Thought on Emerging Markets; and playing (Russian) roulette?

With some of my best performing stocks being emerging market plays, I got to think about the question of …

Are Emerging Market investments disguised games of Russian Roulette? What provocative thought I want to express with this question is the difficulty of judging investments’ return profiles despite recent strong performances.

Roulette can offer big wins for a while despite being a negative expectation game. The reason for this is volatility. When you enter a casino and start playing roulette, your bankrole will not decrease a few percentage points per game of roulette according to expectations (casino’s edge). It will not follow a steady decline, but fluctuate wildly. The only certainty is, it will go to zero in the very long term – this means if you play enough rounds.

Even the casino would (if it had only one customer/gambler) see its profit/loss swing wildy, despite playing a positive expectation game.

Expectation is a statistical fiction, like having 2.5 children.

From the Book: Fortune’s Formula by William Poundstone

Russian Roulette might offer very favourable return profiles … on average! The expectation might be positive. It might offer the chance to double your stake in five out of six scenarios but in a small minority of scenarios leading to a catastrophic and complete loss of the investment. The game offers favourable positive returns on average, but if you play parlayed games (reinvesting winnings) you will ultimately hit zero. This is the differnece between
(for more see my Book-review: Fortune’s Formula by William Poundstone) Also handy definition from :

How do I know that my emerging market investments are no such plays? Their returns so far are strong, but the performance might merely depend on lucky outcomes in a ‘Russian Roulette’ play, due to volatiliy and luck, not skill or superior return profiles. The rare catstropic loss might be triggered by extreme political action like the ruling party expropriating property owners and titel bearers (whatever title a VIE is). We might think of much more extreme action by the CCP with the effect of all Western investors losing their valuable investments in China.

When it comes to emerging market investments I am never entirely sure about the true probability of catstrophic outcomes. I even believe we never can be sure, but uncertainty is higher for EM investments. Thus, I think it is best to

  • keep my overall EM allocation rather small, and to
  • size each single EM investment rather small

Since almost everything in investing cuts both ways, such a small sizing results in less than maximized returns if EM stocks perform best. As such, a few of my EM stocks (SBER RU, GAZ GY, 398 HK) have delivered strong performance recently, but their overall effect to the portfolio performance or ‘contribution’ remains limited.

One more thing has to be mentioned here. I broadly define EMs as regions with higher uncertainty for ‘disruptive events’, mostly due to (perceived) less stable politics and higher uncertainty regarding economic stability. But we should not fool ourselves. Similar events can take place anywhere on earth. A good example might be the rushed German exit from nuclear power after Fukushima. That was quite a ‘disruptive event’ for German utilities and their shareholders. Quantifying EM risks is hard, but I am pretty sure that the range of likely outcomes is wider and distributions have fatter tails.


List of interesting events in this regard:

  • China during 2021 with common prosperity (tech) and various regulations, questioning who will receive profits
  • Kazakhstan (Jan 2022) protests/etc: affecting KAP LI as Uranium-play?

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s