Only the Brave: A Quick Guide to Investing in Frontier Market Stock Exchanges


The only way is up? Karachi Stock Exchange 2013 /14 (Bloomberg)

If you are a risk taking devil may care type of investor then frontier stock markets could be for you. Putting funds into listed equities is an ideal way of investing in frontier markets, allowing you to avoid the huge expense and logistical concerns of developing or investing in a single business. Rapid growth in countries across Asia and Africa in recent years have seen long moribund stock markets see values and listings rise. Ghana’s stock exchange increased in value by 45% in dollar terms in 2013. This represents spectacular growth by any measure and way beyond the tame gains recorded by the mature bourses of Western Europe. The flipside is the danger of markets going in the wrong direction, falls in frontier stock markets can be even more spectacular than their rise.

Currency collapse, political instability and sudden unforeseen drop off in economic growth are all hazards lurking for unwary investors. And these are macro risks which must be considered before you even start looking at the current and future performance of companies on the exchange, normally the central issue for any investor. In addition investors must take into consideration the fact that frontier markets are very shallow. With relatively few shares listed sharp movements in a sector or even a single company can heavily distort the overall market. Another major issue is the lack of good, reliable financial information and independent analysis on listed companies, while this is improving thanks to sites like this – it is still light years away from the Bloomberg terminals of London and New York.

Frontier Markets Vs BRICS Markets

From an investors perspective there is evidence that frontier markets perform well when BRICS markets are performing badly, as demonstrated by the correlation coefficient measured by HSBC between the Morgan Stanley Country Index (MSCI) BRIC index versus the MSCI Frontier market index, which has a negative correlation of 78% over the past decade. This basically translates as when BRICS markets are up; frontier markets are down, and vice versa. If this continues to be true then it strongly suggests that frontier markets are a good hedge against the BRICS.

While Frontier markets are volatile and untested, many of the countries they are based in are predicted to enjoy strong growth rates in the near future, particularly compared to developed countries and even emerging markets, which in theory should buoy stock prices.  So while it doesn’t make sense to place all your investments into say Nigeria or Bangladesh, putting them into a fund which covers a wide range of frontier markets allows investment in this sector without the hassle of having to investigate each single market and individual equities. Of course if frontier exchanges rise and fall in tandem, driven perhaps by US Federal Reserve tightening, then this again could cause havoc with the value of a fund.

Emerging Accounting Standards?

While frontier markets (like all markets) may fall and rise to globally significant news, they also each have their own local dynamics and idiosyncrasies. They would all suffer from poor quality of information as well as high political and business risk that can make investing in these markets more like a private equity play rather than one in a publicly listed security in London or Hong Kong.

In frontier markets you are faced with a relatively unknown company with sometimes very basic financial or corporate information, whereas in mature markets you have an array of publicly listed information and analysis on every possible facet of a potential investment. However information arbitrage is a powerful weapon, those with an intimate knowledge of a market or company have a massive advantage, if you know the inner workings of local business and the country’s political landscape then of course it is possible to buy individual equities with a greater degree of confidence.

Booming Karachi

I last visited Karachi, the Pakistani megacity and financial capital over 10 years ago, on an individual level everyone you meet is very friendly, but this masks a city with serious problems of political and ethnic violence. Despite these issues and an often shaky economic outlook Karachi’s recent stock market performance has been stellar, the KSE 100 index shooting up from 17,408 to 26,751 in a year, a 65% increase (Feb 5 – Feb 5 2014) – great news if you invested a year ago, but would it be so wise now? This is particularly true of a country with such a long history of conflict and instability, not to mention patchy economic performance. If you had put money in the Vietnamese stock market in January 2012, you would have earned yourself a 12.2% rise by December. However, if you bought the same shares a year earlier in 2011 and then sold them the following December 2013, you would have lost half of your money.

For those looking to invest in these markets, do your homework and take a look at the frontier funds available, but first consider carefully whether you are ready to place your hard earned money in such risky countries.

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