Housekeeping and plumbing - Investability of Emerging Markets Sara Zervos Financial Sector Operations and Policy Department The World Bank

OPD 2003 Introduction What have we been trying to do? Ù Identify factors, which impact the “investability” analysis of foreign portfolio investors Macro versus micro Attractiveness versus fundamental access decision How have we done this? Ù Interviews with different types of investors and various functions with importance for the investment process

OPD 2003 Investor Sample Number of institutions. Europe / US Dedicated and cross-over Large and small, internal and external funds Functions: country risk managers, portfolio managers, network managers, back-office managers Selection bias: “fixed income, hard currency, large”

OPD 2003 Focus of presentation The “investability” criteria The investment process The “investable” universe The importance of domestic capital markets

OPD 2003 The “Investability” criteria The universe goes from “Calpers” to “opportunistic hedge funds” (from rules to discretion) Ù Dedicated EM investors: very few have explicit internal “investability” criteria, use of a model Ù Cross-over investors: often limit the investable universe by credit rating Ù Hedge funds: no explicit limits In reality: many driven by (formal or informal) benchmarks

OPD 2003 The Investment Model / Process The risk model: Ù Input:Quantifiable data and Non-quantifiable data Ù Output: Score of risk to expected returns Investment process: Ù 1) crunch numbers => 2) add non-quantifiable factors => 3) adjust score with subjective analysis

OPD 2003 The “investable” universe “Must” invest: countries with more than 5% weight in “the” index “Can’t” invest: Ù countries on the US State Department blacklist “May” invest: Ù Countries that are not too small and not too poor

OPD 2003 “Must” Invest Category Countries with more than 5% weight in benchmark More scope for illiquid investments in large countries Weights (%) EMBI Global2803 EMBI Global diversified 2362 ELMI+1680

OPD 2003 “Can’t” Invest Category Countries the U.S. has comprehensive sanctions against: (currently: Iran, Iraq, Libya, Sudan, Burma and Cuba). Countries sanctioned by the UN. Client driven clauses: scores especially related to minimum human rights, labor rights and judiciary. Minimum plumbing requirements: physical settlement, custodian requirements, and back-office capabilities

OPD 2003 “May” Invest Category Is there something to buy / sell? Is it worth spending resources to research? Ù Too small, too poor Ù “Too successful” to be attractive to dedicated EM managers Plumbing: how long, how easy to get in? (and out!) Have fingers been burned (recently)?

OPD 2003 The hunger for information The hunger for data: Ù Bottoms up: firm level data, input to assess firm profitability Ù Top down: country level data, input to models assessing macro and political risk The hunger for quality: regularly published quality historical data. The hunger for access to public officials

OPD 2003 Size matters Size of country: very few Goldilocks’ “just right” Size of issue (Minimum issue size set by:) Ù secondary market liquidity requirements Ù contribution to portfolio performance Ù contribution to diversification Size of investor: Ù Smaller investors buy small issues

OPD 2003 The importance of domestic markets Local investor base Ù As information providers Ù As liquidity providers (also last resort) Ù As alternative providers of financing for the government Quality of overall financial system

OPD 2003 Summary Few explicit restrictions on dedicated EM portfolio investors. Many implicit restrictions: from benchmarks, from size, from plumbing, from housekeeping Some double standards

OPD 2003 What can emerging markets do? Housekeeping/transparency: Provide timely reliable data Provide access to officials Provide clear information about changes in the legal and regulatory environment Plumbing: fix basic leaks in the plumbing. [Just to minimum not first world standards]