A World Bank policy research paper published in September this year states that any rise in the US interest rate could be devastating for some emerging and frontier market economies (EFEs).
Kaushik Basu, World Bank chief economist and senior vice president, reports: “Financial stress in global markets tends to disproportionately affect those EFEs that have weak growth prospects, sizable vulnerabilities, and challenging policy environments.
Financial market volatility during the tightening cycle could potentially combine with domestic fragilities into a perfect storm that could lead to a sharp reduction in capital flows to more vulnerable countries.”
PICKING OPPORTUNITIES
Of course, proponents of frontier market investment argue that the key to maintaining a successful exposure in the asset class is to avoid those countries with ‘domestic fragilities’ and focus on those capable of riding out overseas economic policy.
Dominic Bokor-Ingram, portfolio adviser for frontier emerging markets at Charlemagne, says: “Frontier markets cover a huge range of countries. We are looking for where you get the excess economic growth and that is [in countries] where you have reform.
This needs to be political, economic or stock market reform, or a combination of these.”
Returning to Romania as an example, the political reform there ticks a critical box, as does a growing appetite for consumer goods – mobile phones for example – and a vastly improving infrastructure network.
Bell says: “Romania has got between €30bn and €60bn of EU funding coming its way just for infrastructure. In the same way Poland, Spain and Hungary have developed their roads on the back of EU funding, Romania is next in that line.”
Commentators also point to political reform in Argentina as a key driver of growth. The news that incumbent president Cristina Fernández de Kirchner would not contest the election in December saw the Buenos Aires stock markets rise 50% in the first six months of the year.
Bell says: “Whomever takes over [ from Kirchner] will re-engage Argentina with the global capital markets. This is a very well educated, large country that will suddenly regain access to capital markets and growth will kick off.”
Africa also boasts a range of frontier markets with attractive growth prospects.
Eduardo Gutierrez, partner at DPI, a private equity house in Africa, points to the northern and eastern parts of the continent, and singles out Egypt as having particular promise following its recent political reform.
However, he is less comfortable with those countries reliant on oil revenue and those still tackling political instability. Gutierrez says: “We are concerned about Nigeria. That is not to say there aren’t opportunities there but it is in a state of flux. We are waiting to see the consequences of reduced [oil] revenue and how that might impact the Nigerian financial system.”
In Asia, fund managers appear attracted to Vietnam which offers a cheaper manufacturing
alternative to China. Bell says: “The [Vietnamese] labour costs are a third of China’s and productivity is as good if not better.”
CONTRARIAN, BUT REWARDING
Irrespective of which frontier market the fund managers favour, the fact remains that appetite for frontier market remains low. While there are no clear figures on how much UK institutional investors allocate to the asset class, Bokor-Ingram notes that 50% of emerging market stock markets are owned by foreign investors compared with just 5% of frontier markets.
He says: “You can’t single out the UK for that, but institutional investors generally are underweight frontier markets.”
Nick Samuels, head of equity manager research at Redington, agrees that ‘appetite is still low’ among UK investors and points to the miserable returns this year as a disincentive.
However, he says frontier markets are well suited to pension funds’ long-term time horizons, and says they could be rewarded for riding out the lows.
“[Frontier markets] is still a contrarian asset class, but should be rewarding for patient, long-term investors… In many ways a pension fund is an ideal frontier market investor as it has the long-term time frame needed to weather the inevitable bumps along what will be a long journey,” Samuels says.
But Samuels advises schemes to choose their provider carefully since so much of the asset class’s success hinges of the strength of the active manager at the helm.
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