Far-flung investments get their place in the sun
By Miki Tanikawa
Friday, February 8, 2008
TOKYO: Bernard Moody, investment director at Progressive Asset
Management, probably logs more time on the road than most fund
managers. From his base in London, he travels frequently to Cambodia,
Uzbekistan, Kenya and other far-flung corners of the world looking for
stocks to add to his ****tfolio.
He is also one of the calmest individuals in a notoriously nervous
business. When Kenyan stocks, which he holds, fell sharply over the
New Year, he barely blinked.
"The market was closed for the entire period since Christmas" because
of the presidential election scandal, Moody said in a low, calm voice.
"I think it reopened yesterday." He leaned over to check the computer
screen in his London office. "Oh, it reopened Wednesday, and fell 5
percent. It hasn't opened on Thursday and Friday."
Aplomb is a staple character trait of fund managers who invest in
"frontier" markets, the outer reaches of global investing. Farther
afield even than emerging markets like China, India and Brazil, and
characterized by small trading volumes and high volatility, frontier
markets have a reputation of being to investing what off-piste is to
downhill skiing: a risky way to reap potentially high rewards.
And there are certainly rewards. From October 2001 to last September,
the S&P IFC Global Frontier Markets index - including 20 frontier
economies like the United Arab Emirates, Vietnam and Nigeria - rose
553 percent, surpassing even the healthy 430 percent gain by the
benchmark for emerging markets, the MSCI Emerging Market index for the
same period.
But what has started to come home to investors is that frontier
markets, which are remarkably diverse, have achieved these good
returns with low correlation to the developed markets. That is a
blissful disconnect these days that investors - stunned by the
spillover of subprime-related turmoil from developed to emerging
markets - increasingly appreciate. For the month of January, as
markets from the Dow Jones industrial average to the CAC 40 sank, the
IFC frontier index slipped just 2.8 percent.
Frontier markets still represent a small part of the total world
equity universe. The market capitalization of the 20 markets in the
MSCI frontier index is $172.7 billion; that compares with $3.25
trillion for emerging markets. Those who specialize in frontier
investing say that while the op****tunities to participate are growing,
frontier markets are likely to remain a niche investment for some time
to come.
But as major world stock markets continue to be whipsawed by credit
crunches, oil shocks and other crises - and as the "decoupling" theory
of regional separation falls further into disrepute - the appeal of
frontier markets is also likely to grow.
One reason for the appeal is the do***ented lack of correlation with
developed and emerging markets.
Over the past seven years, frontier market correlation to MSCI World,
an index that represents equities of the developed countries, stood at
0.4, while that of emerging markets was about 0.8. A correlation of 1
means 100 percent lockstep, while 0 means no correlation.
That relative lack of correlation insulates frontier markets from the
whims of big global investors like hedge funds, who make quick moves
in and out.
"Frontier markets are very thin and they are not very open to a lot of
institutional investors, and hedge funds cannot short them," said
Christian Deseglise, global head of emerging markets for HSBC
Investments.
In August, when the subprime loan crisis first rocked markets around
the world, the S&P Frontier index actually gained 1.1 percent. The
MSCI Emerging Market index lost 2.1 percent.
That makes it sound as though the frontier markets have escaped the
equalizing forces of globalization - for now. But in fact
globalization is the main reason that these markets have captured such
wide attention.
"It is a combination of global demand for resources, plus the moving
of manufacturing base to the cheapest labor markets and the
development of the capital markets," said Leila Heckman, senior
managing director at Bear Stearns Asset Management in New York. "These
countries became more plugged into the world's resources markets as
globalization progressed, while the ability to tap the world's
financial markets let them build the necessary infrastructure."
And as labor costs in emerging markets like China and India move off
rock-bottom, the frontier markets look more advantageous to
multinationals.
For those who invest across the range of frontier markets, volatility
is reduced because the frontier category is extremely diverse. Members
differ widely from one another in the stages of economic development,
size of the economy and population, political stability and cor****ate
governance, resulting in widely different performance and valuation.
By contrast, the mainstream emerging markets mostly are politically
stable and have attained certain levels of legal and regulatory
structures necessary to run markets.
"There are huge diversification benefits to frontier markets," said
Moody of Progressive Asset Management. The IFC index contains 20
frontier markets, and "the range of performance in any given year is
quite significant," he said. "In 2004, Ukraine was up something like
170 percent. The worst market was Kenya, which was down little over 10
percent. In 2005, the best market was Lebanon, which was up 110
percent up. Ghana was your worst market, which was down 30 percent,
and so on."
Moody spreads his $86 million ****tfolio to 50 different countries in
Latin America, the Middle East, Africa and Asia. He assigns fund
management to various investment houses in different regions and
countries. He said it was not practical to invest without the benefit
of local fund management houses, which are springing up in many
markets.
"You cannot find them on Bloomberg, Morningstar or the S&P research
list," Moody said. "The only way to find them is to have contact
locally on the ground and go and visit the countries you invest in."
On a recent trip to Kazakhstan, for example, Moody said, "we filled
two days with meetings with seven to eight proper professional
investment management houses there." In Ukraine, he said, he found 10.
In Africa, the picture is similar: Just two years ago, Moody said,
there were maybe two African funds open to individuals; today there
are 15 to 20.
Investors note that as frontier markets develop, the real possibility
exists that they will become more correlated to other world markets,
and therefore less attractive to a global investor.
"One invests for two reasons, returns and diversification," said
Heckman, the Bear Stearns executive. "As correlation increases, there
is going to be less of a diversifier.
"But on the other hand, op****tunities increase the possibility of
returns," she said. "With the growth of globalization there is a huge
op****tunity for these developing markets."
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