Liquidity Risk on the Frontier


So you decide to invest in a frontier market.  You pick a country you are interested in, you Google how to gain access, you find a broker in the country, and you complete a mountain of paperwork to get access.  Finally, you put in an order to purchase the security you have had your eye on.  In many markets, and in particular, in any developed market, these tasks would be reasonably pain-free.  This is not the case in most Frontier Markets, but that is a topic for another post.

This post will address liquidity issues in many Frontier markets.  Once you manage to get into a security, you need to plan out your investment horizon.  You ought to monitor developments in these holdings as you would with any other investment.  The challenge here though, is that any time you decide to exit, you may not be able to, or at least not at a price that you are happy with.  That is, unless you are patient.  In a situation where an adverse development affects the stock, you are unlikely to be able to get out before the value of your shares has taken a significant hit.  In many cases, it may be better to wait for the equity to recover, rather than try to exit along with everyone else.

The reason for this is that most Frontier Markets have undeveloped stock exchanges, which trade thinly.  It is a parched desert out there at precisely the times that you need some liquidity.  This means that even a small trade of $1,000 could move the market.  An individual investor needs to approach many Frontier Markets as a large asset management firm would approach investing in developed markets.   As an example, take a look at the price and volume charts of two equities that we at Investment Frontier have invested in; Bank of Kigali – Rwanda (BOK), and Phnom Penh Water Supply Authority – Cambodia (PPWSA) (Chart 1 – BOK, Chart 2 – PPWSA).  Bank of Kigali has its initial public offering in 2011; PPWSA had its initial public offering in 2012.  After an initial bump in volumes from the offering, liquidity quickly dried up; barring some sporadic liquidity.  These stocks had little volatility, but this was primarily due to low volume.




Chart 1: Bank of Kigali daily value traded and share price performance (IPO - Feb 2013)
Chart 1: Bank of Kigali daily value traded and share price performance (IPO – Feb 2013)

















Chart 2: Daily value traded for PPWSA and share price performance (IPO - Feb 2013)
Chart 2: Daily value traded for PPWSA and share price performance (IPO – Feb 2013)
















For your reference, 1KHR = 0.000251 USD at Feb 27, 2013 and 1 RWF = 0.00157750 USD.  The median value traded for PPWSA was US$20,852 since its IPO and for BOK it is even lower at US$17,213 since its IPO.  Bank of Kigali has had some recent spikes in volatility which have resulted in price gains, and this is due to scarcity of supply as one large institutional investor was trying to establish a position.  10% of the time, Bank of Kigali has less than $800 of shares traded per day;  PPWSA, 10% of the time has shares worth $3,349 or less traded per day.  This means that even a $5,000 position could take days to exit.

This should make it apparent that Frontier Markets can pose significant liquidity risk to your portfolio.  For this reason, investments in illiquid Frontier Markets should be discounted at a higher premium and your return expectations should be higher.  From a pragmatic perspective, you should make investments for the long-term, not in the hopes of a quick trade.  If you want to exit, plan it carefully and give your broker instructions accordingly.  If you try to hit the market with all your shares, you will pay for it.

If you want us to explore this issue any further, or have questions on some particular issues, let us know.

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