During her recent interview with Tobias, Perth Tolle who is the Founder of Life + Liberty Indexes discusses how investing in ‘freer’ countries helps avoid Taleb’s absorption barrier risk. Here’s an excerpt from the interview:
Tobias Carlisle: Let me just play devil’s advocate for a moment. You and I had lunch with Larry Swedroe who’s the factor king, and I hope to have Larry on this show at some stage. Larry said that, and this is a truth in a lot of investing. You’re rewarded for taking risks. You’re rewarded for taking on. That’s sort of what deep value investing is. You’re taking on the risk that these companies look like they’re trending towards zero, and so there should be some premium in the fact that many of these countries that are more difficult to invest in, or aren’t investible from various other perspectives look like they’re undervalued. But your research seems to show something else.
Perth Tolle: Yeah, so our research does show that freer countries over the long run do have more sustainable returns and the investors in those countries get more of those returns. So for example, in China we saw a huge run up in the last 30 years because they absolutely went from abysmal policies, right? To just bad policies, but not abysmal and that has created an economic miracle.
An illusion of one of sorts, but investors in their stock market got very little of that over the last 30 years. We’ve seen obviously huge growth there. So that’s an issue where in the freer countries investors do capture more of that growth. There is something to be said for risk versus reward. As far as that I would quote Nassim Taleb where he talks about the absorption barrier risk. I don’t know if you’re familiar with that or…
Tobias Carlisle: No.
Perth Tolle: I actually didn’t read the book. I heard a podcast that he did with EconTalk where he talks about absorption barrier risk. That is the risk where, the risk that completely takes you out. So if you’re in a casino it’s like where you run out of money. Basically it’s a risk that you cannot recover from, and so that’s the kind of risks that we’re avoiding in emerging markets by investing in the freer countries, because I mean, think about it if you’re in a very unfree country and then something like the government decides to basically I don’t know, blanking on the word here but true opposite of privatize.
Tobias Carlisle: Yeah, it’s not to take them public because that’s not the right word but to take them over.
Perth Tolle: Right, basically they decide the state now owns your company or something like that, and then your investors are screwed. So that is the absorption theory risks, or your lawyer gets killed and tortured, right? Like Magnitsky. Those are absorption barrier risks that you deal with when you have no rule of law. So we would say that, “Yeah, the rewards should be great for those kinds of risks.” So I don’t actually agree with him. Sometimes, especially in the short-term you’re going to see maybe a slightly lower return. We have very high, we have very low sorry. Low tracking error to the benchmark indices so it doesn’t deviate quite a lot. So I would say the risk is too far off there.
Tobias Carlisle: On the upside you say that there’s a relationship between freedom and human rights, and innovation.
Perth Tolle: Yeah. So freer countries are basically faster to innovate, and so faster to recover from draw downs, or faster to pivot according to market needs. Sometimes they even benefit from the market trends in unfree countries.
So for example, Chile is a very high, they have very high trading with China. They’re a very prolific trading partner with China. They do about 25% of their trade with China. So Chile being one of the freest countries and China being one of the most unfree in the emerging markets by these metrics. Last year China had a smart car or a electric car revolution that’s still going on now where the government is subsidizing a lot of electric car companies, manufacturers and so forth. There’s this huge demand now for the batteries that go in these cars, right? Which are made from lithium. And so that’s an investing trend that you’ve seen globally, is investing in these types of batteries.
Perth Tolle: Chile historically has been a huge miner of copper. So one of their companies that are in our index, SQM is a Chilean mining company and they basically pivoted from mining copper to now mining a lot of lithium, and their stock price benefited as well. So a lot of these more freer countries can quickly adjust to market trends. Even the trends in their trading partners who are less free.
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