Honesty Did Pay

In preparing my mid-August column on international-stock funds, I ran the trailing 20-year performance numbers for various MSCI indexes. Twenty-one of them were single countries. The results are shown below, expressed as annualized total return in U.S. currency.

Victory for the contrarians! In 1993, pundits tended to rate the prospects of Hong Kong and Singapore the highest, and those of Sweden--frequently cited as the poster child for eurosclerosis--the lowest. If anybody predicted that Scandinavia would be a shining investment opportunity for the following two decades, I must have missed that call.

Among the factors separating the winners from the losers, a big item was the euro. Aside from the United Kingdom, every European country that eschewed the euro outgained every country in the eurozone.

It was also helpful to have natural resources. Norway, Canada, and Australia benefited from healthy commodities prices. In contrast, Japan, a large commodity importer, was hurt.

However, the biggest difference between the winners and losers seems to be cultural. The chart below plots the country's rank according to Transparency International's Corruption Index against the country's rank for 20-year stock-market performance. In each case, 1 is the best score, representing the least amount of corruption and the highest stock returns. If the correlation were perfect, the best-fit line would run diagonally from bottom left to upper right.

The line doesn't manage that feat, because it's pulled down at the top right by Singapore and New Zealand, which dramatically underperformed their excellent scores on corruption, and pushed up on the bottom left by Spain and to a lesser extent the U.S., which outdid expectations given their relatively high levels of corruption. (Relatively high, that is, when compared to this elite list. Overall, the U.S. is among the top 10% least corrupt countries in Transparency International's report.) Japan also is a bit of a misfit, having the very worst stock returns while only having only a modestly below-average corruption score.

The remaining 16 countries, however, form as close to a perfect 45 degree line as you will ever see with a study on stock performance.

There is a concern about cause and effect: Have rising stock prices somehow affected Transparency International's corruption scores? That seems unlikely. Transparency International evaluates countries by asking businesspeople about their perception of the honesty of a country's public sector and the prevalence of bribery, and by measuring various industry practices according to Transparency's standards of best practices. It's hard to see how these items could be much affected (if at all) by stock performance.

There's also the question of whether Transparency International gets it right. The company is the leader in its field, dominating Google searches and media reports to the extent that it's difficult to find a competitor. Presumably it does a thorough job, but I couldn't state for certain. At any rate, regardless of exactly what it measures, Transparency International's rankings have lined up quite nicely with the past 20 years of stock performance. It almost certainly won't line up as neatly over the next 20 years, but perhaps there will be enough correlation to make the rankings useful.

International stock investors typically pursue economic growth, not cultural honesty. After all, the ETFs of the BRIC countries of Brazil, Russia, India, and China didn't become far, far more popular than the ETFs of Northern Europe because the former countries have cleaner governments. Investors may wish to adjust their priorities.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.