The Pitfalls of Investing in Emerging Markets

Sometimes investing in emerging markets is like parenting naughty children. You love them, and you see the potential of what they could one day become … but they do little things that make you want to strangle them.

Consider a couple recent examples from India. While China has become the world’s factory, focusing on manufacturing and exports, India has taken a very different development model. India’s focus has been on information services. Common usage of the English language and a large, highly educated work force made India an ideal destination for outsourced software engineering, call centers and various office support functions.

If China is the world’s factory, then India is its back office.

Given the importance of the free movement of information in a competitive economy, some of India’s recent moves are as baffling as they are disturbing. India is launching one of the largest attacks on free speech ever seen in a purportedly free and democratic country.

Bloomberg reports that Google (NASDAQ:GOOG) has complied with a New Delhi district court order that it remove content that might be deemed objectionable to India’s large Muslim minority population. Google removed the content from its YouTube, Blogger and other services. Facebook, Microsoft (NASDAQ:MSFT) and Yahoo (NASDAQ:YHOO) also were named in the lawsuit.

I’m willing to give India the benefit of the doubt and assume that the material the country sought to block really is objectionable and serves no useful purpose. Still, this creates a slippery slope. When a precedent for censorship is established, there is no telling where it will lead. And a reputation for censorship makes India far less attractive as an information technology hub.

But as important as free speech is, it pales in comparison to property rights and the enforcement of contracts. And on these counts, India also is falling woefully short.

The Indian Supreme Court recently canceled 122 controversial mobile telecom licenses over allegations of corruption and favoritism by the former telecom minister that issued them.

Many international telecom companies bought those licenses in good faith, and now their ability to continue doing business in India is in doubt. Suffice it to say, they and their peers might think twice before making another major investment in India. When contracts with a government minister can be invalidated by the stroke of a judge’s pen, your property is not secure.

There are consequences for this, of course. Investment not made today is growth not enjoyed tomorrow. Ultimately, those that suffer the most will not be the international telecom firms, but the consumers and businesses of India.

I write all of this not to bash India or to tell investors to avoid the country altogether. After all, even developed countries are prone to boneheaded anti-business moves from time to time. You only have to look back five years to see the United States slamming the door on Dubai World Ports in the interests of “national security.” Similarly, the Obama Administration’s handling of the General Motors (NYSE:GM) bankruptcy violated the priority of senior creditors to appease organized labor. What can I say? It happens.

Investors should, however, have reasonable expectations. The road from emerging market to developed country is a rocky one, and there will be setbacks along the way.

All of India’s recent travails notwithstanding, I expect 2012 to be a good year for emerging-market equities. My preferred way to invest in emerging markets is through the EG Shares Emerging Markets Consumer ETF (NYSE:ECON). ECON is a basket of the developing world’s premier consumer-oriented companies. It has a 12% allocation to India and also gives investors ample exposure to China, Brazil, Mexico and Indonesia.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Sign up for a FREE copy of his new special report: “4 Dividend Stocks to Buy and Forget.”

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