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Once upon a time, Americans invested about 90 percent of their money at home. Now, individuals and businesses in the United States and many other countries have tempting opportunities to dip into markets around the world. But how much of the returns do they get to keep, and how much can they actually bring home? These two questions don't receive enough attention, especially among investors chasing high returns in emerging markets. Corruption, conflict, crises, and more can eat away at the bottom line. The Baseline Profitability Index (BPI), published here for the first time, takes several of these into account to suggest where investors should really put their hard-earned cash.
The inaugural version of the index includes 102 countries across six continents and redraws the typical economic map of the world. China, for instance, is well known for its rapid economic growth, but the difficulties of doing business there can cut into a foreign investor's return; it ranks 21st in the BPI. Chile may not be such a big or fast-growing market, but its friendly climate for business can make it a more attractive place to invest; it ranks eighth.
Hong Kong and Singapore, which regularly top indexes like the World Bank's Doing Business rankings and the World Economic Forum's Global Competitiveness Report, also take two of the first four spots in the BPI. But three of the top 10 are African countries -- Botswana, Rwanda, and Ghana -- where high returns are accessible and, to a great degree, retrievable. India is the only BRIC country in the top spots; Brazil and Russia languish near the bottom. And Eastern Europe, though perhaps a less glamorous destination to investors, compares favorably to the tigers of East Asia.
So how does the BPI work?
Three factors will affect the ultimate success of a foreign investment: how much an asset's value grows, the preservation of that value while the asset is owned, and the ease of bringing home the proceeds from selling the asset. Each of these factors requires a different kind of assessment. It's not enough to worry only about rates of return, corruption, political stability, investor protection, or exchange rates alone; as I've written before, you have to worry about all of them.
Until now, however, no index has combined these factors into a summary statistic that conveys a country's basic attractiveness for investment. Even as a first attempt, the BPI sends a clear message: Look seriously at frontier markets that offer high returns and improving economic institutions. Six of the top 20 countries in the BPI are African. With the World Economic Forum on Africa taking place this week, the time is ripe for investors to shift their focus.
The calculation of the BPI is, of course, an imperfect exercise fraught with assumptions. For example, how does a survey about perceptions of corruption translate into likelihoods of having to pay bribes, and how big might those bribes be? The more country-specific assumptions you make to answer questions like these, the less comparable countries will be within the confines of an index. Also, an asset's returns may depend on tax treaties between the investor's home country and the country where the investment is based; there are so many possible permutations of this pairing that I've decided to leave taxes out of my calculations.
The scenario envisioned by the BPI is of a five-year investment by a business or a saver -- say, a private equity fund buying a stake in a foreign company. The BPI compares how local policies and conditions would affect the same investment in different countries. In other words, it asks how the value of the principal and the return will change depending only on where the investment is made. It also assumes that the investor reinvests the asset's returns during the five-year period, then sells the asset and brings all the money home.
In calculating the BPI, the first factor to consider is the growth of the asset's value. The BPI starts with the International Monetary Fund's forecasts for five years of economic growth, adjusted for inflation. Implicitly, the BPI assumes that when an economy grows, a given chunk of that economy expands in equal proportion. Then the BPI discounts the asset's value by the risk of a financial crisis or security issues that could hamper the investment. In other words, a default on sovereign debt or a civil war could derail economic growth enough to put a dent in the value of the investment's principal and return. These risks are measured using Standard and Poor's sovereign debt ratings and the World Bank's Worldwide Governance Indicators for political stability and rule of law.
Next, local factors may erode the profit after it appears. These include the payment of bribes and kickbacks (judged by Transparency International's Corruption Perceptions Index), expropriation or nationalization of the asset by the local government (from the International Property Rights Index published by the Property Rights Alliance and Americans for Tax Reform), and self-dealing by local managers. This last risk involves the possibility that employees or executives will eat away at profits by giving themselves perks, excessive pay packages, or other sweetheart deals. The BPI assesses it using an index of investor protection compiled by the World Bank with methodology proposed by Simeon Djankov, Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer.
Finally, there is the question of how much the profits will be worth once they return to the investor. The BPI first asks whether the target country for the investment has any capital controls in place, since these may restrict the repatriation of profits; the metric here is Menzie Chinn and Hiro Ito's index of financial openness. The last issue is whether exchange rates will change enough over five years to affect the value of the investment. For this, I created an algorithm that simulates long-term convergence of purchasing power parity -- essentially, the notion that as poorer countries become richer, their currencies will gain value in real terms. This doesn't happen overnight, of course, but during a period of several years it may begin to occur.
The countries that score poorly in the BPI do so for a variety of different reasons, but there are some common threads. Angola and Venezuela, for instance, are two resource-driven economies with the potential to grow very quickly. Alas, a raft of issues erodes the attractiveness of investing in either of them. Angola has strict capital controls that could affect the repatriation of profits, and Venezuela's currency might actually depreciate in real terms. Both countries fall short in the protection of investors from the use of unscrupulous tactics by government and private partners, and corruption is rampant. Lebanon and Pakistan aren't much better: Security, capital controls, and expropriation are all of acute concern.
The BPI is not the last word on where to invest, but it does offer simple summary statistics to investors who don't have time to research all of these 102 markets in depth. In the past, organizations such as the California Public Employees Retirement System provided multi-factor assessments of foreign markets, and these were useful public goods for the investing community. I hope the BPI will follow in that admirable tradition. For inquiries about the BPI, which can be found on the following page, please contact me here.
About the Index
The Baseline Profitability Index (BPI) ranks countries by their overall attractiveness as targets for a generic foreign investment. The index values offer a better idea of how far countries are from each other. In addition to the overall rank, the countries are ranked by the three main components of the index: asset growth, preservation of value, and repatriation of capital. Note that countries whose currencies are expected to appreciate in real terms will rank higher for repatriation of capital, all other things equal. The time horizon envisioned for investment is five years.
|BPI Rank||Country||BPI Value||Asset Growth||Preservation|
|87||Bosnia and Herzegovina||0.90||98||81||18|
|90||Trinidad and Tobago||0.90||76||44||74|
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