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Investors Explore the Frontier Markets

Businessweek: This year the real action for risk-tolerant global investors is on the frontier.

The MSCI Barra Frontier Markets index tracks equities of 25 countries, including six in the Middle East that account for 55% of the index’s total market capitalization. Year-to-date as of Apr. 12, the Frontier Markets index was up 13.66% compared with a 4.09% gain by the BRIC countries (Brazil, India, China, and Russia) in aggregate and a 5.25% increase for the emerging markets overall.

The distinction between emerging and frontier markets mostly concerns size and how far along they are in developing legal and regulatory systems, critical elements for international investors. The MSCI Barra global equity indexes use both objective and subjective criteria to admit countries to a given index, says Paul Herber, a co-manager of the $44 million Accessor Frontier Markets Fund (FRONX). To qualify as an emerging market, an economy must have a certain number of companies that meet a minimum market-capitalization threshold and certain trading criteria. Also, the country’s equity market must be open to a certain degree to foreign investors, and its legal framework must be stable.

Last year, Argentina and Pakistan were both downgraded from emerging to frontier markets by MSCI Barra. Argentina implemented capital controls that reduced the ability to convert foreign currencies into the local currency, while Pakistan provided artificial supports to its stock market by restricting daily declines at the peak of the financial crisis. Both countries, however, have higher gross domestic product per capita than many emerging economies, says Herber.
Discounted Valuations

Economic growth forecasts may be contributing to the bigger gains in frontier-market stocks than those in the more developed emerging markets so far in 2010. IHS Global Insight (IHS), a leading research and economic forecasting firm, predicts 3.5% GDP growth in the former group compared with 1.6% growth in the latter.

But the apparent preference for frontier markets this year is more likely due to discounted equity valuations. Frontier markets are trading around 10 times projected aggregate earnings for all the public companies in the 25 countries that make up the MSCI Frontier Markets index, while emerging markets are trading at 16 times expected earnings for 2010, according to Nathan Rowader, co-manager of the Accessor fund.

Given the huge rally that the largest, most liquid emerging markets experienced in 2009, it makes sense that frontier markets, which are smaller and still cheap relative to their more developed cousins, would benefit as liquidity spreads to smaller markets, says Nick Chamie, head of emerging-markets research at RBC Capital Markets in Toronto. Recent gains in these markets may partly reflect the exaggerated impact that money flows have on prices in smaller markets with less liquidity, he adds.

Of the component indexes that make up the MSCI Frontier Markets index, the Africa index had the largest gains year-to-date as of Apr. 12—25.2% vs. 9.74% for the Latin America & Caribbean index, 8.32% for the Central & Eastern Europe & CIS index, and 6.95% for the Asia index.

via Stocks: Investors Explore the Frontier Markets – BusinessWeek.

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