When economic freedom has grown, so have returns

Boston  - One of the core tenets of the Eaton Vance Global Income team's emerging market investment philosophy is that growth of economic freedom is a strong driver of excess returns, in both equity and debt markets.

This was true in the examples of Poland beginning in 1990 and Romania of the 2000s, and is supported by the research of Eaton Vance and others. But confirmation of this principle is always gratifying, as we have seen most recently with Georgia - a country we have been bullish on for several years, as outlined in a July blog post here.

On September 15, the Fraser Institute released its annual report Economic Freedom of the World , in which Georgia moves up to #5 from #12 in the economic freedom ranking of 159 countries. Moreover, 2016 is not an anomaly - Georgia has been moving up steadily from #75 in 2004.

Fraser scored Georgia highest on freedom to trade, and it is not hard to see why. Russia cut off its huge trade volume with the country prior to their five-day war in 2008, and Georgia found other trading partners. As we noted in July, Georgia's industriousness has paid off with GDP growth that has averaged 5% per year since 2010.

Georgia is a small country, and hardly likely to move the needle on an emerging market portfolio. But our research (Stocker, 20051, 20142) has shown that the relationship between improving economic freedom and equity investment results has persisted for decades over a broad range of countries. The results were similar in fixed-income markets (Roychoudury, 20103), as increasing economic freedom corresponded to lower yields on sovereign debt.

Specific to Georgia, the country's 10-year Eurobond issued in 2011 has become more valuable as its spread to an equivalent U.S. Treasury has contracted by nearly 100 basis points (bps), compared with a 60-bps higher yield on the JP Morgan Emerging Market Bond Index.

Bottom line:  Emerging markets have, on average, a lower level of economic freedom. Thus, small changes in economic policy can represent a large percentage change in level of economic freedom - and the potential for corresponding gains in their equity and debt. Georgia is just the most recent case in point.