What Egypt Says About Investing in Emerging Markets

February 10, 2011
Shirley M Mueller

Emerging markets are known to be risky, and the situation in Egypt drives the point home. Upheaval in the Middle East demonstrates political risk, one of the major dangers of emerging markets. Another danger? Investment advisers who downplay those risks for their own interests.

Investing in emerging markets has been all the rage lately. Clients proudly tell me their spectacular results. Of course, I am happy for them and invest in them myself. Nevertheless, it is not always rosy.

Emerging markets are known to be risky, and the situation in Egypt drives the point home. Upheaval in the Middle East demonstrates political risk, one of the major dangers of emerging markets -- the other two being economic and concentration. (Concentration risk refers to having a large position in one or two companies in an emerging-market portfolio, because there are few others from which to choose.)

Nevertheless, one would hope that professional investors within the emerging-market countries could do better than the rest of us. Remarkably, this is not always so, according to the information about Citadel Capital, a private equity firm based in Cairo.

As late as Jan. 27, Citadel founder Ahmed Haikel was endorsing Egypt as one of the best investment opportunities globally. This was well after the riots in Tunisia began and days after the initial protests in Cairo. This suggests that the CEO was acting to retain investors, and even engage new ones, in spite of clear evidence the country was ripe for political unrest that could adversely affect its market. Surprisingly, Haikel wasn’t alone. Weeks earlier, Deutsche Bank was recommending Citadel as a “buy.”

Risk is in the eye of the beholder. In this case, the assessor, Haikel, had something to gain from taking a positive view, so he chose to ignore evidence to the contrary. This is known as moral dissonance, a situation where people act in a self-interested way that can cause damage to others. An investor who left his money in the fund, or deposited new money in the fund in late January, could be in for a turbulent long haul.

Egypt will eventually come around, but in the meantime a reasonable question is this, “Who wants to wait when there are safer bets elsewhere that could turn a profit?" The same logic applies to other emerging markets. That is why most managers suggest investing in emerging markets in a limited way, perhaps no more than 5% of a typical portfolio and spread out among different countries. Even in investing there is method to the madness.