Morningstar Advisor - October/November 2009 - 53

I worry mainly about protectionism coming out of the developed markets. It could be catastrophic both for developed markets and emerging markets, but the impact on emerging markets would be worse, certainly in the short term. Arjun Divecha William Rocco: Could you talk about the evolution of your universe over time? For example, for years, we’ve talked about Korea graduating to developed status. And on the other end of the spectrum, how do you think about frontier markets? Rusty, maybe you could start because your colleague Don Olson runs an institutional frontier-emerging-markets fund. Johnson: As far as I’m concerned, Korea’s with a lot of resources. It has the potential to evolve into a serious developing economy. Foster: Working here at Matthews, we are ready to go to developed-market status. They have most of the big issues that are necessary to migrate: Per-capita income is high, banking penetration is high, education levels are world record, Internet and cellular phone penetration is high. Korea shows a lot of characteristics of a mature economy. The banks struggle to earn a return on asset of 1%. So I think it’s prepared to go. In fact, it’s part of our struggle with Korea. We don’t find deep underpenetration of services and products that you can find elsewhere in emerging markets. It would be a good thing for Korea to move on and allow more capital to come into the developing economies. At the other end, there’s no bright line between frontier and emerging. The governments of most frontier countries have started to read the rule book on how to grow their economies. Our frontier group, for example, sees parallels between Nigeria and Brazil. A lot of stateowned enterprises in Nigeria are struggling with privatization and corruption. There’s a high degree of fear, but they understand the path where they need to go. Nigeria is a big country regionally focused. For us, the distinction between an emerging market and a developed market is increasingly blurred. We see it as more of a binary construct of how money is benchmarked and indexed. It really doesn’t fit with the fact that these countries are evolving across a whole series of different spectrums—political sophistication, openness of capital markets, currencies, development of major industries, etc. Take China, for example. It’s both a developed market and an emerging market. There are pockets of that country that are every bit as developed as the major developed countries around the world, and there are pockets that are impoverished, where development is far behind. Divecha: My distinction between emerging and developed markets—which I’ve tried to convince the people from the index committees to think about—is not so much market development, because there are a number of emerging markets that are certainly more sophisticated and more developed than, say, Norway and Finland. To me, the distinction between an emerging and developed market is that a developed market has a finite probability of catastrophic loss. Korea, because of the North Korea dimension, is in my book an emerging market. countries in the set of countries from which we can pick. Realistically, given the size of the assets that we manage, the amount of money that we can put into some of these places is very, very small, so we don’t see frontier markets as being a substantial part of our assets. But as they develop, become more liquid, and become more accessible, we could see putting more assets into frontier markets. Foster: But hasn’t the premise that developed markets have only a finite chance of loss been overturned in the past year? We used to say that a developed market is one where there was transparency of regulation, a fairly free and vibrant private sector, and without a huge amount of government intervention, regulation, or subsidy. We’re starting to see those lines being blurred, and it’s hard for us to say with clarity what delineates the two. Divecha: I don’t have any dispute with what you’re saying. My point is simply that the probability of some government action or something that could have a major impact on foreign shareholder’s holdings should be taken into account. K Arijit Dutta is an associate director of mutual fund analysis with Morningstar. William Samuel Rocco is a senior mutual fund analyst. We think a lot of the frontier countries are getting more interesting. We include 18 frontier MorningstarAdvisor.com 53

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Morningstar Advisor - October/November 2009

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