By Mike Dolan
LONDON (Reuters) - Deserting debt-laden, recession-racked North Atlantic and Japan for the fast-growing emerging market world may have been irresistible for some investors but many others still remain timid.
Why? It may be a case of "hard power" versus "soft power".
If investment decisions hinged solely on the former - measured by raw data such as economic output, population size and military spending - then convergence between rich and developing nation blocs is nigh on complete.
Adjusted for currencies' purchasing power, emerging economies on aggregate reached a "watershed" in 2012 and became as large as the rich developed world, estimates hedge fund manager Stephen Jen.
That train has long left the station, of course, and may well be only part way through its odyssey. According to Goldman Sachs, the giant economies of Brazil, Russia, India and China alone are expected to surge from a fifth of global output today to a third by 2020.
Using an index of "hard power" traced back to the early 1800s, with inputs such as iron and steel production, energy use, urban population and per capita military spending, Jen reckons dispersion of hard power between the top economies of the United States, Europe, Japan, China and Russia is at its lowest for 200 years.
But he reckons the world is still some way off equality of "soft power" - classed variously as the ability to influence ideas through culture, education, democracy or diplomacy but also capturing "intangibles" such as social justice, good corporate governance, transparency of law or open markets.
There's no direct gauge of this fuzzier "soft power". But if you take gauges such as Transparency International's "corruption perceptions index" as one possible component, then no major emerging economy comes in the top 20 apart from long-standing financial centers such as Singapore and Hong Kong.
Through investment eyes at least, the lags in this sort of "soft" development go some way to explaining why emerging financial markets remain far behind in terms of size, liquidity, depth, transparency and legal protections and why they have so badly underperformed of late despite all the "hard" metrics.
The lion's share of world private investable capital still originates in the western world. A recent study by analysts at TheCityUK showed that more than 70 percent of the almost $80 trillion of pension, insurer and mutual fund assets is still based in the United States, Europe and Japan.
And it's this relative gap on "soft power" that may still determine investment success or failure in the years ahead.
"This grating of the tectonic plates - with the real economies moving past each other but with the emerging world continuing to rely on developed countries' financial markets - will continue to create distortions and volatility in the global financial markets," Jen said.
These distortions have been evident for over a decade as booming China and other giants without adequate financial markets of their own banked their new-found and largely state-managed wealth in the west, exaggerated the credit bubble there and triggered sometimes violent and unpredictable capital flows.
On a simple level, emerging underperformance of late may just be a function of an integrated world economy where no market is immune from shocks in its richest trading partners.
But even stock markets in the austerity-sapped recession economies of the euro zone periphery have as a group performed better than the BRIC equity indices for two years in a row now.
And while developed world equity at large is up 6 percent over the past two years, emerging markets are still down 10 percent.
There are many explanations, some related to the speed in which markets priced the long-term economic projections in the early part of the millennium with a 500 percent advance in BRIC markets between in the six years to 2007, for example.
This gets to the bigger worry of whether emerging markets are deep and liquid enough to absorb a wholesale shift of western capital without periodic seismic reversals that unnerve relatively conservative investors like pension funds.
In what Bank of England economist Andrew Haldane described last year as the "big fish, small pond" problem, rapid capital shifts quickly create overvaluation and he reckoned just a 1 percent shift in western pension funds to emerging markets was equivalent to some 10 percent of their entire capitalization.
So much so that even though investors in global equities would have increased money up to four fold over the past 20 years, equity investors who spotted China's explosive boom as early as 1993 are still in the red. Shorter-term, Brazil's real has lost 20 percent since March with no ostensible "crisis".
Emerging bond markets have done much better of late, up more than 15 percent in 2012 for example. But much of these are hard currency fixed contracts governed by New York or London law.
Citing demand for property in London or New York at the worst points of the recent global crisis, Citi Private Bank's Chief Investment Officer Richard Cookson reckons some simple rules apply that still make many wary of emerging markets.
"After decades of crises, you may ask what's with the emerging world? The answer is rule of law, property rights, corruption, failed institutions. How much of that has changed? Not much."
What's more, it's not at all obvious that the mega emerging economies like China even have the desire to move toward a center ground on financial soft power at least.
"China wants the prestige of a global power but not the responsibilities," said Michal Meidan, Asia analyst at political risk consultancy Eurasia. "They would be happy to be considered a global financial power but they are not ready for the responsibility of shoring up the global financial system."
(Additional reporting by Carolyn Cohn and Sujata Rao, Editing by Jeremy Gaunt)