Young Investor

Investor's final frontiers

Adarsh Gopalakrishnan | Updated on February 05, 2011

Jargon Buster

As far as the global investor preference for markets goes, the less risky ones are the developed markets such as United States, Canada, United Kingdom, and Germany among others whose inhabitants have a high standard of living, stable governance and high per capita incomes.

Second in the pecking order, are developing markets, with liquid capital markets and relatively stable governance albeit low per capita incomes and prevalent poverty, such as India, China, Brazil, Russia among others. The third category, frontier markets, is thought of as a subset of the emerging or developing market category. These markets also come loaded with risk of all shapes and sizes of the political, social and other varieties which may give rise to a plethora of scenarios through which one could lose their capital.

Frontier markets

MSCI and FTSE have frontier markets-based indices with companies from 26 and 23 countries respectively. Argentina, Bangladesh, Croatia, Sri Lanka, Mauritius, Nigeria, Pakistan are some of the names which figure on the list. The MSCI and FTSE Frontier indices have provided returns of 20 and 11 per cent respectively over the last one year. This compares favourably to India's BSE Sensex and NSE Nifty indices which have returned 11 per cent over the same period.

States, which belong to the emerging market category, are characterised as those with lower levels of prosperity, vulnerable political conditions and lower levels of transparency and liquidity in their capital markets. The same conditions also enable investors to find bargain investments.

Why Frontier?

Investors who seek out opportunities in frontier markets do so to capitalise on economies which have the potential to grow at a rapid clip as their economies stabilise, governments invest in infrastructure and eager consumers and wannabe capitalists look to make the best of these opportunities. Such opportunities are found lacking in more developed and competitive economies.

Lack of liquidity

Rising levels in metrics such as GDP per capital, per capita consumption of cement, steel and other vital goods, not to mention falling levels of corruption and increasing ease of conducting business are some of the parameters which investors employ to track the progress of these states.

The smaller size of frontier markets, lower market capitalisation of companies in these regions plus lower levels of investor interest make these markets immensely volatile.

Concentrated levels of ownership coupled with the oft-witnessed political instability may lead to investors fleeing at the earliest signs of trouble.

While such behaviour may result in a cheap stock getting even cheaper, crucial assumptions in a effective investment which include respect for law and order scenario and social stability get trampled upon often resulting in a great deal of heart ache for investors. There is also the perpetual holding risk in such economies where traditional mechanisms of ownership are easily undermined by arm-twisting governments. Ever-changing governance ideologies could often infringe upon the traditional assumptions of private ownership.

Tunisia is a constituent of the both the MSCI and FTSE frontier market indices. The Tunisian stock exchange saw over a fifth of its market cap wiped out in a matter of days as the demonstrations and riots in the country overthrew the dictatorial government that had been in place for over 23 years. The exchange had also remained shut for two weeks. Such uncertainty is one of the many costs investors incur for profiting in higher growth levels economies such as Tunisia may experience.

Requisites

Long gestation period, different accounting norms, the ability to stomach massive political risk and weathering storms resulting from controversy of holding stakes in companies whose executives often have questionable list of bosom-buddies are some of the costs investors need to factor while picking up stakes in companies operating in frontier markets.

Published on February 05, 2011

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