“There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don't know we don't know.”
Those now famous lines are from Donald Rumsfeld, who died recently at the age of 88. Whatever you think of his politics, you have to admit he made a wise observation here –– and one certainly applicable to investing. (Though, of course, he was not the first to make it). And he added, it is “the latter category that tends to be the difficult ones.”
Investing in a market other than your home market seems to entail more of the unknown unknowns.
For example, I always think of a story Murray Stahl told in his 1995 collection of essays titled “Collected Commentaries and Conundrums Regarding Value Investing.” The essay is called “An Unorthodox View of Emerging Market Investing.”
The Budapest Stock Exchange
He begins by telling us about Hungary. It is an emerging market. Despite a difficult history, it is on “the verge of major economic progress.” It has a stable democracy in place and good foreign relations. Economic growth is healthy.
Stahl gives us lots of statistical nuggets to support this thesis. Hungary produces a number of industrial commodities, like coal and iron ore. And production rates are up 5-8%. Railroad freight is up 16%. He also shows us the growing clout of the middle class. Travel is up 9% year-over-year. And wine consumption, up 47%.
There is more anecdotal evidence offered too. In Budapest “the neighborhood known as the Garden District is now an eclectic mixture of new villas on tree-lined boulevards built by the rising upper middle class.” Margaret Island, which is in the middle of the Danube between Pest and Buda, is peppered with summer cottages. And city officials are “most proud of recent accomplishments such as a modern subway and the ice-skating rink in City Park.” There are fine restaurants and shops and the boulevard Andrassy Avenue is always crowded.
All in all, a fine portrait. People want to live here. It is a pleasant place. And economic opportunity abounds. But then Stahl drops the hammer and shatters this idyllic portrait:
“These signs of economic progress are important indicators to those investors who seek opportunity in Hungary. However, at this point it is necessary to admit that a literary device has been used... The Hungary which is being described is the Hungary of 1894, not 1994.”
An investor in Hungary in 1894 would’ve lost all of their money if they did not sell ahead of the crisis on the horizon. If you waited too long, you couldn't sell. “In 1914,” as Stahl notes, “it was impossible to sell because, upon the outbreak of war in August 1914, the world equity markets were forced to close.”
An unknown unknown? Stahl’s point is simply that investing in “emerging markets” can involve risks it is impossible to know about beforehand.
There are plenty of other examples where entire markets delivered basically a zero for public equity investors. China in 1949 or Russia in 1917, quickly come to mind. But there are others.
I think all investors have to grapple with the idea of “unknown unknowns.” Those who wander from their home markets doubly so.
Now, if you’re investing in the US, Canada, the UK, Australia, or Sweden... I think we can agree there isn’t much country risk in these places that would greatly separate one from another. Most of Western Europe is probably in the same bucket.
But what about Poland? The Warsaw Exchange (in its current form) has only been around since 1991. Is that a step outside the above markets? What about Mexico? What about China?
I think there are a lot of opportunities to invest in great companies around the world… but how to think about them?
Thomas Phelps on Getting Away from it All
Phelps, in his 100 to 1 in the Stock Market, wrote about investing abroad. He has a great line in a chapter titled “Getting Away from it All”:
“For most people, investing abroad amounts to fleeing from hazards they can see to hazards they cannot see.”
There is a tendency for investors to want to invest abroad because they don’t like what they see at home. For example, Phelps writes about “sophisticated” American investors investing in Argentina and France to get away from the perils of the New Deal and what they expected to be a major dollar devaluation.
As Phelps points out, he doubts any of them made much money on their foreign adventures. They certainly would have made a lot more buying bargains at home. “Distance lends enchantment,” Phelps writes.
He also remembers how, in 1942, the UK government “sequestered” American securities owned by UK citizens to help pay for the war.
Reflecting on the mis-adventures of investors wandering from their home markets, Phelps comes up with two conclusions:
Never invest abroad to escape perils at home unless you are prepared to go with your money.
Otherwise, invest abroad only when the foreign opportunity seems better by a wide margin than anything you can find at home. That “wide margin” is to cover the difference between what you know about conditions in your native country and the most you can hope to know about a country you have perhaps visited occasionally and studied intermittently from afar.
These seem like sensible conclusions to me.
I should say I am a US-based investor with 6 of the 11 stocks I hold not listed in the US. And all of those 6 are in markets I view as no riskier than the US (Canada, Sweden, the UK, etc). I have been investing globally since 2004. I wrote a book about some of my travels up to 2012 in World Right Side Up: Investing Across Six Continents. (Antarctica being the missing continent). I have had many mis-adventures of my own, when I was younger, in places such as Mongolia, Greece, Argentina, Colombia, Namibia and other places. I got fantastic training and a wonderful education in what not to do.
It’s Still Worth Exploring Other Markets
So, I’m not against exploring other markets. Neither is Phelps.
In his book, he spends several pages on why Australia should be a source of attractive investments. Keep in mind, he’s writing in 1972. Australia, to that point, had been a great market with the Australian exchange up 60x in the prior 75 years, more than 2x the Dow. All those natural resources were just getting discovered, you know. Phelps mentions the story of Lang Hancock, who made a mountain of money on iron ore royalties. You can almost hear the gears turning in Phelps’ head as he ponders the 100-bagger potential of investing in royalties...
My non-US holdings are companies for which there is no home equivalent. In the US, there is nothing like, say, Evolution Gaming (Sweden) or Topicus (mostly in the Netherlands). Although, these are in markets I regard as on par with the US market in terms of country risks -- so not the best examples. But you get the idea. Both of these I mentioned in an earlier blog post as new additions to the Woodlock House portfolio in Q1. I have been kicking around a couple of ideas from Poland and Mexico, respectively, which inspired my reflections for this post.
Anyway, I wouldn’t discourage you from exploring markets outside your home market.
However, I would discourage you from relying on the kind of macro chit-chat that Stahl pointed to in his Budapest example. People don’t know what they are talking about. Not because they are not smart or well-intentioned, but because what they’re trying to know is impossible to know.
Lastly, I would encourage you to adopt Phelps’ two points of advice. Especially, #2. And try to give some thought to possible unknown unknowns.
Thanks for reading!
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Published July 6, 2021
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