So far, Arab and African markets have been the star performers of 2010 but investor’s perception towards this investment region is only slowly changing. The past 3 months have been great for Silk Invest and we have doubled our assets under management. We are grateful to our partners for this and we would like to further highlight the misperceptions about our target markets.
Performance
While most developed and emerging equity markets have lost around -3% since the start of the year, Arab markets are at +6% while African markets are +9% ahead of their end year level.
We have been doing our best to explain that the dynamics at play in these markets are very much alive and strongly kicking. Most of what drives the growth comes from inside these economies. However, many investors sold out or decided against entering this space in 2009 as they were not able to comprehend the long term investment case nor were they able to put the events in Dubai and Nigeria in context.
The result was that these markets very much stayed behind in 2009 and, just like we forecasted last year, the African and Arab markets are now significantly outperforming their peers in 2010. We remain very positive as our markets continue to trade at a big discount vs. their peers.
Benchmarks
Silk Invest is not a big fan of benchmarks but unfortunately we cannot ignore their importance and their place in the world. Index providers have systematically made a distinction between global markets, emerging markets (EM) and Frontier Markets (FM). The allocation of countries to these indices is highly questionable. As an example, around 25% of the MSCI Emerging Markets Indices is allocated to Taiwan and South Korea, each of which only have a GDP number that is merely 50% larger than a small “developed” country such as Portugal!
Most of the African and Arab markets have ended up in the FM category. Another striking reality is Saudi Arabia, the biggest Arab market with a market capitalization equal to 60% that of South Africa, was not even good enough for the FM index. Given that the reason for this has to do with restricted access to this market for foreign investors, but it is yet another hint at how distinct FM markets are from the economies they attempt to embody. Even though this world of benchmarks may be absurd, many investors often have no choice but to abide by them. It’s is yet another “big elephant in the room”.
Considering the above, it is no wonder that investors put their newly found positive and adventurous sentiment to work by investing only in the popular emerging markets, avoiding the markets across the “frontier”. Obviously, much of this investment is the result of the residual effects caused by global equity funds that follow a benchmark driven asset allocation. Even most EM specific funds are not investing in frontier markets! This, once again, is due to the fact that many are in the business of beating EM benchmarks.
There are many reasons why investors are not crossing the frontier. It is probably due to the fact that they are feeling around in the dark by not being familiar with the markets or maybe because they don’t have the confidence of knowing any managers well enough to take the leap.
Trying to understand the increasingly multi-lateral world we live in is already time consuming enough and it leaves little time for further exploration of unknown territories. There multiple reasons that help justify the procrastination, but many investors mention “political risk”.
Political risk
In our view, “political risk” has become too vague a concept. It is everywhere in this world, even in developed countries and it takes many shapes and forms. Political risks in most African countries is as high/low as their EM peers. Investors are keen to single out issues in some of our markets but gladly turn a blind eye to the various conflicts which are taking place within or close to the borders of the BRIC countries. As investors, they are even happy to live with the vague property rights that exist in many of these popular EM markets. There are more interesting paradoxes where those came from but the point is that, in our opinion, political risk is tremendously over-played.
Factual reports by e.g. World Bank confirm our thinking that most African markets score well on strength of institutions or ease of doing business (chart below). There is much room for thought here; for example, while generally investors seem to have no problem with an allocation of up to 5% in Russia, and by doing so, they are assuming one single unit of political risk. At the same time they seem uncomfortable with a similar exposure to a diversified portfolio of African or Arab markets, which essentially reduces the element of political risk across various countries, another good example of truncated perception…
More than the exercise of comparing risks amongst emerging market peers, it is worthwhile to take a minute to think about how developed world governments and corporate leaders have dealt with the financial crisis. Were all transactions transparent, free of conflicts of interest and were shareholders treated fairly,…?
In conclusion we think that African and Arab markets when held in a diversified manner are low risk EM strategies and profit from their unique combination of lower valuations, lower leverage, higher GDP growth and a lower dependence on the global economy. For those familiar with “The Matrix”, it is time to take the red pill!
The good news is that we are seeing more and more investors ‘crossing the line’. Our award winning fixed income fund continues to receive inflows and we are adding exposure to new and exciting markets in that space. Our positioning in the African and Arab equity markets continues to produce upside despite the lack of direction global markets seem to be undergoing at present.
Leaving you with these thoughts, I hope you can find the time to read our monthly updates on the African, Arab and Central Asian markets. As usual they are packed with stories of growth and opportunity and provide insight and perspective to issues that make these market and economies tick.
To access the updates, please visit our website.
We look forward to keeping you updated
With kind regards from the Silk Invest Team
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