Frontier markets gathering pace

Stephen Johnston
Stephen Johnston
Emerging markets have hit the headlines lately as one of the main causes of recent turbulence. Business editor Dene Mackenzie finds out why and discovers an alternative investment option - frontier markets.

Last year was a dreadful year for emerging market assets and there has been no respite this year as volatility spread to emerging market equities bonds and currencies, Milford Asset Management senior analyst Stephen Johnston says.

Investors had been pouring out of emerging markets in response to the tapering of the quantitative easing policy by the United States Federal Reserve, together with concern China, the world's second-largest economy, was heading for a ''hard landing'', he said.

Last week, the Fed eased its bond-buying programme by another $US10 billion ($NZ12.16 billion) a month, taking it down to $US65 billion. Since 2008, the Fed has spent $US3 trillion on propping up the US economy.

Emerging market countries such as Turkey, South Africa and Brazil, that depended on cheap foreign capital to finance current account deficits, had been particularly vulnerable to the withdrawal of policy stimulus in the US, seeing their currencies depreciate significantly, Mr Johnston said.

A drop in currency value was of concern to emerging market companies borrowing money in foreign currencies.

Turkish corporates held more than $US160 billion in foreign currency-denominated debt and the plunge in the lira had pushed up their debt repayments which would affect their profitability.

Harbour Asset Management adviser Christian Hawkesbury said while both the Reserve Bank and the Fed met market expectations with their scheduled policy decisions, the real focus of markets had been on emerging market volatility.

That served as a reminder that even in a global economic expansion, there were risks.

''Over recent months, emerging markets have experienced considerable market volatility as investors have grown nervous about how they will cope with a withdrawal of monetary stimulus from the Fed.

"It is a useful reminder that even in a global expansion, economies and markets seldom move in a straight line,'' he said.

Late last week, emerging markets recovered on from a sharp sell-off as Latin American stocks and currencies gained and Russia's ruble and Turkey's lira rebounded after policymakers pledged to take any necessary measures to stabilise their markets. But investors remained worried the respite would be short-lived.

Traders said recent panic selling had abated for now as markets priced in the current pace of stimulus withdrawal by the Fed.

China's economic slowdown, however, left investors cautious after an index of business conditions for Chinese manufacturers dipped for the first time in six months.

Many emerging countries, including Brazil and Chile, greatly rely on commodities exports to China, which makes their currencies vulnerable to further losses should China, the world's second-largest economy, disappoint forecasts.

''China risk has risen, and US Treasury yields have fallen'' since the beginning of the year, David Lubin, chief emerging market economist at Citi, wrote in a research note.

''The net effect is to create a reminder that weak emerging markets still face a rather hostile environment for their exports.''

Citi forecasts real exchange rates to rise further in weak developing countries with ''unfinanceable current account deficits'' in order to cool down domestic consumption and imports.

Turkey and South Africa were among countries that hiked interest rates last week, with only an initial limited impact on investor sentiment.

Currencies eventually steadied as central banks from Istanbul to Moscow and Brasilia took new measures or stepped up verbal intervention to shore up their markets.

The ruble came off a record low against the euro and its lowest level in nearly five years against the dollar after the Russian central bank said it would make unlimited interventions if the exchange rate strayed outside its target corridor.

Mr Johnston said Milford had a small allocation to emerging markets but the firm was ''much more excited'' about the prospects for frontier markets.

Frontier markets tended to be countries less developed, with lower incomes than emerging markets.

''In effect, they are up-and-coming emerging markets. It is a relatively new opportunity set for investors with the indices only launched in 2007.''

The index included a diverse range of countries such as Kuwait, Qatar, Vietnam, Nigeria and Bangladesh, he said. Frontier markets rose 24% in US dollar terms last year while the mainstream emerging market index fell nearly 3%.

The exciting thing about frontier markets was they had many of the same characteristics seen in emerging markets before they had their big boom in their stock markets.

''Broadly speaking, the frontier market story is one of catch-up and convergence with what has occurred in emerging markets.

''The attraction of frontier markets includes a strong economic growth outlook, young and growing populations, rapid growth in middle class, increasing foreign investment and low government debt levels.''

From a market perspective, they also offered diversification benefits as frontier markets had low correlations to emerging and developed markets and low correlations to each other, Mr Johnston said.

Foreign investors had small allocations to frontier markets, making them less vulnerable to periods of market distress.

While emerging markets and developed markets had experienced a torrid time recently, frontier markets continued to shine, he said.

Emerging markets
Brazil, Chile, Colombia, Peru, Egypt, Greece, Hungary, Poland, Russia, South Africa, Turkey, China, India, Indonesia, Taiwan, Thailand.

Frontier markets
Argentina, Jamaica, Bosnia, Bulgaria, Croatia, Romania, Botswana, Ghana, Kenya, Morocco, Zimbabwe, Oman, Palestine, Qatar, Saudi Arabia, United Arab Emirates, Bangladesh, Pakistan, Vietnam.


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