that many other institutional allocators suffer from when they over-allocate into Western markets.
The leverage of active ownership is amplified in emerging markets because there's simply more low-hanging inefficacies to be optimized (in turn implying more fundamental opportunities to generate outperformance). If you get the operational improvements right, the upside potential is tremendous compared to the marginal gains available in more mature, efficiently-run developed market companies.
To take one example close to home – a few years back, Endurance Capital, was invested in a leading listed Vietnamese car retailer where we via a direct ownership stake of only ca. 5% managed to put two people on the board to help drive operational change via active ownership. After years of working through a portfolio of non-core real estate on the balance sheet, restructuring of subsidiary ownership, and realizing overall improvements in the group’s operations and showroom roll-out plan, we were able to exit the holding at ca. 30% IRR, selling at a ca. 50% premium to the then prevailing share price. Similar stories are quite rare in a developed market context.
Creative destruction and wealth mobility
Fourthly, emerging markets offer something that developed economies have largely lost: dynamic wealth creation through creative destruction.
In mature markets like Europe or the US, industrial structures and wealth distributions have become relatively static. The same families, the same companies, the same investment approaches dominate decade after decade. Industry changes happen only very gradually (some would even call it “glacially”), and regulatory moats protect incumbents from meaningful disruption.
Emerging markets operate under completely different rules. Structures and wealth remain fluid. Even old-school industries can double in value on a 3–5-year horizon as they professionalize, consolidate, and scale. Fortunes are earned and lost every 5-10 years as new technologies, regulatory changes, and competitive dynamics reshape entire sectors.
This creative destruction creates extraordinary opportunities for entrepreneurially-minded investors. A Vietnamese textile manufacturer can transform into an integrated national fashion platform. An Indian trucking company can become a digital logistics network. A Thai commodity trader can evolve into a vertically-integrated agricultural technology company.
These transformations rarely happen in mature markets where industry boundaries are rigid and competitive positions are entrenched. The massive capital market phenomenon that many investors have grown used to calling “the Fed put” or “the Powell put” as well as the massive bailouts around the Great Financial Crisis are large-scale examples of this – the regulator strongly favors the incumbents and are ready to do “whatever it takes” to counter the natural and beneficial process of creative destruction by letting them fail. In emerging markets, the combination of rapid economic growth, technological leapfrogging, and fluid market structures creates continuous waves of creative destruction that can be captured by investors with the vision to recognize transformation before it becomes obvious.
Greater benefits to asset allocation discipline
Finally, the profound mismatch between economic reality and capital allocation creates a behavioral edge for contrarian investors.
Most Western investors can't psychologically handle emerging market volatility. They panic sell every time there is a 20% draw down in a local stock market, question their thesis during political uncertainty, and liquidate positions exactly when valuations become most attractive.
My best emerging market returns have always come from buying local assets when the general consensus narrative around emerging markets was the worst.
The reason this type of contrarian allocation strategy works particularly well in emerging markets (and will continue to do so again and again) is that the key reason to invest into emerging markets is that their economic fundamentals are simply stronger (they grow faster structurally, they are a more important economic force than Western countries, they have stronger demographics, they have more catchup-growth ahead from urbanization, infrastructure, etc, etc.). None of these structural advantages change with short-term headlines and market sentiments - while we can be sure sentiment ultimately always comes back.
Sentiment volatility in emerging markets is your path to doubling down at attractive valuations. It creates the entry points that generate exceptional long-term returns for patient capital. Make it a feature of your emerging investing style to top up whenever these sentiment-driven opportunities come along.
The coming reallocation
According to the latest UBS data, family offices as a group are planning to increase their exposures to emerging markets over the next 12 months, suggesting that institutional recognition is beginning to catchup. The best sovereign wealth funds from Norway, Singapore, and the Middle East have already significantly increased their emerging market allocations.
When the majority of pension funds, insurance companies, and family offices begin properly weighting their portfolios toward emerging market global market cap share or GDP share (meaning, going from 4% towards 25-50%), the capital flows will be enormous. The investors who positioned early (when valuations were attractive and sentiment around emerging markets was still “not perfect”) will capture the greatest benefit from this structural shift.
On top of the graphs behind the 10:1 current allocation of European family offices in terms of what Warren Buffett called “playing with fire” vs “good buying opportunity” in my previous newsletter, we have gone through four additional reasons for why I myself significantly over-weight emerging markets (currently 77% of my total net worth) at this juncture:
- Market inefficiency is a core outperformance generator and you find these much more in emerging markets than developed markets (in line with the insights from Yale’s CIO David Swensen)
- The positive impact on returns from the practice of active ownership is much greater in emerging markets than in developed markets (there is simply more “low hanging fruit”)
- Creative destruction and wealth mobility is greater in emerging markets
- Rewards from asset allocation discipline are greater in emerging markets (as the swings and regular mispricing are greater)
Most importantly, we're still early in this reallocation cycle in favor of emerging markets. The 4% family office allocation to emerging markets represents the opportunity, not the obstacle. When that allocation doubles, triples (or more) over the coming years (as economic reality demands it must) the valuation appreciations in emerging markets will be significant (after almost two decades of relative under-performance as an overall asset class vs. developed market equities).
The investors who understand this structural opportunity (and who have the allocation framework to capture it) will participate in what might be the greatest wealth creation story of the coming decades.
Christopher B. Beselin
Investing, compounding & exiting
Christopher B. Beselin - is the Chief Investment Officer of Endurance Capital. The views & opinions expressed in this newsletter is for informational and educational purposes only and should not be considered investment advice.
PS. If you're a qualified professional investor and you’re not sure where to begin structuring your emerging market investment exposure - feel free to schedule a 1-to-1 emerging market strategy call with Christopher B. Beselin via this link. DS.
