In this conversation, Perth Tolle outlines a compelling case for a fundamentally different approach to emerging market investing: prioritizing freedom over market capitalization. The core thesis is that authoritarian regimes, by their very nature, create systemic risks and stifle genuine economic growth, leading to suboptimal investment outcomes. This approach reveals the hidden consequence that traditional emerging market indexes, by overweighting autocracies, inadvertently subsidize oppressive regimes and expose investors to significant, often unpredictable, downside risk. Individuals and institutions seeking robust international diversification without funding authoritarianism, and aiming to capture sustainable growth, will find this analysis invaluable. It offers a strategic advantage by sidestepping predictable pitfalls and aligning capital with environments conducive to long-term prosperity.

The Unseen Cost of Autocracy: Why Freedom is the New Frontier in Emerging Markets

The conventional wisdom in emerging market investing is to follow the market capitalization. This approach, while seemingly straightforward, leads investors down a predictable path: funneling capital into countries governed by authoritarian regimes. In this conversation, Perth Tolle, founder of the Life and Liberty Indexes and creator of the Freedom 100 EM Index (FRDM), argues that this standard practice is not only flawed but actively detrimental to long-term investment success. The obvious answer--diversifying across all emerging markets--is insufficient because it fails to account for the profound systemic risks embedded within autocratic systems. Instead of capturing growth, investors often find themselves inadvertently funding regimes whose interests are fundamentally at odds with their own, leading to hidden costs and suppressed returns. Tolle's work reveals a deeper system dynamic: where freedom flourishes, so too does sustainable economic growth, creating a powerful, albeit less obvious, pathway to superior investment outcomes.

Why the Obvious Fix Makes Things Worse: The Autocracy Premium

Barry Ritholtz, host of Masters in Business, introduces Perth Tolle by highlighting a fundamental question plaguing modern finance: do fundamentals or narratives drive market valuations? This question is particularly acute in emerging markets, where the political landscape often dictates economic realities. Ritholtz points out the paradox of traditional emerging market indexes: they broadly invest across all countries, regardless of their political structures, often leading to significant allocations in problematic nations. This is where Tolle's approach diverges sharply.

"The problem we're trying to solve here is that emerging markets investors," Tolle explains, "previously did not have a way to get a diversified emerging markets allocation without funneling money to autocracies." Traditionally, indexes are weighted by market capitalization. This means that the largest economies, which in the emerging market space often include autocracies like China, Russia, and Saudi Arabia, receive the largest weights. Tolle cites that prior to the war in Ukraine, these three countries were historically in the top 10 of most emerging market indexes. During the height of COVID-19, China alone constituted 41% of the MSCI Emerging Markets Index, and even now, it remains close to 30%.

This market-cap weighting strategy, while seemingly neutral, has a profound and often negative downstream effect. It directs significant investor capital towards regimes that may not prioritize economic freedom, property rights, or the rule of law--all critical components for sustainable growth. The consequence is that investors are, in effect, subsidizing these autocracies, a fact that is rarely the intention of most investors.

The Origin of Discomfort: A Personal Journey Through Contrasting Systems

Tolle's insight is deeply rooted in her personal experiences, growing up in both China and the United States. Born in Beijing and moving to the U.S. at age nine, she later worked in Hong Kong, providing her with a unique vantage point to observe the stark differences between market systems. "I saw that policies impacted the future of a society and the future of markets," she recalls.

One policy that profoundly shaped her understanding was China's one-child policy. "That policy has caused the biggest demographic crisis in the world today," Tolle states, "and probably we won't recover from that in our lifetimes." This personal experience underscored the tangible, long-term impact of governance on societal and market trajectories.

Her career as a financial advisor at Fidelity further solidified this conviction. She encountered clients who explicitly did not want to invest in certain countries due to their political nature. "I had a Russian client that said I don't want to invest in Russia because it's like funding terrorism," she notes, a sentiment that proved prescient. These experiences highlighted a disconnect: investors often sought international diversification but were unaware that their portfolios might be indirectly supporting regimes with questionable practices. This created a strong impetus to build a mechanism that allowed for emerging market exposure without funding autocracies.

Defining Freedom: Beyond Political Slogans to Market Metrics

The core of Tolle's innovation lies in redefining how emerging markets are screened and weighted. Instead of market capitalization, her Freedom 100 EM Index uses a "freedom weighting" methodology. But what does "freedom" mean in a market context?

"The first thing is, we need those quantitative metrics for freedom," Tolle explains. Her index utilizes data from the Human Freedom Index, compiled by the Cato Institute and the Fraser Institute. These think tanks, notably, are privately funded and do not accept government money. They assess 87 different variables across three key categories: civil liberties, political freedoms, and economic freedoms.

Civil liberties include aspects like protection from terrorism, trafficking, and torture. Political freedoms encompass freedom of speech, media expression, and the fairness of legal procedures. Economic freedoms are more familiar to investors: taxation, business regulations, private property rights, the rule of law, sound monetary policy, and the freedom to trade internationally.

"All of these things added together--87 different variables and sub-variables--combine into the composite country score," Tolle states. This score then dictates the country weights within the index. Higher-scoring, freer countries receive a greater allocation, while lower-scoring, less free countries receive a lower allocation. The most egregious offenders are excluded entirely. This process transforms abstract notions of freedom into concrete investment decisions, directly impacting portfolio construction and, consequently, capital flows.

The System's Response: How Freedom Weighting Shapes the Universe

The Freedom 100 EM Index operates with a universe of 24 emerging market countries, but not all are eligible. Tolle's methodology incorporates a crucial screen for market size and liquidity. "Markets that are too small or too illiquid are not part of the eligible universe," she clarifies. This results in an eligible universe of approximately 18 countries.

Within this eligible group, the weighting is 100% freedom-based. The highest-freedom countries receive the highest weights. A key aspect of the methodology is that a country must score above the average of these 18 peer countries to be included. This ensures that the index comprises the freest emerging market countries within the eligible universe.

Tolle provides illustrative examples: India, she notes, is often a borderline country, its freedom score hovering just around the average among the 18 peers. Countries like Taiwan, Chile, and Poland are on the freer side, while China, Saudi Arabia, and Egypt are on the less free side. This dynamic means that country inclusion can fluctuate annually, reflecting shifts in freedom metrics and their impact on investment eligibility.

Once the freedom-weighted country allocations are determined, the index selects the "10 largest most liquid constituents" within each country. These companies are then market capitalization weighted within their freedom-weighted country allocations. A critical exclusion at the security level is state-owned enterprises. "That's just to bring the economic freedom theme all the way through," Tolle explains. "The less government interference in private markets, the better." This focus on private enterprise further reinforces the commitment to economic freedom as a core investment principle.

China's Laggard Performance: The State's Interest Over Investor's

Tolle's personal history with China provides a powerful lens through which to examine the country's investment performance. Ritholtz points out a stark statistic: "Over the past 30 years since 1995, China's markets have essentially been down a couple of digits." When including total return and dividends, it's up about 100%, a figure that pales in comparison to the S&P 500's 2700% total return over the same period. "China has turned out to be a fairly terrible investment for western investors," Ritholtz concludes.

Tolle attributes this underperformance to a fundamental conflict of interest: "The main problem with investing in Chinese companies is that these are companies that have to put state interests first." Instead of striving for success by offering the best value to clients, these companies are motivated to "curry favor with the government." This division of interests means investors are effectively subsidizing the cost of the state's priorities.

She elaborates on the implications: "When we look at an app like TikTok, the question is how involved is China's state surveillance security and their version of the CIA tracking, managing, manipulating what U.S. teenagers see." This highlights how companies like Tencent, whose app WeChat is known to be used for government surveillance, must prioritize state interests over their own business interests. "These are kind of the dangers of investing in a country where all the companies are more subject to the state's interests than their own," Tolle asserts. This dynamic directly translates into suppressed investor returns, as the company's primary objective is not shareholder value maximization but adherence to state directives.

The Contagion of Freedom: Directing Capital for Good

While autocracy can be a drag on investment, Tolle posits that freedom is also contagious, and the finance world has a unique role to play. "I believe that the more people invest in freedom, and especially here in the finance world on Wall Street, we are in a position of privilege and power," she states. This power lies in the ability to direct assets.

In emerging markets investing, Tolle argues, "there is no neutral." Investors are either directing assets towards environments that foster growth and individual liberty or, inadvertently, towards those that suppress it. "We don't want to be in the position of directing assets to enable more authoritarianism," she emphasizes. "And if we can, we want to be in the places that are promoting freedom in the world." This perspective reframes investment decisions not just as financial choices but as ethical ones with tangible global consequences. By consciously choosing to invest in freer markets, investors can actively contribute to a more prosperous and liberated world, creating a positive feedback loop where capital flows to where it can be most productively and ethically deployed.

Russia's Fall from Grace: The Unforeseen Risk of Autocracy

The invasion of Ukraine by Russia served as a stark, real-world demonstration of the risks inherent in investing in autocratic regimes. Ritholtz recalls this period: "I suspect a lot of people first recognized the merit of your approach to emerging market investing when Russia invaded Ukraine, and effectively their stocks plummeted to zero." He notes that if one held Russian stocks, they were "pretty much marked down to nothing in everybody's portfolio."

Tolle reveals that Russia has never been included in the FRDM index. "We were the only emerging markets index that did not have Russia in it for this particular reason," she states. When Russia's market collapsed, it was a shock to many, as the country had been a significant holding in traditional emerging market indexes like the MSCI. "Investors got hit, you know, quite hard during that time," Tolle observes, "and that was the time when, as I recall, most investors woke up to autocracy risk."

This event underscores a critical point: autocracies introduce a level of risk that is often not priced into traditional market-cap-weighted indexes. The decision to exclude rather than merely underweight such countries is deliberate. "Even if we underweight autocracies, we would still be funneling money towards them," Tolle explains. Given the scale of funds tracking major indexes, even a small allocation can represent substantial capital. Tolle's conviction is that there are abundant opportunities in emerging markets outside of autocracies, such as Chile and Poland, which, despite having less weight in traditional indexes, possess the market size and liquidity to be significant components of a well-structured ETF. These freer countries, she believes, offer the most compelling growth stories for the future.

The Power of Exclusion: Why Underweighting Isn't Enough

The decision to completely exclude countries like Russia, rather than simply underweighting them, is a cornerstone of the Freedom 100 EM Index's strategy. Tolle elaborates on this distinction: "Even if we underweight autocracies, you know, we would still be funneling money towards them." She emphasizes the sheer scale of capital involved. Her fund manages $2 billion, while MSCI indexes track hundreds of billions. Therefore, even a minimal allocation to an autocratic regime represents a significant flow of capital that Tolle believes is better directed elsewhere.

"We don't believe that's the best place to invest," she states plainly. Furthermore, Tolle highlights the existence of numerous attractive opportunities within the emerging market universe that lie outside autocratic systems. She points to countries like Chile and Poland, which often receive less than 1% weight in market-cap-weighted indexes. Yet, these nations possess the market size and liquidity to be scaled within products like ETFs. Investors, she argues, can participate in the "tremendous growth" that has occurred in these freer economies. The core belief is that "the freer countries are the places that have the best growth stories in the future." This exclusionary approach, therefore, is not about avoiding risk but about actively seeking out environments where freedom and economic prosperity are intrinsically linked, creating a more durable and potentially higher-returning investment thesis.

Key Action Items for the Freedom-Minded Investor

• Re-evaluate Emerging Market Allocations: Conduct a thorough review of your current emerging market holdings. Identify any exposure to countries with significant autocratic governance and assess the associated risks beyond standard market volatility.
  • Immediate Action: Review fund prospectuses and country breakdowns for existing emerging market ETFs and mutual funds.
• Understand the "Freedom Score": Familiarize yourself with the metrics and methodologies used by organizations like the Cato Institute and Fraser Institute to assess political, civil, and economic freedoms. This provides a quantitative basis for evaluating investment environments.
  • Immediate Action: Explore the Human Freedom Index reports to understand the criteria and country rankings.
• Consider Freedom-Weighted Indexing: Explore investment vehicles that employ freedom-weighting or similar non-market-cap-based methodologies for emerging markets. This shifts capital away from autocracies and towards countries that prioritize individual and economic liberty.
  • This pays off in 12-18 months: As these markets demonstrate more stable and sustainable growth due to better governance.
• Exclude State-Owned Enterprises (SOEs): Be mindful of investments in companies that are significantly influenced or controlled by the state, even in otherwise freer economies. Prioritize private enterprises where management incentives are more aligned with shareholder value.
  • Immediate Action: When selecting individual stocks or actively managed funds, scrutinize the proportion of state ownership.
• Embrace Delayed Gratification: Recognize that investing in countries with strong rule of law and economic freedom may require patience. These environments often foster slower, more sustainable growth, which can be more durable than the speculative booms seen in less free markets.
  • This pays off in 3-5 years: As the compounding effects of stable governance and economic liberty take hold.
• Align Capital with Values: Understand that investment decisions can have real-world impacts. By directing capital towards countries that champion freedom, investors can contribute to positive global change while seeking superior risk-adjusted returns.
  • This creates lasting advantage: By building a portfolio that is resilient to geopolitical shocks and aligned with long-term global trends toward liberty.
• Seek Transparency and Accountability: Favor markets and companies that operate with a high degree of transparency and accountability. These characteristics are often correlated with stronger property rights, predictable regulatory environments, and reduced corruption, all of which are conducive to investment.
  • This pays off in 18-24 months: As transparency reduces uncertainty and improves the efficiency of capital allocation.