The world's wildest investments

January 28, 2011



by Bartle Bull

/ January 28, 2011







What do Mongolia, Ukraine,
Argentina, Kazakhstan, Zambia and Croatia have in common? Bartle Bull
investigates the world of frontier markets





With economic growth stagnant in mature economies, and demand for
raw materials surging in China, globally-minded investors piled into
developing markets in 2010. MSCI, the data provider, saw its emerging
markets index go up 15 per cent; but its frontier markets index
performed even better, delivering a 20 per cent return.

What is a frontier market? The index itself is hardly a good guide.
Developed Kuwait and the UAE are in it, while Iraq is out. Argentina,
embarrassingly for Argentinians, is in.


For investors, frontier markets are those at the outer edge of the
economic development and political risk spectrum. If Thailand is
“emerging,” for example, and Vietnam is somewhere between frontier and
emerging, Laos and Cambodia are clearly frontier.


Miles Morland, founder of Blakeney Management, the largest stock
market investor in Africa and the Middle East, argues that the term
itself means nothing.


“What,” he asks, “do the markets of Algiers, Baghdad, Damascus,
Tehran and Tripoli have in common?” Many investors would answer that
they are all frontier markets. But Morland’s answer is “Zip”: such
markets have nothing in common. “One,” he says “is up 64 per cent in the
year to date, while the rest have mostly been dead. If an asset class
doesn’t exhibit some common traits then it ain’t an asset class, except
when seen through the bottom of a lazy fund manager’s lychee martini
glass.” (The best performing of these markets, the one that gained 64
per cent last year? Tehran.)


George Magnus, senior economic advisor at UBS, regards politics as
the key. “It’s about how amenable the political infrastructure is to
change and reform. In the 1970s, Latin America and the Far East were
almost identical on most economic measures. Since then, Asia’s been the
hare while Latin America’s been the tortoise. This is all thanks to
superior political leadership from people like Deng Zhao Peng in China.”


If the current economic era began with the collapse of Lehman
Brothers in September 2008, it is worth noting that since then, emerging
markets (Philippines and Indonesia, Russia and Poland, Brazil and
Chile) have risen almost 40 per cent, while the frontier markets index
has lost 25 per cent.


Frontaura, a Chicago-based fund, had a good 2010 on the frontier,
returning about 36 per cent. Steve Mack, the fund’s managing director,
is now eyeing the former Yugoslavia: Serbia, Croatia, Macedonia and
Montenegro, each of which has a stock market. He likes their
“conservative banking sectors, the lack of real estate issues, and the
fact that the Serbs are no longer initiating and losing wars with their
neighbours. We should see convergence between these economies and those
of their more advanced neighbours.” He also recommends Zambia and
Tanzania, where he says companies are undervalued compared with the more
fashionable markets of Nigeria and Kenya.


Investing in such countries is not easy. Matterhorn, a developing
markets fund, is run by Paul Bate. During the early 1980s, Bate worked
in China for Schlumberger, the oilfield services company. He then
founded and sold companies in Asia, and so learned to look at frontier
markets as an owner and operator of companies. Since launching
Matterhorn in 2001, he’s produced 22 per cent a year with only one down
year. For 2011, he is looking at emerging, or developed, market
companies in frontier economies. Enka, the Turkish construction company
doing business in Romania, Kazakhstan and Turkmenistan, is one such.
Bate’s team focuses on individual companies, seeing country-level
analysis as a way to understand the risks of specific stocks, rather
than as a way to predict capital flows in to markets.


Other fund managers derive returns from getting the country calls
right. Mongolia, which led the world with a 180 per cent return in 2010,
is still looking good for 2011, says Viktor Broczko of Advanced
Emerging. Argentina and Kazakhstan are other commodity exporters that
Broczko says look interesting. Appetite for the marginal economies is
picking up, he says, and his firm is launching a second frontier fund in
the first quarter of this year.


Frontier debt markets are often over-looked and tend to be larger
than equity markets. Peter Stiler, a debt specialist who runs New York’s
Soundbrook, a fund that returned 17 per cent in 2010, aims for returns
of 15-20 per cent a year from credit markets. For 2011, he likes
Ukraine, citing “improving politics, a decent macro-economic back-drop,
and strong commodities exports.” Avangard is a Ukrainian agribusiness
whose bonds carry a 12-13 per cent yield plus the potential for price
appreciation as Ukraine becomes more accepted by international markets.
Stiler is looking for a similar 20 per cent from some of the better
Argentine credits such as the Province of Buenos Aires as the political
situation improves with the end of the left-wing Kirchner era.