December-January 2012

FRONTIER MARKETS: A coming of age

GraphFrontier markets are what emerging markets were ten or 15 years ago. Stefanie Eschenbacher explores the phenomenal rise of this sector. Two decades ago, the International Finance Corporation’s Farida Khambata first drew attention to a group of high risk but potentially higher return investments: frontier markets. Today, there is still no widely accepted definition of frontier markets. In fact, the three big index providers FTSE, MSCI and Standard & Poor’s all use different categorisations. They do share some characteristics, though. Khambata, who is now a global strategist at Cartica Capital, says most frontier markets are illiquid, have a low market capitalisation and are relatively difficult to access. But they have come a long way. “The fact that investors are now discussing asset allocation to frontier markets such as Nigeria, Ghana and Kenya speaks how much they have appeared on the radar of asset managers,” she says. HSBC Global Asset Management recently made its frontier markets expertise available to retail investors, having previously offered it only to institutional investors. Andrea Nannini manages the newly created GIF Frontier Markets fund, the first version of which was originally launched in February 2008 as a Luxembourg-based specialist investment fund because frontier market investments were not Ucits compliant at that time. It has since been merged into the new fund. “We continue to find undiscovered investment opportunities in these markets,” he says, adding that frontier markets are today what emerging markets were ten or 15 years ago. Nannini says investors should adopt a slightly longer investment horizon because these markets can see “irrational movements”, both upwards or downwards, in a relatively short time frame. Dealing in these markets and hedging currency exposure is typically more expensive. Bid and ask spreads are also slightly higher than in more sophisticated markets. Nannini typically holds between 70 and 90 stocks, selected from an investment universe of 300. One of his largest country allocations is Nigeria, in stocks such as Guaranty Trust Bank, Nestlé Nigeria and Guinness Nigeria. Another major country allocation is Qatar, where he holds Qatar National Bank and Qatar Telecom. Another way of investing is to buy companies that are listed in developed markets but derive their revenues from frontier markets. SouthGobi Resources, which operates in Mongolia but is listed in Hong Kong, or Millicom International Cellular, which operates in the sub-Saharan Africa and South America under the name of Tigo but is listed in the United States, are such examples. Of the 30 most commonly labelled frontier markets, Nannini considers between 20 and 25 as “investable”. Then there are countries, such as Zimbabwe and Iraq, that few fund managers would have touched until recently. Grant Flanagan is the manager of the Imara Zimbabwe fund, which launched in 2007. The country, he says, is recovering from a decade of economic contraction and hyperinflation. Zimbabwe’s monthly inflation rate peaked at 80 billion per cent in 2008, an equivalent daily rate of 98%. This means prices doubled every 24 hours. Flanagan, however, says the establishment of the Global Political Agreement ushered in a period of stabilisation, helped by the de-monetarisation of the Zimbabwean dollar and adoption of a multi-currency system, which is now dominated by the dollar. Widespread investment
“Politics continue to dominate the headlines, but Zimbabwe has one of the oldest stock markets and the investment opportunities are widespread,” he says. Zimbabwe has a stock market capitalisation of $4.2 billion (€ 3.1 billion), with 78 listed companies. Flanagan’s high conviction holdings include SABMiller’s Zimbabwe subsidiary and hybrid seed producer Seed Co, which are both expanding. Meanwhile, FMG Investments launched its Iraq fund in 2010. The fund aims to take advantage of the growth derived from post-war reconstruction and massive oil production expansion, which the managers expected to be a “catalyst of change”. FMG warns that the “relatively high risk profile can multiply invested capital over time but the development will also consist of heavy temporary downturns”. Mongolia is one of the frontier markets that currently features high on the buy-list of fund managers. Origo Partners recently launched a fund investing in Mongolia. The Mongolian Stock Exchange Liquidity fund is a hybrid yield and equity product targeting above average deposit rates of 16% in Mongolian commercial banks as well as giving exposure to the Mongolian tugrik.   The Mongolian Stock Exchange has a total of 325 listed companies of which 75% of that combined $1.6 billion market capitalisation lies in the top 20 companies. Best of both worlds
The fund aims to benefit from the developments in the commodities and retail sectors, construction, property and even fire prevention businesses servicing the mining sector. “Some 27% of Mongolia has been mapped to a scale of only 1:50,000, which presents enormous opportunities for new discoveries in a very prospective country with estimated reserves valued at $1.3 trillion,” says Eric Zurrin, the chief executive officer of Resource Investment Capital, who carry out the day-to-day activities. “The offshoot of the mining expansion has been phenomenal to date, which is very positive for many of the equities listed on the Mongolian Stock Exchange. Restaurants in Ulaanbaatar, for example, have seen an 800% year-on-year increase in turnover in the past twelve months.” One country that might soon be part of both frontier and emerging market fund allocations is Qatar. Jubin Jose, an investment adviser to the Qatar Investment Fund, says the Qatari market continues to deliver attractive valuations relative to its earnings growth potential and profitability. “We prefer stocks that are underpinned by domestic demand dynamics rather than the global cycle,” he says. “We favour banks, industrials, energy, and utilities.” Although the fund focuses on capital growth, like most other funds investing in emerging or frontier markets, it does have a dividend policy. Jose says Qatar’s combination of budget surpluses, increasing export volumes, and price floors and ceilings in its long-term gas sale contracts should ensure that government expenditure in the domestic economy will be largely unaffected by all but the most dramatic and sustained fall in oil prices. Sebastien Lieblich, vice president, index research and management, at MSCI, says during the financial crisis frontier markets have suffered in a way similar to emerging markets. “Frontier markets have largely followed the performance of emerging markets, perhaps slightly underperforming them,” he says. “Although they have recovered in a similar way, the uptick has not been quite as strong.” Khambata says frontier markets should be an integral part of investing in emerging markets, arguing that they have a role to play in returns and diversification. Much has changed since she coined the term frontier markets, yet some things remain the same: they are high risk but potentially higher return investments. ©2011 funds europe

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