The increasing popularity of passive investing is likely to place strain on the liquidity and capacity of emerging and frontier market indices, according to Mark Mobius.
Speaking at an event in London this week, the Templeton Emerging Markets Group executive chairman raised concern over the influx of money into index-tracking products such as exchange traded funds driven by regulatory pressure on fees and transparency.
Mobius (pictured) said this inflow is likely to create a big divide between truly active managers at one end of the spectrum and purely passive managers at the other. This, he explained, could result in a sharp move in prices up or down which could lead to “all kinds of dangers” and people “running through the door at the same time”.
He described the move as a “casino development”, adding it was something he was “concerned about”.
“If passive dominates, you end up with one owner that thinks and does the same,” he added. “That is a danger.”
Mobius, who has more than 40 years’ experience investing in emerging markets, said the situation could be exacerbated by MSCI’s decision to upgrade Pakistan from a frontier market to an emerging market, effective 1 June.
As a result, the weight of Pakistan in the MSCI Emerging Market index will become 0.14% and open up the region to the $1.5trn from the global investors tracking the index, as of 31 December 2016.
Mobius said: “These markets will be exposed to buying and selling and I wonder whether they are big enough and liquid enough to absorb that.”
In May 2014, MSCI similarly upgraded Qatar and the United Arab Emirates from frontier to emerging status. Mobius observed that following this the domestic stock market “went through the roof” before entering a prolonged downturn.
Mobius said the onus was on managers to come up with a better option than the benchmark index. A “reasonable solution”, he added, was a customised index which capped a country’s weighting at 10%.
This comes as Franklin Templeton announced it is re-opening its $868m Templeton Frontier Markets fund on 31 May. The manager previously soft closed the fund in June 2013, at which point it had $3.6bn under management.
According to Mobius, the fund was closed because too much money was coming in and it could not be deployed quickly enough.
Templeton Emerging Markets Group director of frontier markets strategies, and co-manager of the fund, Carlos Hardenberg, added the firm had not wanted to be seen as “asset gatherers” at the time.
The duo said the fund is reopening thanks to the availability of new companies and countries in the frontier markets, as well as the region’s favourable demographics, attractive valuations, increasing urbanisation and low correlation to developed countries.
According to the Economist Intelligence Unit, eight out of the 10 fastest growing countries between 2012 and 2016 were frontier markets with Ethiopia and Ivory Coast leading the charge.
The two managers said in Bangladesh and Pakistan, the median age of inhabitants is just 25 and 26 respectively.
Elsewhere, they believe many frontier market countries are embracing political and economic reform. One example of this is in Argentina where since taking office in December 2015, president Mauricio Macri has made several policy changes including lifting currency controls, settling a lawsuit that blocked the country from international capital markets and launching a $16.5bn bond.
Meanwhile, Saudi Arabia is opening up its stock market to foreign investors and its companies are expanding into other frontier markets, for example Africa and Bangladesh, they added.
Countries Franklin Templeton currently views as attractive include Pakistan, Saudi Arabia, Romania, Vietnam and Bangladesh, as well as areas of Africa.
Mobius said Africa could be “the breadbasket of the whole world,” as long as it gets its house in order when it comes to developing its natural resources.
However, Hardenberg said currency risk still persisted in some of these markets, notably Nigeria.
