Balance risk and reward when exploring new frontiers (Birmigham Post article 23.05.2019)

I was in a meeting with a fund manager not long ago and he asked the question: How many companies are there in Africa with annual revenues greater than $1 billion?

It turns out that there are over 400 (not 10 as I thought).

When the same question was asked of leading Western business leaders, the answers were all between zero and 100.

An indication that a lot of regions and countries previously not thought to be investable are likely to be coming up on fund managers’ radars.

Hence, when it comes to reporting on global financial markets, though it’s developed and emerging markets that tend to garner most of the attention, one should not forget this third group, dubbed frontier markets, which are proving increasingly appealing.

Albeit that has to be balanced by risk levels that are commensurately higher.

The performance of the MSCI Frontier Markets Index illustrates the pronounced volatility. It lost 16.2 per cent of its value in 2018; but in 2017, it gained a hefty 32.3 per cent.

Countries recognised by the MSCI are: Argentina, Bahrain, Bangladesh, Burkina Faso, Benin, Croatia, Estonia, Guinea-Bissau, Ivory Coast, Jordan, Kenya, Kuwait, Lebanon, Lithuania, Kazakhstan, Mauritius, Mali, Morocco, Niger, Nigeria, Oman, Romania, Serbia, Senegal, Slovenia, Sri Lanka, Togo, Tunisia and Vietnam.

The latter is being touted by the World Bank to be among Asia’s fastest-growing economies in 2019, with a 6.6-per cent GDP growth rate forecast.

Kevin Snowball, who co-founded Vietnam-focused investment firm PXP Vietnam Asset Management, highlighted two main drivers – foreign direct investment and exports. “As the population becomes less poor, domestic demand becomes a big feature. That’s the story in China, and it will be a similar one here.”

For a country to be classified as a frontier market, the FTSE suggests five elements generally apply – a formal stock-market regulatory authority, no significant restrictions on repatriation of capital, a rare occurrence of failed trades, clearing and settlement of trades in five days or better and a timely trade-reporting process.

Nicholas Larsen, of International Banker magazine, stated: “It is clear that frontier markets offer a multitude of benefits to investors looking for both high-growth opportunities and the possibility of diversifying their portfolios.

“Nevertheless, a number of risks persistently arise in such markets, including political unrest – which is preventing countries such as Myanmar (formerly Burma) from even being included in the frontier-market category; inadequate market infrastructure, transparency and/or liquidity; volatility, often due to currency fluctuations and an insufficiently diversified economy that relies on just one or two sectors such as oil and other commodities; and lax financial-market regulation and poor standards of financial reporting.

“It is the existence of such risks that means that frontier markets may only ever end up representing a small portion of an investment portfolio.”

In Africa, research group Brookings cites burgeoning opportunities around a population that is fast growing and urbanising with incomes and consumer spending rising, a ramping up of industrialisation and production, a push to close the infrastructure gap, innovations to unleash agricultural and resource wealth, and the potential of increasing digital and mobile access.

Barclays added: “Africa has nearly two-thirds of the world’s mineral reserves.

“However, frontier countries often have an immature financial infrastructure. Companies may have poor levels of shareholder and corporate governance, and there is often a lack of information available to investors.

“The risks of investing are therefore much greater than in more developed emerging markets such as China, Brazil and India.”

So well worth re-emphasising how frontier markets should only form a small part of a balanced portfolio for those investors willing and able to accept the risk.