Merrill Lynch’s international investment strategist Michael Hartnett posed the question in a report released on Tuesday, in which he noted, inter alia:
For much of the decade Frontier markets were an uncorrelated, outperforming asset class.
- Between 2000 and 2008, the Frontier market index had a low 32% correlation with the S&P 500, compared with 78% for Emerging Markets
(EM) and 86% for Developed Markets.
- Between January 2000 and August 2008, annualized returns from Frontier Markets were 19% versus 8% from Emerging Markets.
- And the perceived risks from Frontier markets were falling thanks to policy improvements – external debt as a share of GDP fell in almost all regions , most dramatically in Africa from 70% to 14% in Africa
Frontier markets – loosely defined as emerging emerging markets – did indeed look positioned to conquer (or at the very least, outperform all comers).
In late 2007 the FT, citing Investec Asset Management’s chief executive Hendrik du Toit, described the enthusiasm for them as “reminiscent of the early waves and crashes of the more mainstream emerging markets during the 1980s.”
That was also the year in which MSCI Barra, creator of indices, launched a series of indices dedicated to the asset class and covering 19 countries including Bahrain, Bulgaria, Croatia, Kazakhstan, Kenya, Nigeria, Sri Lanka, the United Arab Emirates and Vietnam.
But mere months later, Lehman Brothers had gone bust and the world was a different place, Hartnett says:
Frontier went from being an increasingly popular growth theme to a lonely and illiquid trade in a matter of weeks. Correlations with the S&P 500 spiked from a 32% to a very high 90%, in line with EM and DM (Chart 3).
He continues (emphasis ours):
Simultaneously the two key drivers of the asset class, bull markets in commodities and risk collapsed, causing emerging markets to depreciate and levels of CDS to soar. Frontier Markets plunged, with countries that had relied on foreign borrowings for growth particular hard hit:
- The credit squeeze hit Eastern Europe countries loaded by external debt; the Ukrainian market is down 67% since Lehman went bust.
- Lower commodity prices have hurt oil exporters; Gulf equities are down 33% since the Lehman event.
- Markets sensitive to both commodity prices and capital flows have been crushed; Kazakhstan down 48% and the UAE 42%.
Hartnett is, over all, cautious on the outlook for the frontier asset class, and advises secular bulls to be patient, since for for the frontier bear market to come to an early end, two cyclical catalysts are needed:
- higher oil prices, preferably in excess of $60
- and a recovery in global risk appetite
Neither of these, as Hartnett contends, is immediately likely.
Related links:
Investors’ enthusiasm grows new frontiers – FT
A patchwork of changing status – FT