Human Freedoms Make Better Markets

Freer markets are smarter investments, says founder of Life + Liberty Indexes.

Reviewed by: Lara Crigger
Edited by: Lara Crigger

Perth TolleGovernments that treat their citizens better tend to have stronger markets. That's the premise underpinning the Life + Liberty Emerging Markets Index, which uses human and economic freedom metrics as the primary factors in its investment selection process.

Recently, spoke with Perth Tolle, founder of Life + Liberty Indexes, about their flagship index. Before forming Life + Liberty Indexes, she was a private wealth advisor for Fidelity Investments in Texas and California. Tolle has lived and worked in Beijing, Shanghai and Hong Kong, where she learned firsthand the relationship between freedom and market impact.

Tolle is a panelist at the upcoming Evidence-Based Investing Conference, presented by Ritholtz Wealth Management and IMN on Nov. 2. What does evidence-based investing mean in the context of emerging markets?

Perth Tolle: Basically, the empirical evidence shows that freer markets grow faster, they're more innovative, they're more resilient. They use their human capital more efficiently. Data shows the freer a market, the higher its GDP growth and per capita income.

And it's not only economic freedoms, but human freedoms that play a part in this. You can't be "half-free." How do you mean?

Tolle: Look at China. It's Exhibit A of [a market that’s experiencing] tremendous economic-freedom growth from an abysmally low base. That alone has propelled them into what they are now, in just 30 years. But now they've hit a ceiling of sorts, because they haven't coupled those economic freedoms with human freedoms. Instead, human freedoms continue to decline.

If they'd allow people to be free, and if they would encourage innovation and creativity, they'd be more efficiently using their human capital. They'd have less human capital flight, even destruction that they're experiencing right now. If they were to actually reform, not just in rhetoric, that would give them a huge advantage. Freedom is kind of a nebulous term. How do you define and evaluate "human" freedom, "economic" freedom, and so on?

Tolle: I categorize it into three properties: Life, Liberty and Property. "Life" refers to civil freedoms, "Liberty" is civil freedoms, and "Property" is economic freedoms. Economic freedoms have been quantified pretty well, but before this index, nobody else had quantified human freedoms as well.

So, under the category of "Life," some of the things we evaluate for each market are how much violent conflict there is, organized crime, terrorism, disappearances, detainment, torture and trafficking.

Under "Liberty," you've got things like the rule of law, due process, judicial independence, corruption, freedom of movement, freedom of expression, freedom of the press and assembly. These freedoms have been reported on in the past, but mostly in qualitative reports. We've developed a patent-pending process on how to quantify those freedoms instead. Something like human trafficking actually has a measurable impact on how a country's markets perform?

Tolle: That's human capital, right? Again, China is a prime example. China had the one-child policy for three decades. That led to a shortage of women in the country; in turn that led to heightened trafficking, not just in the country or in the region, but around the world, such as the high percentage of women who are trafficked in Colombia end up going to China.

Things like this don't stay contained. They have a ripple effect on other countries and regions as well. Basically, you're saying we can't treat markets as mechanical; we can't separate markets from the context in which they operate.

Tolle: Exactly. There's a quote by [investor and co-founder of Discovery Institute] George Gilder that I love: "An economics of systems only—an economics of markets but not of men—is fatally flawed." You can't ignore the people within the mechanical models.

How did we come to the innovations we have right now? The iPhone, for example, or the automobile—nobody could have predicted they would be invented and change the way we do things in such dramatic fashion. These are the surprises that arise from human creativity, the things that create wealth and change the world.

There are so many factors in investing now. But freedom is a new factor, something that's never been used before. It's a new way to drive alpha, especially in emerging markets. Could similar principles be applied to developed markets, too?

Tolle: Yes, but you'll see more of an “alpha add” in emerging and frontier markets, because they have such divergence in freedom levels. But yes, it can be done.

You could even do it domestically—between states, for example, because some U.S. states are freer than others. There's actually a lot of discrepancy between states. There's a lot of discrepancy between the 23 countries in your index, too. How did you arrive at the universe of countries you select from?

Tolle: We're not looking at a certain line-in-the-sand level of freedom; we're looking at freedom in relation to peers. Also, we measure a country's absolute level of freedom, not its freedom trajectory or momentum.

So, let's take Turkey, which is in our index. Turkey experienced a lot of growth in human and economic freedoms over the past several years, until the recent past. [Current President Tayyip] Erdogan didn't used to be like this; he used to be better. Before, it looked positive, now it’s very negative. But on an absolute level, Turkey is still freer than, say, Egypt or Russia or Qatar.

Poland is another good example. They've been a shining star for freedom in the ex-Soviet bloc. They're the only ones who didn't go through a depression in the past 10 years. But two years ago, a new government took over, with enough power to attack the institutions and the freedoms they have in place, like freedom of the press and women's freedoms.

Two years ago, our Poland contact told me, "Look, if this government gets into power, things will go a little crazy. But not for two, three years." And, well, it happened just as he said. The government got into power, things went a little crazy, but it didn't affect the markets. In fact, Poland is probably one of, if not the best, performing markets this year. Doesn't that run counter to your argument that human freedoms have measurable market impact, though?

Tolle: It's a long-term play. It doesn't price in immediately. Think of elections. People do a lot of trading based on elections, and it's very rarely priced in correctly at the time of the election.

These types of policies [that limit freedoms] are long-term. They don't take effect for years afterward, and then they have impacts for generations afterward. So that's why we look at the absolute level of freedom. Some of these countries in our index that are declining in freedoms are still enjoying the benefits of their past. Maybe even the U.S. can be included in that category. Where does the U.S. fall now?

Tolle: I think we're like 18th, out of 159. The U.S. has declined, but we're still enjoying the benefits of our freedom tradition. How does evaluating countries in terms of their freedoms change the way investors should think about emerging markets?

Tolle: The main problem I see in emerging market investing, as far as how ETFs and indexers do it, is that it's all market-cap-weighted at the country level. It ignores country fundamentals, the things that drive growth: demographics, policies, governance.

As a result, you have a huge allocation to Asia. Most of these funds are 70% Asia and even 50% in the China region. As a result, you have slower recovery times, less allocation to more resilient markets and a lot of market concentration.

Lara Crigger can be reached at [email protected]


Lara Crigger is a former staff writer for and ETF Report.