Frontier markets? Here are some helpful hints
Themes, value and, of course, risks; Matein Khalid clues you in
Frontier markets have fascinated me as they offer the potential to generate extraordinarily high returns (Pakistan since 2012, Argentina since 2015, Colombia in 2016), though also hold some of the world’s biggest basket case stock markets — Nigeria, Venezuela and the Ivory Coast. The MSCI Frontier Markets index is also hyper-volatile, as its 30 per cent fall between 2014-16 indicates and frontier economies are vulnerable to epic political and currency risks.
For instance, the Cairo stock market shut down for more than a month after the 2011 resignation of President Hosni Mubarak and the Egyptian pound plunged 120 per cent after its devaluation and floating regime last November. The Baghdad stock market collapsed after terrorists seized Mosul, Iraq’s second-largest city, and crude oil prices collapsed in 2014. This asset class is definitely not for widows, orphans and those without the abdominal fortitude for high risk since liquidity and corporate governance are also a nightmare.
The MSCI Frontier Market index is up 18 per cent to date in 2017, thanks to resilient global economic growth and positive earnings revisions. Franklin Templeton has recently reopened its frontier markets fund, which boasts asset under management of $1.2 billion. While Pakistan has recently been upgraded to emerging markets, I see no shortage of potential double-bagger equity ideas from Argentina to Vietnam. Banks, FinTech, e-commerce budget airlines and consumer shares remain my favourite sectors in both the frontier and emerging markets.
High risk can also result in high return if the macro milieu changes. It is only a matter of time before the Iraqi Army retakes Mosul and the coalition vanquishes terrorist enclaves in Iraq. This could be a steroid shot for Iraqi Eurobonds and banks/telecoms listed on the Baghdad stock exchange. The horror of the Palm Sunday bombings in Egypt have destroyed yet another tourist season six years after the original Tahrir Square protests devastated a sector that once generated 10 per cent of the Egyptian GDP. Foreigners hold a mere $1.3 billion of Egyptian Treasury bills, one-tenth their holdings in the twilight of the Mubarak era. Despite the plunge in tourist arrivals, offshore capital flows, Suez Canal tolls, LNG prices, remittances from the Egyptian diaspora in Saudi Arabia/GCC and central bank foreign exchange reserves, the Egyptian pound is one of the cheapest currencies in the frontier markets at almost 19 to the US dollar.
Terrorism in the Nile Delta and the Sinai, the chronic hard currency shortages, food riots and endemic poverty make Egypt one of the riskiest components of the frontier market index. Yet the El Sisi government has enacted painful IMF mandated reforms, the reason its $3 billion sovereign bond issue was four times oversubscribed. Egyptian pound Treasury bills and Commercial International Bank remain my favourite proxies for Egypt’s financial resurrection.
Vietnam is another frontier market crown jewel investors should not ignore. The Communist Party has staked its political legitimacy on economic reform, like postWTO China. The Vietnamese central bank has midwifed commercial bank mergers and eased limits on foreign bank ownership. The government’s agenda is reform, the creation of one million new businesses and export linked industrialisation. Trump dealt a blow to Vietnam when he cancelled the Trans-Pacific Partnership but Vietnam delivered six per cent GDP growth in 2016 and attracted almost $12 billion in foreign direct investment, mainly from South Korea, Japan and Singapore. Vietnam is also one of Asia’s biggest beneficiaries from the collapse in oil prices. Vietnam’s country index fund is not expensive at 13 times forward earnings for Asia’s most attractive frontier market. Vietcombank, owned by the Hanoi government and Japan’s Mizuho, is a play on Southeast Asia’s last underbanked major mass market.
I had originally recommended Argentina in November 2015 as I thought the election of reformist, pro-business President Mauricio Macri was a game-changer after a decade of failed Peronist statist policies. Since Macri’s election and my original “frontier market fairytale” article, Argentina’s Merval index has risen a stellar 54 per cent and Banco Macro’s New York GDR has tripled in value. MSCI relegated Argentina from emerging to frontier market after President Fernandez-Kirchner imposed currency controls and falsified its economic statistics. However, Macri’s election means Argentina has the most reformist government south of the Rio Grande. The Argentina country index fund is up 25 per cent in 2017 to date, even though MSCI failed to upgrade it to emerging market. The 15 per cent correction in Pakistan is due to $400 million in frontier market fund out flows since six Pakistani stocks are now included in the MSCI emerging market indices. Time to revisit Habib Bank and MCB?