Far-flung investments get their place in the sun

The Nairobi stock exchange on the frenetic first day of an initial public offering, an event in which some locals sold cows to buy shares. (Radu Sigheti/Reuters)

TOKYO: Bernard Moody, investment director at Progressive Asset Management, probably logs more time on the road than most fund managers. From his base in London, he travels frequently to Cambodia, Uzbekistan, Kenya and other far-flung corners of the world looking for stocks to add to his portfolio.
He is also one of the calmest individuals in a notoriously nervous business. When Kenyan stocks, which he holds, fell sharply over the New Year, he barely blinked.
"The market was closed for the entire period since Christmas" because of the presidential election scandal, Moody said in a low, calm voice. "I think it reopened yesterday." He leaned over to check the computer screen in his London office. "Oh, it reopened Wednesday, and fell 5 percent. It hasn't opened on Thursday and Friday."
Aplomb is a staple character trait of fund managers who invest in "frontier" markets, the outer reaches of global investing. Farther afield even than emerging markets like China, India and Brazil, and characterized by small trading volumes and high volatility, frontier markets have a reputation of being to investing what off-piste is to downhill skiing: a risky way to reap potentially high rewards.
And there are certainly rewards. From October 2001 to last September, the S&P IFC Global Frontier Markets index - including 20 frontier economies like the United Arab Emirates, Vietnam and Nigeria - rose 553 percent, surpassing even the healthy 430 percent gain by the benchmark for emerging markets, the MSCI Emerging Market index for the same period.
But what has started to come home to investors is that frontier markets, which are remarkably diverse, have achieved these good returns with low correlation to the developed markets. That is a blissful disconnect these days that investors - stunned by the spillover of subprime-related turmoil from developed to emerging markets - increasingly appreciate. For the month of January, as markets from the Dow Jones industrial average to the CAC 40 sank, the IFC frontier index slipped just 2.8 percent.
Frontier markets still represent a small part of the total world equity universe. The market capitalization of the 20 markets in the MSCI frontier index is $172.7 billion; that compares with $3.25 trillion for emerging markets. Those who specialize in frontier investing say that while the opportunities to participate are growing, frontier markets are likely to remain a niche investment for some time to come.
But as major world stock markets continue to be whipsawed by credit crunches, oil shocks and other crises - and as the "decoupling" theory of regional separation falls further into disrepute - the appeal of frontier markets is also likely to grow.
One reason for the appeal is the documented lack of correlation with developed and emerging markets.
Over the past seven years, frontier market correlation to MSCI World, an index that represents equities of the developed countries, stood at 0.4, while that of emerging markets was about 0.8. A correlation of 1 means 100 percent lockstep, while 0 means no correlation.
That relative lack of correlation insulates frontier markets from the whims of big global investors like hedge funds, who make quick moves in and out.
"Frontier markets are very thin and they are not very open to a lot of institutional investors, and hedge funds cannot short them," said Christian Deseglise, global head of emerging markets for HSBC Investments.
In August, when the subprime loan crisis first rocked markets around the world, the S&P Frontier index actually gained 1.1 percent. The MSCI Emerging Market index lost 2.1 percent.
That makes it sound as though the frontier markets have escaped the equalizing forces of globalization - for now. But in fact globalization is the main reason that these markets have captured such wide attention.
"It is a combination of global demand for resources, plus the moving of manufacturing base to the cheapest labor markets and the development of the capital markets," said Leila Heckman, senior managing director at Bear Stearns Asset Management in New York. "These countries became more plugged into the world's resources markets as globalization progressed, while the ability to tap the world's financial markets let them build the necessary infrastructure."
And as labor costs in emerging markets like China and India move off rock-bottom, the frontier markets look more advantageous to multinationals.
For those who invest across the range of frontier markets, volatility is reduced because the frontier category is extremely diverse. Members differ widely from one another in the stages of economic development, size of the economy and population, political stability and corporate governance, resulting in widely different performance and valuation. By contrast, the mainstream emerging markets mostly are politically stable and have attained certain levels of legal and regulatory structures necessary to run markets.