“They get your money. You get a piece of paper.”

My first job in investment management was as a mutual fund analyst at Morningstar, and to this day I still remember my first Morningstar Conference. This was back in the days just before emerging markets were commonly accepted as an asset class, which in investment industry terms is tantamount to saying “when dinosaurs roamed the earth.”

That’s likely why the emerging markets fund manager panel is the one that sticks in my memory. The first speaker was superstar Templeton manager Mark Mobius, who entered the conference by wading through the audience of khaki-clad financial planners in a cream-colored suit, with a completely shaved head, and surrounded by giant bodyguards in black suits with earpieces. Mobius gave his characteristically bullish take on the emerging markets and recounted several stories about his recent travels across Asia and Africa, and zeroed in on the massive changes taking place in China as the drivers of a once-in-a-lifetime investment opportunity. I vaguely remember anecdotes about the proliferation of cranes in Shanghai and the wonders of the enormous new consumer market just around the corner.

I don’t remember the name of the next speaker, which is appropriate since he worked in the hive mind of the Capital Group that runs the American Funds. What I do remember is the manager’s deep skepticism of China’s separate equity market for foreign investors in Chinese shares. Given the near total lack of transparency and protection for minority shareholders, the manager said, it wasn’t hard to see who got the better end of foreign investment in Chinese shares. “They get your money. You get a piece of paper” without any rights, he said (more or less – I didn’t write it down).

To be fair, both Templeton and the American Funds went on to invest heavily in Asia, as did most other fund managers. Nonetheless, I was reminded of that manager’s skepticism when I saw this in Bloomberg over the weekend:

China’s 20-year economic boom has boosted the wealth of its 1.3 billion citizens at the fastest pace worldwide and spawned some of the biggest companies in history. Foreigners earned less than 1 percent a year investing in Chinese stocks, a sixth of what they would have made owning U.S. Treasury bills….

While China’s shift toward a market economy has lifted per-capita incomes by 1,074 percent and helped its companies raise at least $195 billion through stock sales in Hong Kong, investors with $695 billion say that corporate governance concerns, competition and state intervention have eroded returns for minority shareholders. Now, as China allows unprecedented access to its local capital markets amid the weakest projected gross domestic product growth since 1990, Aberdeen Asset Management Plc says valuations must fall further before it buys.

“China is a case in point that great GDP doesn’t mean a great stock market,” Nicholas Yeo, a money manager at Aberdeen Asset, which oversees about $322 billion worldwide, said by phone from Hong Kong on July 10. “The lack of quality in terms of corporate governance is one of the main reasons we find why companies don’t perform well over the long term.”

The difference between an exciting narrative and a great investment is often invisible even to the experts. That’s doubly true when competitive performance and marketing pressures lead investors to ignore the fundamentals of governance.

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