by Dambisa Moyo
March 11, 2013
The search for superior, uncorrelated risk-adjusted returns continues, and savvy investors such as endowments and family foundations are turning their attention to the frontier markets. Such markets exclude the BRICs, many of which posted sizable equity returns of over 30% last year, including Nigeria, Estonia, Pakistan, and Kenya. The MSCI Africa sub index posted one-year returns of over 60%. By comparison, the BRICs (Brazil, Russia, India and China) grew slower and sluggish—for example, around 4% on the Shanghai index and -2% on Brazil’s Bovespa.
A set of well-known factors bind these seemingly random countries. Solid debt and deficit dynamics; attractive labor trends, favorable demographics and upward mobility; and important productivity gains all make for a compelling economic growth story. However, there are two areas where perceptions of frontier economies are really changing: risk and liquidity.
In regards to risk, investors are beginning to better understand the significant benefits of delineating between risk, measurable and possible to calculate, and uncertainty, which is not. Like anywhere else, investors who can tap into on-the-ground networks and relationships have an advantage with risk management. But thankfully meaningful, the task of risk assessment has gotten easier with increases in transparency around economic and political information, data flows and widely available regulations over jurisdictions. The transition to western-styled democracy and fully transparent and liquid capital markets will be bumpy, but the uncertainty arising from these growing pains should be viewed in the context of an upwardly sloping trend line of progress which will almost certainly occur over a relatively short time line.
Correlations between frontier and developed stock market returns are around 0.75, compared to roughly 0.90 between developed and emerging economies such as the BRICs. Country risk premiums are close to those of the broader emerging markets. With proper risk management tools, this implies that investors can garner significant diversification benefits. The lower correlation between frontier and developed markets points to risk factors that are orthogonal to the global risk-on, risk-off theme that has captivated markets over the past five years. Frontier markets provide opportunities to step away from the global macroeconomic themes and focus on the micro stories on the ground, thus providing a better environment to identify unique investment opportunities. Smart investors are looking for great opportunities that are driven by company-specific issues from which they can analyze and profit.