Smaller Markets with Better Governance Offer Investors Higher Long Term Returns: Goldman Sachs

Governance of corporations and countries has become recognized as a significant determinant of reputation and management success. Jim O'Neill, head of economic research at Goldman Sachs, who coined the term "BRIC" has identified a new crop of growth markets differentiated by their superior governance. By Reuters as reported in the New York Times

The BRIC acronym for the world’s biggest emerging economies, created by the Goldman Sachs economist Jim O’Neill a decade ago, became a somewhat self-fulfilling prophecy. It arguably diverted billions of investment from elsewhere to his chosen markets of Brazil, Russia, India and China.

Mr. O’Neill’s new bloc of large growth markets — which could be called MIST for short and is made up of Mexico, Indonesia, South Korea and Turkey — may do the same. But smaller markets with better governance could offer investors higher long-term returns.

The BRIC grouping in 2001 was well timed. With global interest rates low for several years after its coinage, large money pools were actively seeking new investment opportunities. Growth in Asia made investing there appealing. And the active marketing of the BRIC concept attracted large amounts of money to Russia and Brazil that otherwise might not have flowed to either country, and thereby increased growth in both.

The self-reinforcing effect may repeat itself. The latest countries chosen by Goldman have little in common aside from the fact that each economy represents more than 1 percent of world gross domestic product (in Indonesia’s case, just below it in 2009). For example, South Korea is much richer than the other three, with a per capita G.D.P. of $27,000. Growth in Mexico, meanwhile, has been notably sluggish over the last two decades.

This G.D.P. limitation is unduly restrictive, as the indicator fails to correlate particularly well with market liquidity. For example, Indonesia’s Jakarta stock exchange had a November 2010 market capitalization of $339 billion and Turkey’s Istanbul exchange $304 billion. Meanwhile, the Santiago exchange had $326 billion, even with Chile’s much smaller economy. Exchanges in Johannesburg, Taiwan, Singapore and Malaysia, also in much smaller economies, were larger and presumably more liquid.

Investors, therefore, may do better to focus on governance. The quality of national governments and their respect for property rights matter more than size when it comes to choosing investment opportunities. Apart from making an economy grow more rapidly, good governance ensures some protections to make the problems investors have encountered in, say, Russia or Venezuela, less likely. But understanding the nuances of such complex dynamics may require more than any simple acronym can ably provide.

G.E. Chief’s New Role

When the president asks for help, it would be difficult for even the busiest corporate chief to say no. It’s even harder when he owes the government a huge favor. And so it is that Jeffrey R. Immelt, General Electric’s longtime boss, is heading to Washington to advise Mr. Obama on how to make the United States a job-creating colossus again.

G.E. shareholders, already cheered by stellar fourth-quarter earnings, including a strong showing by its troublesome GE Capital unit, didn’t seem bothered Friday that Mr. Immelt will divert some of his attention to the president’s agenda. After all, many of the objectives — like bolstering America’s manufacturing might and promoting access to foreign markets — dovetail nicely with G.E.’s own global industrial businesses.

But it’s a matter of timing. While G.E.’s share price has nearly tripled from the dark days of the financial crisis, it’s still around 50 percent off the highs seen before the investors panicked about shaky investments that the conglomerate’s finance unit made. Mr. Immelt should be credited with steering the company — with generous support from the government through debt guarantees and short-term loans — in the right direction. But he clearly failed to avert G.E.’s fall into a precarious state to begin with.

Gaining access to the president’s ear has its advantages, and there’s a long history of executives, including former G.E. officials, advising a commander in chief while continuing to run their own companies. Yet the current climate carries a distinctive disadvantage: backlash from the public if it suspects the relationship is too cozy. Just ask Goldman Sachs.

And G.E. still needs its best minds focused on business. To Mr. Immelt’s credit, investors spend much less time worrying about the finance unit, which knocked its mammoth parent to its knees two years ago. He’s committed to cutting it down to a more manageable size by 2012 and making it less dependent on short-term financing.

But G.E. shareholders, especially those who held on through its darkest days and are still nursing losses, deserve a committed captain. Should Mr. Immelt appear stretched too thin, they would be right in demanding he choose one job or the other