Force Of Law And The Law Of Force

I believe in international investing. My colleagues and I dive deep into the funds we consider for our clients, carefully sifting and balancing to create what we consider to be just the right the mix of regions, countries, industries and company sizes.

We have done this for many years. The world has changed considerably in that period, but one constant in our approach has been to avoid any direct investments in Russia and mainland China.

Investment practices our size, especially those with a global focus, generally do not do this. Since our business began in the 1990s, China has grown from a minor economic power to the world’s second-ranked economy. Russia, meanwhile, recovered from its late-1990s economic crisis to become the world’s number one oil producer, as well as a major market for Western (primarily European) and Chinese goods, as well as high-end American real estate.

So why do we avoid investing in Chinese and Russian companies?

In a nutshell, we avoid them because I believe there is a key distinction between investing and gambling, and that committing capital to these countries is more like the latter than the former. As my firm’s founder and president, I passed these views on to my co-workers. They may agree with me or they may not, but on an issue this fundamental, it doesn’t matter. I have the ultimate responsibility, and I make the call.

I define investing as the commitment of resources in the rational expectation of receiving a return. Gambling, or speculation, is based on hope rather than rationality. We can rationally expect, from historical results, that the S&P 500 will be higher 20 years in the future than it is today. It is not at all rational to assume that it will be higher tomorrow than it is today. Buying an S&P 500 index and planning to hold it for 20 years is an investment. Buying that same index and planning to sell it tomorrow at a profit is just a gamble.

Business operates on rational expectations. If we make a decent product for which there is demand, and if we price it right, we rationally expect people to buy from us. If we meet the requirements for government permits, we expect to get the permits; we should not need to plan on paying bribes in order to get them. And if we sign a contract, we expect the other party to honor the contract or the courts to enforce it, if necessary.

In dealing with other nations, we similarly expect them to make and honor commitments, to use established mechanisms to resolve disputes – which are inevitable – and not to resort to violence for political, commercial or strategic advantage. We also expect governments to be accountable to their own people, which is what enables them to make valid long-term commitments on behalf of their nations.

In other words, we should expect to do business under the force of law, rather than the law of force.

We cannot realistically expect that to be the case in Russia or China today. Those conditions have never existed there in my lifetime, and long before. For a decade or so beginning with the fall of the Iron Curtain, we hoped Russia would establish a durable democracy, along with the rule of law, with an independent judiciary to enforce it. Instead, Russia experienced a chaotic period of privatization-driven kleptocracy under Boris Yeltsin, followed by a steadily more autocratic, nationalistic and repressive regime under Vladimir Putin and his bench player, Dmitry Medvedev.

In China the power of the Communist Party remains the paramount consideration, even as communist ideology has withered to irrelevance. The result is a self-perpetuating elite that seeks to maintain its privilege through censorship, repression and nationalistic campaigns against neighboring nations, as well as through the more appropriate means of raising living standards for its people.

In Russia and China, contract and property rights mean whatever the local authorities want them to mean at any given moment. A nation that forcibly seizes territory from another sovereign will have no qualms about seizing foreigners’ local investments.

Investing in Russia means gambling that Putin will not do something unpredictable to seize or impair your investment. Investing in China means gambling that some future crisis over domestic politics, foreign territory or Taiwan will not create an economic or human disaster.

There is no way to invest sensibly today without investing in those countries at all. Too many multinationals have substantial business interests in Russia and China to avoid them as a practical matter. Most of those companies have global portfolios, however; a single adverse development in Moscow or Beijing might be costly, but usually it would not jeopardize the entire enterprise.

Companies organized and managed in Russia and China, however, are entirely subject to the whims and vagaries of local authorities. We can assume that those authorities act responsibly and rationally, but as events playing out in Ukraine illustrate, those assumptions are based more on hope than on fact. In other words, acting on such assumptions is a gamble. Keep this in mind later this year when big Chinese companies like Alibaba and Weibo make their initial public offerings in the United States.

When I direct a client’s investments to a certain place, I am basically entrusting that investment not just to the fund managers who pick the company shares we hold, or to the company managers themselves. I am entrusting someone else’s money to the political, legal and social systems in which those companies operate. I have to at least expect fair and predictable treatment.

I never had that sort of trust in Boris Yeltsin, Vladimir Putin or any Chinese Communist leader. I often wonder how Western CEOs could persuade themselves that these are safe enough places to make big investments. I do understand the jackpots these places offer. I just don’t like to gamble.

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