By: Dr. Bob Swarup, CAIA, AllAboutAlpha.com Editorial Board

The great thing about investing in emerging markets is that they have fundamentally always been a macro trade.

The lousy thing about investing in emerging markets is also the same.

On the one hand, attractive demographics combined with superior household finances and ironically these days, lower sovereign indebtedness and a more stable banking system means that the shift in power from West to East initiated over the last two decades will likely continue. Ardent proponents can trot out endless numbers to support this case, reminding us that last year, for example, the developing world – for the first time ever – consumed more energy than the developed world, and that emerging economies will account for more than 50% of world GDP in 2009, though the latter arguably has also been helped along by the cocktail of debt, leverage and securitisation the developed world chose to OD on.

At the same time, a compelling macro picture doesn’t always mean great returns either. Just ask the countless investors who bought into the dotcom craze in the late 1990s in the belief that the internet would revolutionise our world. They were right – the world was redefined but then so were basic tenets such as valuation and cashflow, as many found to their painful cost in 2000. Moreover, the unique risks of emerging markets – their lack of transparency, illiquidity, political risk and so on – are often compounded by the crowding of large numbers of investors into a consensus trade where the exit door appears dangerously narrow in times of stress. And as 2008 will attest, no matter how credible your investment thesis, the short-term volatility along the way can kill you.

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