Patchy outlook for frontier stock index as top scorers exit

Jun 02 2014, 21:43 IST
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SummaryA flagship index of frontier market stocks is likely to struggle to match its previous strong performance...

A flagship index of frontier market stocks is likely to struggle to match its previous strong performance after the promotion of its two top scorers, Qatar and the United Arab Emirates.

Youthful populations, high economic growth rates and an expanding middle class have drawn investors to frontier markets in recent years, leading them to significantly outgun emerging and developed markets in terms of returns.

Though smaller and less accessible, these rapidly-changing frontier markets exhibit the characteristics that many bigger emerging markets had a decade or more ago, before growth in economies such as Brazil, Russia, India and China started to become more sluggish.

MSCI's frontier markets index has returned 21 percent this year in dollar terms, compared with 3.5 percent in emerging markets and 4.6 percent for developed markets.

But a large part of those frontier gains were driven by Qatar and the UAE, each of which has delivered 30-40 percent returns this year. The outperformance is partly due to a recovery in Dubai and strong government spending, but also in anticipation of their well-flagged upgrade to emerging market status this week.

But as they start their new careers as emerging markets, the frontier index will be dominated by two markets - Kuwait and Nigeria - which together will make up 45 percent of the index.

These markets, and the new skew of the index, may not appeal as much to investors.

"Kuwait is hardly a pre-emergent consumer economy with plenty of upside," said Daniel Broby, a veteran frontier market investor and chief executive of Gemfonds.

"Its weight, a function of listed financials and lack of stock markets in other frontier markets, is the bane of the frontier space."

Kuwait has returned 15 percent this year in dollar terms, but that is partly down to a steady currency.

Nigeria, struggling with a weak currency and beset by political risk over upcoming elections and the abduction of over 200 schoolgirls by Islamist group Boko Haram, is flat in dollar terms.

High-yielding Nigeria is considered a risky play, while highly-rated Kuwait is seen as a relatively safe frontier investment. Investing in both countries at once therefore doesn't make much sense, analysts say.

SMALL FRY

Despite the attention given to frontier markets, analysts see only around $20 billion following this sector, compared with more than $1 trillion for emerging markets.

Frontier investing tends to be the preserve of specialist investors, with passive money - which mirrors the performance of an index - making up less than $1

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