A new asset called ‘Frontier Markets’

These markets in diverse countries like the Philippines, Vietnam and Turkey are being sold as a chance to get in on the ground floor. But it’s important for investors to make distinctions between these markets

Both emerging markets and the emerging marketing campaign, led by the famous BRIC countries as propounded by Goldman Sachs and James O'Neill, have been very successful. To repeat the success, the modern marketing 'MadMen' of Wall Street have created a new asset: Frontier Markets. Even the venerable Financial Times describes these markets as "a lot like emerging markets a generation ago". So these assets are being sold as a chance to get in on the ground floor of a no-lose growth story.

A good example of frontier markets is the MSCI Frontier Emerging Markets Index of 26 countries, which basically includes every market not part of another index. A little more discriminating is the selection of the ever inventive Goldman Sachs. Called imaginatively the Goldman 11, these countries include South Korea, Mexico, Indonesia, Turkey, the Philippines, Egypt, Vietnam, Pakistan, Nigeria, Bangladesh and Iran.

In an attempt to replicate the success of the BRIC brand, there are the CIVETS. These include Columbia, Indonesia, Vietnam, Egypt, Turkey and South Africa. The choice of the civet, a mammal, might be accurate. The civet is known for two things: creating very expensive coffee by ingesting and excreting the coffee bean and potentially being the source for an interspecies virus known as SARS (severe acute respiratory syndrome).
Despite the odd names, there is some truth to the Frontier Market "Story". In the last six months of 2010, the MSCI Frontier Markets Index did outperform the emerging markets by gaining 16.5% against 12.3%. Of course this is a rather recent phenomenon. After doing quite well from 2003 to mid-2008, frontier markets collapsed. Like all markets, frontier markets did recover, but until recently they underperformed not only the emerging market index by 27% but the S&P 500 as well.

In terms of economic growth, these markets are very attractive, with some of the fastest-growing economies in the world. Their debt burden is often lower than both emerging and developed markets. Their growth seems generally to have a lower correlation to both emerging and developed markets, and at 13 times earnings their equities seem quite cheap. Besides they all have growing populations with young cheap labour.

But the happy talk only goes so far. There is another side of the story. First, other than marketing, the grouping of frontier markets has no purpose. To place countries as different as Kuwait, Argentina, Bangladesh, Kenya and Estonia in the same group is simply silly. These countries, their markets, economies and growth prospects have really nothing to do with each other.

Many of the problems for investors in these countries are similar to those in other emerging markets except on steroids. Their legal infrastructures are exceptionally economically inefficient if they exist at all. Many have high levels of political instability and some are nearly failed states. According to Transparency International's Corruption Index, there are countries in this group like Qatar and Estonia which rank fairly well, 19 and 26 respectively. Most do not. Few rank even in the top 100. Countries like Bangladesh, Nigeria and Philippines are all tied at 134.
Like many emerging markets, they are dominated by state-owned and family-owned companies. According to one ranking provided by the Asian Corporate Governance Association, their corporate governance is rather low. Indonesia and the Philippines ranked at the bottom for Asia with scores of 40 and 37 respectively. In contrast, Singapore has a score of 67 out of 100.
Their labour forces are young, but sadly their economies are often growing too slowly to provide jobs. Unemployment rates among younger workers are often as high as 40%. Education does not seem to help. According to the International Monetary Fund (IMF), in Egypt, Jordan and Tunisia, the unemployment rate exceeds 15% even for those workers with a tertiary education.

Also the growth assumptions may be dependent on some potentially short-term effects. For example, the African investment story is based on a belief that Chinese demand will continue. According to recent research at the IMF, the quantitative monetary easing (QE2) in the US has transferred itself almost completely to emerging markets.

The result is often highly volatile markets. Presently, Chile, Peru, Indonesia, the Philippines, Sri Lanka, Taiwan and Thailand are all at or near all-time highs. In the past, many of these markets have dropped enormous amounts. Egypt, in 2008, dropped 60%. While this was similar to the S&P 500, the recovery has not. While the S&P 500 is only 17% off its all-time high, Egypt is still 36% below its peak. Kuwait has recovered only 4% since 2008 and is still 54% off its all-time high. Saudi Arabia reached its peak in 2006. Even after five years it is trading at only 35% of its peak.

While the promise is there, it is exceptionally important for the investor to make sophisticated distinctions between these markets. Strategies that might be applicable to more developed markets have no use in frontier markets. And as always, new highs should be a signal for caution rather than the promise of greater profits.

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected])  


Inflation likely at 6.5% this fiscal end: Chawla

New Delhi: The finance ministry today said inflation will come down to around 6.5% by March-end, from 8.43% in December, reports PTI.

"It will be around 6.5% by March end," finance secretary Ashok Chawla told reporters here.

The finance secretary's remarks came even as expensive food items jacked up overall inflation, measured on the basis of wholesale prices, to 8.43% in December from 7.48% in November.

Also, the government's move to raise petrol prices is expected to fuel inflation.

"Six months ago we may have said inflation will be 5.5%-6% (by March end). Since it is always a dynamic process, today nobody is saying because the trend has not really gone down," Mr Chawla said.

He, however, added that inflation is coming down.

The wholesale price rise in December has also prompted the prime minister's economic panel to further revise upward the March-end inflation forecast to up to 7% from 6.5% estimated earlier.

Food inflation has also remained high through December, touching the year high level of 18.32%. It finally eased somewhat for the week ended 1st January to 16.91%.

The government, recently, unveiled measures to check spiralling prices by deciding to continue ban on exports of edible oils, pulses and non-basmati rice and asked states to waive local taxes on essential commodities.


Capital protection funds cannot guarantee safety of capital

These funds invest a minimum in equities, but even this is enough to drag down the fund in a downslide

Canara Robeco Mutual Fund has filed an offer document with the Securities and Exchange Board of India (SEBI) to launch a closed-ended Capital Protection Oriented Fund. It will be called Canara Suraksha Fund-Series 1. Capital protection funds are structured products, designed to attract risk-averse investors to the stock market.

The scheme endeavours to protect capital by investing in high-quality fixed income securities maturing in line with the scheme's tenure as the primary objective, and to generate capital appreciation by investing in equity and equity-related instruments as a secondary objective.

The scheme offers both growth and dividend (payout) options for investment. Its two-year plan invests 85%-100% in debt securities and money market instruments where there is low to medium risk. The three-year plan will do the same, except that asset allocation will be 75% -100%, and the one-and-a-half-year plan investment will invest 80%-100% in these instruments. The two-year plan will invest up to 15% in equities, the three-year plan up to 25% and the one-and-a-half year plan will invest up to 20% in equities.

Capital protection funds invest most of their capital in assets with a low risk, for example in government securities. At the end of maturity, this part of the capital with its returns will be worth as much as the capital of the fund at inception. So the invested money can be repaid to investors at the end of the investment term. The remaining smaller part of the capital is to be invested in more risky assets. The possible yield on this part could produce the extra return over the capital protection at the end of the duration. The funds do not invest directly in bonds or equities, but in complex structured assets, usually options.

But how useful are these funds? Capital protection funds are advantageous for investors who do not want to expose themselves too much to equity risks, and they are willing to sacrifice some part of the returns to invest in safer instruments. With capital protection funds, you may also be exposed to exotic investments. For example: Far-Eastern or commodity market investments, which are undesirable and unsafe.

Apart from this, the high fee structure is a deterrent. The typical fee structure is 2.25% of assets under management. These funds invest mostly in risk-free instruments, which can be done by an individual without the expertise of a fund manager. The returns are also slightly higher than fixed deposits. They simply offer investors moderate safety and moderate returns. That is why they are benchmarked against the Crisil MIP Blended Index. There is little scope for fund managers' expertise and the high fees are not justified.

Most importantly, you cannot be sure that your capital will be protected, given the way the asset allocation will happen. If interest rates shoot up and equities fall sharply you could lose the capital. During the collapse of 2008, for instance, these funds should have protected investors from the downslide. However, this was not so. They underperformed miserably against their benchmarks in that year, yielding pathetic returns of -8% on an average. So, it can be seen that even with a minimal exposure to equities, such investments drag down the returns for the whole fund.


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