Frontier Markets Full-Cycle, Full-Circle Gaze

Three decades after Kleiman International clients first requested analysis and investment opportunity identification in remote markets – before they were labeled “frontier” and at the time economies in transition in Central Europe/Central Asia, Africa, and smaller Asian destinations – interest in uncorrelated, less liquid stocks and bonds is again growing despite often disproportionate pandemic blows.  As with the core emerging markets, the definition of “frontier” differs by index provider and investor. For instance, Egypt is considered a frontier market by most fixed income investors and FTSE Russell’s new Frontier EM Government Bond Index Series, but on the equity side it is solidly in the core MSCI EM Index. 

Even as some commodity prices come off recent highs and the US Federal Reserve turns hawkish, frontier markets are largely disconnected from DM rate moves. While QE tapering and rate hikes may begin late next year in the US and EU on rebounding economies and inflation, they will remain very low by historical stands. Frontier markets are also beneficiaries of DM growth. At the same time, continued multilateral assistance and the IMF’s recently announced new SDR issuance will continue to support them.

On the equity side, the MSCI Frontier Index is up 13% is USD terms through end-June. Of the 28 markets, only 7 are in the red with Pakistan and Sri Lanka the worst performers, both down 10% as the former awaits formal re-demotion.  Both countries will benefit from the IMF’s SDR issuance, with Pakistan due to receive some USD 2.8 billion and Sri Lanka USD 780 million, according to Fitch Ratings. Nigeria has also lagged, down 4.5%, on 18% inflation, FX shortages, reimposition of fuel subsidies, and World Bank/IMF criticism of the exchange rate regime.

Aside from Zimbabwe, up 166% in USD terms with domestic investors pouring savings into the market as inflation tops 100%, Kazakhstan has soared 60% through the first half. The central Asian country returned to growth through the first five months. A 25% surge in fixed asset investment and higher oil prices, with inflation contained at 7%, sent output up 1.6%. Fintech Kaspi – listed domestically and in London last year – has attracted new attention to the country, and the government plans a wave of share offerings in state-owned companies including KazMuniGas and Air Astana next year.

In fixed income, FTSE Russell’s new index, launched in early June, includes 13 local currency bond markets valued at USD 414.8 billion with a weighted average coupon near 10%.  It is market value weighted with each country capped at 10% of the index. Netherlands-based TCX, founded by bilateral donors and development finance institutions, has also this year launched a frontier market index. It tracks bonds issued by international finance institutions, like the EBRD and AfDB, in local currency-linked Eurobonds. The instruments – carrying investment grade ratings and settled in USD or EUR – are indirect bets on the local currency.  The European Investment Bank recently issued in Georgian lari, while the EBRD has issued local currency bonds in lari, Serbian dinars, and Armenian dram. 

North and sub-Sahran African markets are particularly attractive to debt investors seeking high yields and diversification.  Foreign holdings in Egypt’s debt market are near the USD 28.5 billion record high hit in March, with local bonds returning 5% so far this year. Egypt’s Minister of Finance believes that inclusion in the new FTSE Russell Index and likely addition to JP Morgan’s GBI-EM will together attract over USD 4 billion in fresh inflows. The Governor of the Bank of Ghana recently commented on the “domination of the country’s bond market by non-residents,” even though foreign investors are prohibited from buying short-term Treasuries. In contrast to recent years, the Ghanaian cedi has been relatively steady against the USD through the first half as a longer 7-yr maturity was introduced.

In the year through end-May, the 37 dedicated frontier equity funds tracked by Frontier Market News have returned from 20-60%, while the 9 fixed income funds were behind at 4-21%.  Despite the new waves of Covid and slower vaccine rollout in these markets, debt and equity benchmark and instrument proliferation has joined the “traditional” investment rationale of young populations and growing middle class. Healthcare/pharmaceuticals, technology, and SRI/ESG-related stocks have overtaken the “breweries and cement” from early discovery years, as frontier sovereigns were noticeable last year in monetary policy QE experimentation matching advanced economy enthusiasm.