The institutionalization of Frontier Markets

275

June was a bad month for most investors.  Equities and bonds tanked globally.  Thus far, July has shown some respite, but it has once again highlighted the risk that is always present in financial markets.  Specifically, for pension funds and endowments it is compelling them to re-examine their traditional perception of risk, where ‘conservative’ generally implies a higher allocation to fixed income assets.  However, with rising rates, a portfolio that is intended to deliver lower risk, may not actually achieve this objective.

Many institutional investors are now looking at creating a portfolio of uncorrelated assets that will provide a steady, risk-adjusted return in any environment; lagging in the good times, and leading in the bad.  Frontier markets have a unique appeal for such investors, if they are able to satisfy their liquidity demands.

Barings Asset Management recently released a survey of pension investors, where 18% believed that Frontier Markets have the largest potential for equity gains in the next 10 years.  Similarly, many university endowments have been reported to be seeking investment opportunities in Africa.   As a group of investors, pension funds and endowments bring corporate governance, liquidity and a long-term focus to any market they invest in.

US-based Notre Dame University invests 2% of its $8bn endowment in Africa, and expects this to increase to 5% in the next five years.  Many universities and pension funds have announced similar plans.  In the UK, this trend is growing, as evidenced here.

From our perspective, this has many positives.  An increased demand for Frontier Markets’ equities should increase prices across the board, boost liquidity, and provide opportunity for savvy investors to pick stocks that have the qualities international institutional investors look for.   The primary negative, is that an increased presence of international institutional investors is likely to lead to increases in correlations for Frontier Markets with other global equity markets.

Expect trading costs to decline and for information available from exchange websites to improve.

We believe this a long-term trend that will be realized in a similar vein as it has been for emerging markets.  These markets will gradually increase in liquidity and provide strong risk-adjusted returns in aggregate.

 

Leave a Reply