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Venturing into wild frontier markets

bmilner@globeandmail.com

While most of us focus on the market noise emanating from the developed world and the biggest emerging markets - the austerity vs. stimulus battle, the guarded pronouncements of harried central bankers, the quarterly blitzes of earnings reports and the latest mixed economic signals - a growing number of investors have set their sights on distant markets that account for only a tiny fraction of global trading volumes.

Those would be the frontier markets, too tiny and illiquid to be counted among the emerging ranks but with the potential to get there one day.

Frontier markets "offer compelling stock valuations, comparatively high bond yields and low volatility ... but few investable assets," Blackrock Investment Institute said in a recent report.

But investors seem to be finding places to put their cash. Earlier this month, net amounts invested in frontier market equity funds climbed above $1.8-billion (U.S.), says EPFR Global. That totals about 13 per cent of global net equity inflows in the latest week. And an increasing chunk is being earmarked for once-shunned sub-Saharan Africa. Stock indexes in the largest markets, Nigeria and Kenya, as well as Zimbabwe, of all places, have climbed more than 25 per cent so far this year. Ghana is up more than 50 per cent.

"There's a huge positive story about Africa that is missed on a day-to-day basis, simply because of the headline news that's taking place," says Samuel Maimbo, an expert in financial sector development with the World Bank. His list of the unheralded and undervalued include the likes of Mozambique, Ethiopia and Rwanda, none of which would have much appeal to the equity crowd. But they are pulling in private capital.

As much as $7-billion has been invested in sub-Saharan Africa through private placements, circumventing national stock exchanges. "Can you imagine what would happen if these markets became much more transparent, much more open?" exclaims Mr. Maimbo, a former Bank of Zambia official who has been working on such initiatives.

"This is the story about Africa. If you look at the stock market indices, it's very discouraging. You could add up all the transactions on the entire continent and they'd be less than what the New York Stock Exchange trades in a morning."

True, but not everyone is discouraged about the public markets. Take Andy Brown, a senior investment manager who specializes in frontier markets with Aberdeen Asset Management in London. Aberdeen's frontier markets fund invests on several frontiers, including sub-Saharan and North Africa, as well as such outposts as Bangladesh, Pakistan and Romania. But Nigeria and Kenya combined account for more than one-quarter of its invested assets.

Mr. Brown's formula for success in such markets starts with extensive homework, plenty of patience and a willingness to buy and hold for at least a decade at a time when most investment pros are doing more portfolio churning than ever.

"We spend a lot of time going to the countries where we invest, doing fundamental proprietary research on the companies that we find there. And what we've generally found is that there are a number of really well-managed companies in Kenya and Nigeria, particularly, which are growing at a reasonable pace and which have solid long-term competitive advantages."

Investing in any frontier market comes with hefty hurdles, not the least of which is that it's hard to exit from positions, transaction costs are high, there's a dearth of research and worries about local governance, politics or corruption are often well-founded.

About 80 per cent of Aberdeen's African shareholdings are in listed subsidiaries of multinationals like Vodaphone, Diageo, Nestlé and Unilever. This adds a measure of safety, because the parents tend to impose the checks and balances to ensure effective governance. They also have a track record of success in other emerging markets that are further along the development trail.

These businesses have another key advantage: a portfolio of well-known brands that they can launch as the market develops.

For example, Nestlé Nigeria, which his fund owns, obtains about 40 per cent of its revenue just from its low-priced Maggi stock cubes. "As time goes by, if Nigeria develops the way we would expect it to, its youthful population is likely to gain more spending power. As that grows, you're likely to see them trade up in terms of products."

But Mr. Brown closes with a stark reminder: "These markets are in an early stage of development. There are going to be ups and downs and you have to stick with it. But generally, we hope that over the next 10 to 20 years these are markets which will evolve quite substantially."

*****

IN HIS OWN WORDS

Andy Brown on the need for patience and homework in Africa

You have to be a patient investor to be able to take the liquidity risk. So you really have to know the companies firstly and be willing to back them through the cycle. If you have a business which you're going to struggle to sell the shares in, you have to have a lot of conviction to buy the shares in the first place. And in order to do that, you need to get on the ground and do the work yourself.

On the sectors he likes

We find opportunity primarily in the consumption sectors, whether it's consumer staples businesses like a Unilever or a Nestlé [subsidiary] or the banks. We like businesses which are exposed to the uptick in credit growth within these markets, where credit penetration is still extremely low.

On where Africa funds go wrong

We've seen funds go wrong in the past because they had daily dealing and as a result, they had liquidity needs. Which meant the fund managers were forced to go and buy big companies that were perhaps the more liquid ones and not necessarily the best businesses to go in.

On Zimbabwe

If you were to read the papers, you'd probably never invest a dime in Zimbabwe. But if you go there and visit some of the companies, some of them are actually of reasonable quality. And if things ever settle down there, then there are some really well-managed businesses that would be in a good position to take advantage of any growth opportunity.

On other markets with potential

In the last couple of years, we have started looking at more peripheral markets we maybe wouldn't have visited 10 years ago, like Zambia and Mauritius. We're looking into doing trips to places like Tanzania and we've also had people in Ethiopia over the last couple of years.

© 2007 The Globe and Mail. All rights reserved.

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