The global economic recovery already seemed to be hampered by the increasing weight of inflationary pressures of high food prices and the cost of energy. Prospects are even darker now that Japan, the world’s 3rd largest economy, is seriously challenged. Hopefully a nuclear disaster can be averted and the reconstruction of the damage could help the Japanese economy avoid a harsh collapse. In any case it could be fair to expect Japan to be less of a contributor of global GDP. Let’s also hope the tectonic plates don’t have too much further adjusting to do.
What to do now? We say it is best to remain rational, diversify risk and and seek opportunities of genuine growth. Easily said, but where are they to be found?
If we go back to 2008, the global economy went through a recession, markets sharply corrected, especially those of the frontier markets, despite the fact that most of these economies continued to steadily grow. One of the conclusions we draw today is that back then there already was hard evidence that many of the new emerging economies had de-coupled from the developed world. Their financial markets, on the other hand, were still shackled to the major developed markets. Frontier markets went straight out of portfolios along with all other investments deemed to be ‘very risky’.
When the markets recovered during 2009-10, the frontier markets lagged behind. This didn’t have much to do with fundamentals, but rather with the fact that they were mostly ignored because investors were too busy allocating to the major emerging markets.
Over the past 3 years, most of African and Middle Eastern frontier markets have continued to grow steadily and further improve their infrastructure resulting in a better framework that will only help to further facilitate ongoing domestic growth. If you factor in that during the global recession, the levels of FDI slightly declined, it only further emphasizes the fact that most of the growth is increasingly derived from internal drivers. The good news is that FDI is probably going to rise again, not only the flows that come from the developed world, where most corporate players have by now understood the enormous local consumption potential in the years to come. increased FDI will also come from the dynamics of increasing regional economic integration. This will obviously further boost growth.
The recent social uprisings, while they are very spectacular, should be seen as a clear symptom that there is a significant shift in the fundamentals towards a more modern framework in developing nations. We should not forget that the political changes were led by a young, popular and secular uprising (rather than military or religious movements). This has emboldened the population across the region and should ultimately result in greater government accountability and transparency.
Basically the action is a result of a demand for more prosperity. The individual outcomes for each country will probably differ, but the net result will be that, going forward governance will have to be more in sync with the demands of the youthful population for progress. What we are seeing in Tunisia and Egypt increasingly looks like a successful revolution.
The tremendous discount in valuation remains in place today in many of the frontier markets. The unrest may still be keeping investors away from the MENA region but we continue to see this as a very good medium term entry point to gradually start building a position in the region.
Allocating to frontier market fixed income can offer an additional source for high returns on top of an equity portfolio. Frontier market debt issuers still offer high yields despite solid credit profiles and adequate diversification can even further enhance the overall credit profile of the portfolio. Higher prices for natural resources means higher reserves for producing nations and hence more collateral for outstanding debt – very simple and very positive for the bond prices of these countries.
Simplistically put, rising oil and food prices result in higher inflation, which in turn pushes interest rates up, all this is not good for the developed countries with much debt outstanding. A strong case is building that in the long run investors will be much better off by betting on the economies that enjoy genuine growth, many of which can be found in the emerging and frontier market space.
We have attempted to make this point numerous times before, but the 2 main reasons that keep investors from entering frontier markets are the fear of political risk and the lack of liquidity. These are very valid concerns to have. However, since there are a number of frontier markets to invest in, these risks can be mitigated by adequate country and sector diversification, this is a habitual practice for frontier market fund managers.
The essence is to invest in the obvious growth opportunities of tomorrow’s world. We need a new template of thought that allows us to accept the fact that there are a few billion people out there that are ‘getting a life’ and that there are ways of benefiting from that as an investor. We really need to re-asses and rationalize the true nature of ‘risk’!
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