Dr Jerome Booth (London, England) is a well-known economist, emerging market expert, investor and entrepreneur.  He is a sought after commentator on global economic events, was part of the MBO creating Ashmore Investment Management, which is now one of the world’s leading investment managers dedicated to emerging markets and, until May 2013, served as its head of research. Through his private office, New Sparta, Jerome manages a number of his investments.  He is the principal shareholder and Chairman of the UK phone company New Call Telecom. He is Chairman of the investigative news journalism company ExaroNews, and Chairman of Walpole Publishing which produces Moving On Magazine for school-leavers. He is also Chairman of New Sparta Films, and also recently bought Icon Film Distribution UK. Jerome is also the principal shareholder of the Lloyds insurance broker, CBC UK Ltd. He is currently a visiting professor at Cass Business School, a governor of Anglia Ruskin University, chair of the Fitzwilliam Museum Development Trust, Deputy Chairman of the Britten Sinfonia and a council member of the Royal Philharmonic Society.

All proceeds from the sale of this book are donated to the Ashmore Foundation, which supports charitable causes benefitting disadvantaged communities throughout emerging markets. For more information on the work of the Ashmore Foundation and the charities it supports, please visit the website: www.ashmorefoundation.org

Acknowledgements xiii

Introduction 1

I.1 Upside down: perception vs reality 2

I.2 The structure of the book 4

1 Globalisation and the Current Global Economy 9

1.1 What is globalisation? 9

1.2 Economic history and globalisation 12

1.2.1 The desire to control and its impact on trade 13

1.2.2 The influence of money 15

1.2.3 Trade and commodification 16

1.2.4 Nationalism 17

1.3 Recent globalisation 18

1.3.1 Bretton Woods 19

1.3.2 Ideological shifts 21

1.3.3 Participating in globalisation: living with volatility 23

2 Defining Emerging Markets 25

2.1 The great global rebalancing 25

2.1.1 Financing sovereigns 26

2.1.2 Catching up 27

2.1.3 The poorest can also emerge: aid and debt 29

2.1.4 From debt to transparency and legitimacy 30

2.2 Investing in emerging markets 31

2.3 Emerging market debt in the 20th century 32

2.3.1 Types of external sovereign debt 33

2.3.2 FromMexican crisis to Brady bonds 36

2.3.3 Market discipline 39

2.3.4 Eastern Europe 40

2.3.5 Mexico in crisis again 41

2.3.6 The Asian and Russian crises 42

2.3.7 Emerging markets grow up 44

(a) The first change: country and contagion risks fall 44

(b) The second change: the investor base 46

2.3.8 Testing robustness: Argentina defaults 47

2.3.9 The end of the self-fulfilling prophecy 48

2.4 The growth of local currency debt 51

2.5 Why invest in emerging markets? 53

3 The 2008 Credit Crunch and Aftermath 55

3.1 Bank regulation failure 58

3.1.1 Sub-prime 60

3.2 The 2008 crisis 63

3.3 Depression risk 64

3.3.1 Reducing the debt 66

3.3.2 Deleveraging is not an emerging market problem 67

3.4 Global central bank imbalances 71

4 Limitations of Economics and Finance Theory 77

4.1 Theoretical thought and limitations 77

4.2 Economics, a vehicle for the ruling ideology 78

4.3 Macroeconomics 79

4.4 Microeconomic foundations of macroeconomics 81

4.4.1 Efficient market hypothesis 84

4.4.2 Modern portfolio theory 87

4.4.3 Investment under uncertainty 88

4.5 Bounded decisions and behavioural finance 90

5 What is Risk? 95

5.1 Specific and systematic risk 99

5.2 Looking backwards 103

5.3 Uncertainty 104

5.4 Risk and volatility 105

5.5 Risk in emerging markets 106

5.6 Rating agencies 108

5.7 Capacity, willingness, trust 109

5.7.1 Rich countries default by other means 110

5.7.2 Two sets of risk in emerging markets 111

5.8 Sovereign risk: a three-layer approach 114

5.9 Prejudice, risk and markets 116

5.9.1 When you have a hammer, everything looks like a nail 117

6 Core/Periphery Disease 119

6.1 The core/periphery paradigm 120

6.1.1 Core breach? 121

6.1.2 Another core/periphery concept: decoupling 124

6.1.3 And another: spreads 124

6.2 Beyond core/periphery 125

6.2.1 Towards a relative theory of risk 125

6.2.2 GDP weighting 126

7 The Structure of Investment 131

7.1 Misaligned incentives 132

7.2 Confused incentives 134

7.3 Evolutionary dynamics, institutional forms 135

7.3.1 History matters 137

7.4 Network theory 138

7.5 Game theory 139

7.6 Investor structure and liquidity 140

7.7 Market segmentation 142

7.7.1 Warning signals 144

7.8 Investor base structure matters 147

8 Asset Allocation 149

8.1 Asset classes 151

8.1.1 Alternatives 154

8.2 How asset allocation occurs today 155

8.2.1 Investor types 156

8.2.2 Asset/liability management 158

8.3 From efficiency frontiers to revealed preferences 161

8.4 Asset allocation vs manager selection; active vs passive 164

8.5 Allocating at sea 167

9 Thinking Strategically in the Investment Process 169

9.1 Thinking strategically 169

9.1.1 Thinking strategically: appropriate discounting 169

9.2 Scenario planning 170

9.3 Global structural shifts ahead? 171

9.3.1 Asset allocation: some proposed new rules 172

9.4 Investment process in emerging debt 174

9.5 Conclusion 177

10 A New Way to Invest 179

10.1 Sense-checking assumptions 180

10.1.1 Risk, uncertainty and information asymmetry assumptions 181

10.1.2 Investor psychology and behaviour assumptions 185

10.1.3 Structure, market efficiency, equilibrium and market dynamics 187

10.1.4 Asset class definitions 188

10.2 Assessing liabilities 189

10.3 Your constraints 190

10.3.1 The decision chain 190

10.3.2 Institutional capabilities 191

10.3.3 Psychological constraints 191

10.4 Consider changing your constraints: agency issues 192

10.5 Building scenarios 193

10.6 Understanding market structure 194

10.7 Asset allocation 195

10.7.1 Route 1: Comprehensive 196

10.7.2 Route 2: Entrepreneurial 197

10.7.3 Asset allocation dynamics 198

10.8 Meta-allocation: toolset choice 199

10.9 Follow the skillset 200

10.10 Portfolio construction and monitoring 201

11 Regulation and Policy Lessons 203

11.1 Regulating financial institutions: new and old lessons 204

11.1.1 Fix the banks 204

11.1.2 Non-banks: who holds what? 206

11.1.3 Reduce agency problems: trustee incentives 206

11.1.4 Honour public service 207

11.1.5 Choice architecture 208

11.2 What to do about systemic risk? 208

11.2.1 Avoid regulation that amplifies risk 209

11.2.2 Beware market segmentation 210

11.2.3 Structure matters 210

11.2.4 Map perceptions of risk 212

11.2.5 Detect and stop asset bubbles 212

11.2.6 Preserve credibility 213

11.3 Wish list for emerging market policymakers 213

11.3.1 Allow markets to work 213

11.3.2 Proclaim and foster greater pricing power 214

11.3.3 Promote EM global banks, south-south linkages 214

11.3.4 Build capital markets 216

11.3.5 Fight core/periphery disease 216

11.4 Reserve management and the international monetary system 217

11.4.1 The dollar is your problem 217

11.4.2 Alternatives to the dollar 218

11.4.3 Too many reserves 221

11.5 What investors can expect from HIDC policymakers 222

11.5.1 Financial repression 222

11.5.2 Consequences of financial repression for banks 223

11.5.3 No early exit from quantitative easing? 223

11.5.4 Bond crash 224

11.5.5 Inflation 224

11.5.6 Appeals to foreign investors 224

11.5.7 Regulatory muddle-through 224

11.5.8 Pension reform 225

11.5.9 Pension regulatory conflict may only abate once EMinvestors exit 225

11.5.10 Rating agencies 225

11.5.11 Intellectual reassessment 225

11.6 What investors can expect from emerging market policymakers 226

12 Conclusion 229

12.1 Afinal list… 229

12.2 … for an upside down world 231

Further Research 233

Disclaimer 235

Glossary 237

Bibliography 245

Index 257

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