Country Based Equity Asset Allocation
Financial, sector & valuation analysis by market
An Investment Taxonomy That Makes Sense
-John Authers, Financial Times
Ecstrat's classification of governance regimes globally comprises of nine distinct categories of Governance Regime, defined as the relationship between minority investors, controlling shareholders, labour and the state, taking into account broader commercial, social and political factors.
The Anglo-Saxon countries, including the US, UK and Australia where equity markets play a key role in capital allocation and shareholder returns are prioritised over other more societal objectives. They have the most transparent markets with high levels of free float and dispersed control .
Coordinated Governance Regimes are characterised by a relatively high level of social consensus, which limits the role of markets to some extent, but which also prevents elite groups such as wealthy families from capturing state resources
Network based governance regimes are characterised by the horizontal networks, which often control listed companies. They have most in common with Coordinated Governance Regimes where equity markets have also generally played a secondary role to bank finance
This classification derives from Ben Ross Schneider’s ‘Hierarchical Market Economies and varieties of Capitalism in Latin America’ for those political and corporate systems, which are dominated by elite families.
Authoritarian Governance Regimes are those where the state dominates the listed corporate sector either through direct control or via a capability and propensity to intervene directly in the private sector
State-Guided Governance Regimes are those where the state guides most financial and capital-intensive economic activity to facilitate national economic development, whilst also allowing private sector companies to develop
Dependent Governance regimes are those where foreign direct investors dominate private capital allocation. They are located in developing economies
Autarkic Governance Regimes are largely closed to portfolio and direct foreign investment
We place each of the major global equity markets into the one of these categories which we believe best represents the prevailing Governance Regime, although there will be some elements of other systems present in almost every country. We then identify the potential catalysts for change to gauge the direction in which each market is most likely to evolve.
THE MISSING LINK BETWEEN POLITICS AND MARKETS
Secular shifts in governance regimes by country are one of the main drivers of long term economic and financial market performance. Governance regimes also undergo their own cycles of hubris, which can help to time market cycles. The analysis of governance regimes forms the basis for a country-based asset allocation process, which cuts across the existing division between frontier, emerging and developed markets.
Each secular market cycle is marked by the concentration of moral hazard and hubris in a particular Governance Regime, leading to economic and financial crises. The two previous secular market cycles in the post-1991 settlement, culminated in the 1997-2002 emerging market crises of Hierarchical Governance Regimes or family-based capitalism and the 2007- 09 Great Financial Crisis (GFC) of Liberal Governance Regimes.
Between 1991 and 2008, it appeared that the corporate control structures and broader Governance Regimes would gradually converge towards supposed Anglo-Saxon liberal norms, but since the GFC this is no longer the case. Instead the legal, historical, social and political context of individual countries, increasingly shape the environment for investors in the listed corporate sector.
We believe that this is a much more useful representation of the fundamental characteristics of each market than the current split into Frontier, Emerging and Developed categories, from the perspective of a global equity investor.