Which is the best country to invest in?

Which is the best country to invest in?

We're constantly told that the countries worth investing in are those forecast to enjoy the highest rates of economic growth. It sounds intuitive. But is it actually true? Perhaps surprisingly, the academics who've studied the evidence, including Professor Elroy Dimson and his colleagues at London Business School, say it isn't.

In this video, Professor Dimson explains a puzzle uncovered in his research. Looking across countries over more than a century, those with the highest economic growth actually delivered somewhat inferior stock market performance. Jay Ritter's study, "Is Economic Growth Good for Investors?", examined data from 15 emerging markets between 1988 and 2011 and found a genuinely negative correlation between growth and stock prices. In China, for instance, growth averaged around 9%, while stock returns averaged minus 5.5%.

You'll learn why economic growth so often fails to reach investors' pockets. For Professor Dimson, the crux of the issue is dilution: the benefits of growth are shared between many different parties, and the investor may not benefit at all. Entrepreneurs create valuable businesses. Workers receive better compensation. Governments engage in public works. Corporations raise funds by issuing new shares. None of these automatically benefits current investors, though they may benefit future investors who buy in later. It's a considerably more nuanced picture than it first appears.

You'll also learn about a second explanation: simple market efficiency. Projected growth rates are already incorporated into share prices. Investors operate internationally and are willing to pay more for shares in a high-growth economy than a low-growth one, which means the returns they earn from investing in that growth are no higher than a fair reward for the risk taken.

The takeaway: the next time you read or hear that a particular country is tipped for stellar economic growth, resist the temptation to pile in. A balanced, globally diversified portfolio is always the better policy.

Chapters / Key points

• The common belief that high-growth economies make the best investments
• What the academic evidence actually shows
• Why high-growth countries have delivered inferior stock returns
• Jay Ritter's study of 15 emerging markets
• The striking example of China's growth versus its stock returns
• Why dilution means growth doesn't reach investors
• How entrepreneurs, workers, governments and new share issues absorb the gains
• Why market efficiency prices growth in already
• Why a globally diversified portfolio is the better approach

Transcript

Which is the best country to invest in?

Robin Powell: Hello again. We're often told the countries to invest in are those forecast to produce the highest rates of economic growth. But is it actually true? Perhaps surprisingly, the academics who've studied the evidence, including Professor Elroy Dimson and his colleagues at London Business School, say it's not.

Elroy Dimson: When we wrote our book, one of the things that we noticed was, if you looked at the cross-section of countries over more than a century, the ones which had had the highest economic growth actually had somewhat inferior stock market performance. That's a puzzle.

Robin Powell: In his study, "Is Economic Growth Good for Investors?", Jay Ritter examined data from 15 emerging markets between 1988 and 2011 and found there was actually a negative correlation between growth and stock prices. In China, for example, growth averaged about 9%. But stock returns averaged minus 5.5%. For Professor Dimson, the crux of the issue is dilution. In other words, the benefits of economic growth are diluted between several different parties. The investor might not benefit at all.

Elroy Dimson: It can be individual entrepreneurs creating businesses that had value to the economy. It could be people who have jobs, who are getting better compensated for doing that work. It could be the government. It could be a country which is engaging in public works. Or it could be the corporate sector that's raising funds, issuing shares. So, those are not automatically a benefit to current investors, those may provide a benefit to future investors who buy shares in a company. So it's a more subtle, more nuanced issue than it appears at first sight.

Robin Powell: Another reason why investors are so often disappointed by returns from high-growth economies is simple market efficiency. In other words, projected growth rates are already incorporated into prices.

Elroy Dimson: Investors operate internationally in general, and they will be willing to pay more for shares in a high-growth scenario than shares in a low-growth scenario. So the investment performance that they can gain from investing in a growing economy will not be any higher than you'd expect as a fair reward for their investment.

Robin Powell: So, next time you read or hear that such and such a country is tipped to enjoy stellar economic growth, don't be tempted to pile in. Having a balanced portfolio that's globally diversified is always the best policy. Goodbye.