LONDON Feb 5 As emerging markets tumbled this
year, the riskiest country groupings on the fringes have been a
Small markets, local stories and in some cases pegged
currencies backed by strong central bank reserves have shielded
frontier markets from the worst of the emerging market rout.
Lebanon, Tunisia, Bulgaria, Lithuania, Qatar and Kuwait are
among the world's lesser developed markets and are outperforming
more mainstream emerging markets in the most recent storm.
The benchmark MSCI frontiers index has eked
out a 1 percent rise in total returns this year, but that
compares with a 7.4 percent loss in emerging markets
and a 5.4 percent drop in developed stocks.
To be sure, the performance of headline frontier indices
mask the differing fortunes of an eclectic group of markets that
includes Argentina, which is going through another severe
But far from the widespread advice to be hyper selective
right now within the emerging markets universe, sticking with
the broad frontiers index may have been the most reliable play
over the past year.
Last year too, emerging stocks, bonds and currencies fell as
investors fretted about lower growth in countries such as Brazil
and China and the end of the U.S. Federal Reserve's monetary
stimulus programme, which had depressed U.S. bond yields and
driven volatile investor flows to high-yielding assets.
But frontier stocks and bonds rose in 2013, boosted in
markets such as sub-Saharan Africa by a stronger growth outlook.
"We have picked up where we left off last year," said Slim
Feriani, CEO of Advance Emerging Capital. "The key difference is
currency, you do not have currency moves like we have seen in
the Fragile Five."
The so-called Fragile Five currencies of the major emerging
economies of Brazil, India, Indonesia, South Africa and Turkey
have suffered sharp losses over the past 12 months, forcing
protective interest rate rises in several cases, on a reversal
of the investor inflows of the past few years.
Many frontier markets, including the Gulf countries of
Kuwait, Qatar and the United Arab Emirates, have currencies
pegged to the dollar.
Pegs can be a problem if central banks run out of foreign
exchange reserves to prop up their currencies. But the
energy-producing surplus countries of the Middle East have
$30-60 billion in reserves, and can likely ride out the current
volatility if push came to shove.
These three countries make up more than 50 percent of the
frontiers index, helping to explain its outperformance.
Other top-performing frontier markets this year include
Bulgaria and Lithuania, which have currencies linked to the
still relatively buoyant euro.
Frontier markets, so-called because of the relative
difficulty of getting in and out of them, have won far less
international investment than emerging markets and so have been
less prone to the flight of speculative hot money.
Emerging markets have attracted index-tracking retail
investors through exchange-traded funds (ETFs) and these have
been among the first to take fright and leave, investors say.
Emerging stocks are a trillion-dollar market, of which $300
billion is in ETFs, compared with less than $20 billion under
management in frontier stocks, according to estimates by banks
and fund tracker EPFR.
This cash has headed for the exits as the Fed started
cutting its bond-buying programme, a process famously described
as "tapering" last May by then-chairman Ben Bernanke.
"A lot of the money coming out of emerging markets is still
due to tapering tantrums," said Antoon de Klerk, fund manager at
Investec. "That liquidity would not have reached frontier
markets to nearly the same extent."
Because of this lack of liquidity, there is also a lack of
correlation between frontier markets and other markets, and
between individual frontier markets.
Investors look more closely at local factors instead.
The top-performing frontier markets this year are Jordan and
Lebanon, which investors ascribe to improving sentiment about
neighbouring Syria, following a peace process which started last
Tunisia has also rallied, boosted by the adoption last week
of a new constitution.
And just as investors cheer reform-friendly emerging markets
such as Mexico, Morocco, which suffered a downgrade from
the emerging market to the frontiers index last year, has shown
resilience following the government's willingness to tackle
Even where frontier markets have fallen this year, it is not
necessarily related to the global situation, analysts say.
"The frontier currencies that are not pegged get driven by a
lot of internal factors," said Angus Downie, head of economic
research at African bank Ecobank.
"The global economic situation has had an impact in Africa
but it's somewhat muted - Africa is not fully integrated with
global economic trade."
The Ghanaian cedi, for example, has hit record lows,
forcing the central bank to stabilise it. But
investors say this is because new energy resources in the
country encouraged high levels of government debt, rather than
due to global factors.
"The fall in the cedi has wholly been of Ghana's making, it
is a massively overheated economy," said de Klerk.
However, some of last year's frontier darlings are now
feeling the heat of the global sell-off.
Nigerian stocks, which soared 43 percent in 2013,
have fallen 2.5 percent in 2014, the naira is trading
below its 150-160 per dollar band, and the central bank says hot
money remains in the system.
Mauritian stocks have fallen after rallying 20
percent last year, domestic bond yields have risen and the
central bank governor said this week that rates should be raised
to prevent capital flight.
And even if investors like local stories, they may have to
sell the bad with the good in the event of an even larger-scale
sell-off, in order to meet client redemptions from their funds.
"We are seeing continuing outflows of emerging markets, week
in, week out, we have seen some panic," said Feriani.
"Frontier markets have remained uncorrelated, that won't go
on forever - I am a bit cautious."