CORRUPTION CONCERNS
Corruption is a major concern for those investing in frontier markets and understanding the relative position of countries is essential to understanding the overall picture.
“If a country is coming to the market and its corruption is in line with for instance Tanzania or its governance is in line with Senegal, it allows you to price the risk,” says Nazli. “Regulation is a whole other thing. We have seen how that has played out in western markets and that’s why we always look for some international financial institution involvement in the country.”
The fear corruption brings led to the creation of Transparency International’s Corruption Perception Index and it makes interesting reading.
Compared with the BRIC countries – most of whom have an elevated emerging market status – Africa is clearly putting its house in order.
“If you look at all the frontier markets and compare them to Brazil, India, China and Russia where investors are happy to put their money, many are less corrupt than Russia,” says Bell at T Rowe Price. “Take Africa, for example, and 43 African countries are less corrupt than Russia, while 23 are considered less corrupt than India. It’s a smaller number for China, but it gives you an idea that you can’t tar the region with the same brush and say that they are all corrupt.”
Though ESG is claimed as becoming an essential component of mainstream investments, the truth is somewhat different. But those committed to investing in frontier markets must look at everything through an ESG lens, says Peter Elam-Hakansson, head of portfolio management at Stockholm-based East Capital.
“From our point of view, we always have the same principle when it comes to ESG, no matter where the investment is,” says Elam-Hakansson. “It is key if you want to be a long-term institutional investor, so it must be taken into account everywhere.”
Gustavo Galindo, portfolio manager at Russell Investments, agrees that ESG cannot be ignored and is an essential element of the investment process.
“If companies that incorporate good governance as part of their DNA have an advantage in the long run and that, to take advantage in frontier markets you have to be there for the long run, the consideration of ESG has to be almost implicit in the understanding of a company.”
SOCIALLY AWARE
Many considerations of ESG in investment circles tend to skirt the issue of the S of ESG, because it is a difficult and sometimes intangible subject to grapple with. However, the mere fact of investing in frontiers is providing a great benefit to worldwide distribution of wealth, says Galindo.
“It is true that developed world investors from rich countries will hopefully over the long run benefit providing the returns are obtained there, but there is definitely a benefit for the local countries in which they invest, because you are providing capital to people who are in dire need of capital.
“This is a very rewarding aspect of what we do in frontier markets. These are the people that we’re ultimately working for, because these are the people that are going to have a better country.”
That said, it cannot be approached the same way as in developed or emerging markets, adds Galindo, because there is little reporting, little transparency, and accounting standards may not be as good, so you have to think about it differently.
“As markets develop further there will be more of an opportunity to apply traditional metrics,” he adds. “You have to broadly think about all the benefits that you are generating, you know, into society through this kind of approach.”
ACCESS ALL AREAS
Frontier markets will contine to develop and investors will follow as they pull back from some emerging markets but seek sustainable growth.
Kieran Harkin, a director of investment consulting at JLT Employee Benefits, has been increasing allocations to frontiers since last early last year. He says frontier can be added to an equity allocation or an emerging markets equity allocation because it complements both well.
“Frontier offers diversification in both,” says Harkin. “Equity allocations in pension schemes have been reduced now for a number of years and that to some extent limits the allocations. But unless you’re a very big scheme, they offer a diversification across the board and we would support their use even for smaller clients.”
Josef Odili, head of Africa research at RisCura favours a fund of funds approach but agrees that diversification across frontiers is better than many will think.
“Despite individual countries being very concentrated in very few sectors across frontier markets, you get a lot of diversification because correlation is very low. Nigerian banks are very different from Pakistani banks, which are in turn very different from other banks. So a wide portfolio through fund of funds can offer similar return profiles, but lower volatility than accessing on a single market basis.”
Many argue the distinction between frontier and emerging markets is no longer valid, but merely an artificial construct, proven by Argentina’s fall from grace. However you view them the future looks bright for frontier markets, and as they normalise their governance regimes, investors will find them less exotic and easier to understand.
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