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25 June 2024

‘Frontier markets’ gives us a whole new investing label

By Paul Murphy

Take two countries – Qatar and Mozambique. Both are lightly populated lands, with large tracts of undeveloped land. Each can boast areas of stunning natural beauty and yet they remain largely untouched by the modern tourism industry.

Thereafter the comparisons start to decline – rapidly! Qatar, with its strategically important oil reserves, counts as one of the richest places on earth, on a per capita basis. Mozambique, now rebuilding its economy after a shattering civil war which ended in 1992, remains one of the world’s poorest countries, still battling with natural disasters like flooding and persistent health matters like malaria.

Yet, from an international investment perspective, both countries have long been placed in the same catch-all pot. Both Qatar and Mozambique are, in the traditional language of bank and institutional portfolio management, “emerging markets”.

The label is deeply patronising, of course. (Qataris might rightly claim that they did their “emerging” as an important sovereign state many years ago.) But there are few niceties accompanying international investment flows.

Much more important is that the label is too broad – if an emerging market can mean anything from Qatar to Mozambique, via India, China and Saudi Arabia, then it lacks descriptive precision. Indeed, the phrase “emerging markets” has become a cliché in the sense that over-use and randomised labelling have rendered it meaningless.

Time then for new descriptive labels with tighter definitions. Step forward then Morgan Stanley, which is now enthusiastically promoting the concept of “frontier markets” – a class of investment which really should have arrived a long time ago.

The phrase frontier markets, in investment banking parlance, is not employed on in a Wild American West sense. Rather, it is about those economies and markets whose importance is growing at such a speed that they now require their own dedicated investment basket.

The actual frontier market name has been bandied about for a number of months now, but it is only recently that it has begun to stick – and there’s a reason for this.

Morgan Stanley’s investment index business, MSCI, has now compiled a frontier market investment index and named the constituents – one of its global series of widely followed investment benchmarks. It means international investors have a ready yardstick against which to measure investment performance – and, if the launch of so many new MSCI benchmarks is any guide, the move will significantly boost the interest of international investors in the underlying constituent markets and companies. Not surprisingly, perhaps, the new frontier market index is heavily biased towards Gulf countries. Indeed, Kuwait, UAE, Qatar, Oman, Bahrain and Lebanon account for two thirds of the index’s so called “free float” market capitalisation. That is a total of $131bn (Dh480m) of readily investable shares of a benchmark total of $196bn.

Other notable constituents include Nigeria, at $25bn, and Slovenia, at $9m. But with the likes of Mauritius at $1.8bn and Tunisia at $0.6bn lower down the scale, it can be seen that the new MSCI frontier markets indicator is very much a proxy for Gulf Inc.

So how is Gulf Inc doing in relation to everywhere else? Extraordinarily well, according to Michael Hartnett, an emerging markets investment strategist at Merrill Lynch. In a recent research note to Merrill clients welcoming the new MSCI Frontier Markets benchmark, he noted that since the end of September last year, Gulf stock markets are up 31 per cent. That compares with broadly flat returns from the traditional catch-all measure of emerging markets and eight per cent losses for the developed equity markets of the West.

Sharp sell-offs in London and New York over the past week will have made the divergence of performance even more apparent.

So Merrill are actively shepherding clients into the Gulf region. Says Hartnett: “We estimate GCC current account surpluses will total $750bn per day in 2008. Massive oil surpluses, excess liquidity and strong domestic demand mean the dramatic re-rating of Gulf markets is set to continue.”

Crucially, for a strategist like Hartnett, who is advising investors with global reach and a desire to balance the risks in their portfolios, historical figures show that investments in what we are now calling frontier markets have proved to be uncorrelated with stocks in both traditional emerging markets and developed equity markets.

So, from Merrill Lynch’s perspective, the Gulf offers a way to reduce overall investment risk, while at the same time giving exposure to potentially dramatic capital growth. And that’s a rare opportunity in the tricky game of stock selection.

Hartnett sums it up: “Our top frontier recommendation continues to be the Middle East Gulf Markets. It is consensus, but it’s hard to argue against massive oil surpluses, excess liquidity, easy fiscal and monetary policies and inexpensive stocks. Likely FX appreciation and the promise of a safe haven from global equities provide the icing on the cake.”

The writer is the associate editor of the Financial Times