Bloomberg News

Frontier Stocks Lose in Best Rally Since ’91

February 27, 2012

An operator checks nylon warpers at a textile factory in Thulhiriya, Sri Lanka. Photographer: Michael Hughes/Bloomberg

An operator checks nylon warpers at a textile factory in Thulhiriya, Sri Lanka. Photographer: Michael Hughes/Bloomberg

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 eight of the world’s worst-performing equity indexes this year are in frontier countries, where the average stock- market value of $30 billion is about 95 percent less than in emerging nations. While the MSCI All-Country World Index (MXWD) jumped 11 percent, gauges in Bangladesh (DHAKA) and Sri Lanka sank at least 9 percent as interest rates increased. Nigeria’s stock index fell 1.8 percent after union strikes and attacks by Islamic 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 percent slower than larger developing nations on average during the past three years, won’t accelerate in 2012. Bank Julius Baer & Co. says the losses create buying opportunities for long-term investors. Ashmore EMM LLC has been cutting frontier-market holdings and Oversea-Chinese Banking Corp. (OCBC) 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.”

Emerging-Market Rally

The 25-country MSCI Frontier Markets Index (MXFM) increased 2.8 percent this year, trailing the emerging-market measure by about 13 percentage points. Nigeria’s Union Bank of Nigeria, Bangladesh’s Dhaka Electric Supply Co. (DESC) and Sri Lanka’s Lanka Orix Finance Co. (LOFC) declined more than 29 percent, countering gains in Vietnamese shares including Bao Viet Holdings and Vietnam Dairy Products Joint-Stock Co. (VNM)

MSCI Inc. (MSCI)’s gauge of shares in 21 emerging countries, which have an average stock-market capitalization of $603 billion, surged 15 percent this year as Brazil reduced its benchmark interest rate to the lowest level in 18 months and China cut banks’ reserve requirements. A new three-year lending program from the European Central Bank and data showing a rebound in the U.S. job market eased concern that developing-nation exports will slow.

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 percent discount to the emerging-market measure, made up of companies with a mean market capitalization of $12 billion.

‘Macro Risk’

“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. “It’s a year you don’t want to add on another layer of risk on top of macro risk.”

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 gross domestic product for nations in the frontier index is $118 billion, compared with $994 billion for the emerging-market gauge, according to data compiled by Bloomberg and the International Monetary Fund. Frontier countries have an average ranking of 74 in the World Bank’s ease of doing business index, compared with 70 for emerging markets. Their mean ranking of 82 in Transparency International’s corruption perceptions index is worse than the 75 average for emerging countries.

Liquidity Trap

Less than $15 million of shares changed hands each day on Sri Lanka (CSEALL)’s Colombo Stock Exchange during the past month, compared with $12 billion on the Shanghai Stock Exchange in China, the biggest emerging market, according to data compiled by Bloomberg.

“Frontier markets are riskier on the liquidity front, so you may get trapped there when times change,” Chong Yoon Chou, the Singapore-based investment director at Aberdeen Asset Management Asia Ltd., which has $75 billion of assets in Asia, said in a phone interview on Feb. 13.

The rally in emerging-market stocks in October 2008 foreshadowed the end of the last bear market in frontier countries. The MSCI frontier index surged more than 50 percent in three months after hitting a bottom in March 2009. The gauge’s ratio of price to trailing earnings was 10 when the rally began, compared with 10.7 on Feb. 24, data compiled by Bloomberg show.

Vietnam Gains

The short-term challenges facing frontier countries haven’t reduced their long-term growth potential, said Mark Matthews, the Singapore-based head of research for Asia at Julius Baer. While their average expansion may slow to 4.3 percent this year from 4.6 percent in 2011, growth will probably accelerate to 4.8 percent by 2015, forecasts by the Washington-based IMF show.

Frontier countries including Vietnam will lure manufacturers from China as labor costs in the world’s second- largest economy rise, according to Matthews. About 60 percent of Vietnam’s 87 million people are below the age of 35 and minimum salaries were equivalent to $85 a month in 2009, compared with $173 in China, according to the United Nations’ International Labour Organization.

Frontier markets “are a great structural story,” said Julius Baer’s Matthews, who helps oversee about $180 billion. “If you are taking a three-year view, you won’t worry if it falls in six months.”

Vietnam’s benchmark VN Index gained 1.2 percent today. It advanced 22 percent this year, rebounding from a 27 percent retreat in 2011, as inflation slowed for a sixth straight month in February to 16.44 percent. Dominic Scriven, the chief executive officer of Ho Chi Minh City-based money manager Dragon Capital Group Ltd., said by phone on Feb. 17 the rate may drop to between 8 percent and 9 percent this year, giving the central bank room to cut borrowing costs.

Mobius Is Bullish

Bao Viet Holdings (BVH), a Hanoi-based insurer, has rallied 43 percent in 2012. Ho Chi Minh City-based Vietnam Dairy Products, known as Vinamilk, has increased 5.8 percent and trades for 11.8 times reported earnings, compared with an average 17.5 times since Bloomberg began compiling the data in 2006.

“Taking a long-term view is the best way to cope with volatility,” said Mark Mobius, who oversees more than $40 billion in developing nations as executive chairman of Templeton Emerging Markets Group. “As these countries move ahead, their governments are taking the steps necessary to help support sustained, steady growth.”

Nigeria Inflation

The best investment opportunities so far this year are in emerging markets, Ashmore EMM’s van Agtmael said. The MSCI emerging-market gauge is valued at 12 times reported profit, lower than the 13.7 average during the past decade, data compiled by Bloomberg show. In China, where the economy expanded at an 8.9 percent rate in the fourth quarter, stocks in the Shanghai Composite Index (SHCOMP) trade at a 53 percent discount to their 10-year average price-earnings ratios.

Van Agtmael said he cut holdings in Nigeria, where the benchmark equity index dropped 16 percent last year. Lagos-based Union Bank of Nigeria sank 33 percent since the end of December, and was the second-biggest drag on the Nigerian Stock Exchange All Share Index after Dangote Cement Plc. (DANGCEM)

A week-long general strike last month mobilized millions against President Goodluck Jonathan’s decision to remove fuel subsidies, while attacks by Islamist militants killed as many as 256 people in the northern city of Kano.

Sri Lanka, Bangladesh

Nigeria’s central bank predicted inflation will accelerate to about 14 percent by mid-year from 12.6 percent in January, even after policy makers lifted the benchmark interest rate 6 percentage points since September 2010 to 12 percent.

Inflation in Bangladesh has exceeded 10 percent every month since March as food and electricity prices climbed and the nation’s currency, the taka, depreciated 13 percent against the dollar during the past year. The central bank raised interest rates on Jan. 5 for the second time in four months.

Concerns about political stability have increased after Bangladesh’s army said on Jan. 19 that it foiled an attempt to oust Prime Minister Sheikh Hasina Wajed’s government. The Dhaka Stock Exchange General Index tumbled 16 percent this year, extending last year’s 37 percent drop. Dhaka Electric, which distributes electricity in Bangladesh, lost 30 percent in 2012.

In Sri Lanka, the government said it raised petroleum prices this month and will add a fuel surcharge on electricity bills. Higher fuel costs and the rupee’s tumble to the lowest level since April 2009 have stoked inflation and prompted the central bank to raise interest rates for the first time since 2007 this month.

Volatile Markets

The Colombo All-Share Index, which surged more than 200 percent in the two years after the nation’s 26-year civil war ended in May 2009, declined 9.8 percent this year. Lanka Orix Finance, a Colombo, Sri Lanka-based consumer-finance company, tumbled 32 percent.

For stocks in Sri Lanka and Bangladesh, “I wouldn’t buy them immediately, I will probably wait until the end of the year once the tightening is complete,” said Arjuna Mahendran, the Singapore-based head of Asia investment strategy at HSBC Private Bank, which oversees about $500 billion. “Because they are small, they tend to be really volatile, a little bit of money can pump the market up very fast, and vice versa.”

To contact the reporter on this story: Weiyi Lim in Singapore at wlim26@bloomberg.net; Shikhar Balwani in Mumbai at sbalwani@bloomberg.net; Michael Patterson in London at mpatterson10@bloomberg.net

To contact the editor responsible for this story: Darren Boey at dboey@bloomberg.net


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