Frontier stocks lose in best rally since 1991

Written by Bloomberg | Updated: Feb 28 2012, 06:09am hrs
The best start to a year for stocks in two decades is leaving the smallest markets behind, a sign of reduced investor confidence in the least-developed economies.

All nine of the worlds worst-performing equity indices this year are in frontier countries, where the average stock- market value of $30 billion is about 95% less than in emerging nations.

While the MSCI All-Country World Index jumped 11%, gauges in Bangladesh and Sri Lanka sank at least 8% as interest rates increased. Nigerias stock index fell 1.1% after union strikes and attacks by militants. Frontier-nation stocks trade at the lowest valuations since at least 2008 versus emerging-market shares.

Falling valuations reflect concern that growth in the smallest economies, which expanded about 20% slower than larger developing nations on average during the past three years, wont accelerate in 2012. Bank Julius Baer & Co says the losses create buying opportunities for long-term investors. Ashmore EMM has been cutting frontier-market holdings and Oversea-Chinese Banking is avoiding the stocks.

On a purely tactical basis, we have actually reduced exposure in frontier markets, said Antoine van Agtmael, who coined the term emerging markets in 1981 and now oversees about $7.1 billion as chairman of Ashmore EMM in Arlington, Virginia. The larger, more liquid markets offered relatively more compelling investment opportunities. The 25-country MSCI Frontier Markets Index increased 2.8% this year, trailing the emerging-market measure by about 13 percentage points. Nigerias Union Bank of Nigeria, Bangladeshs Dhaka Electric Supply and Sri Lankas Lanka Orix Finance declined more than 29%, countering gains in Vietnamese shares, including Bao Viet Holdings and Vietnam Dairy Products Joint-Stock.

MSCIs gauge of shares in 21 emerging countries, which have an average stock-market capitalization of $603 billion, surged 16% this year as Brazil reduced its benchmark interest rate to the lowest level in 18 months and China cut banks reserve requirements. The price-to-reported earnings ratio for the frontier index, comprised of companies with an average market value of $2.6 billion, dropped to 10.7 from 16 a year ago and trades at a 10% discount to the emerging-market measure, made up of companies with a mean market capitalisation of $12 billion.

I would go for quality as opposed to underperformance, said Vasu Menon, a vice-president of wealth management at Oversea-Chinese Banking, the second-largest financial services group in Southeast Asia.

Frontier markets have smaller economies and worse rankings on gauges of business climate and corruption than emerging markets. They also have lower trading volumes, which make it more difficult for investors to sell shares. The average annual GDP for nations in the frontier index is $118 billion, compared with $994 billion for the emerging-market gauge. Frontier countries have an average ranking of 74 in the World Banks ease of doing business index, compared with 70 for emerging markets.

Less than $15 million of shares changed hands each day on Colombo Stock Exchange during January, compared with $12 billion on the Shanghai Stock Exchange, the biggest emerging market.

Frontier markets are riskier on the liquidity front, so you may get trapped there when times change, said Chong Yoon Chou, the Singapore-based investment director at Aberdeen Asset Management Asia.