``There is a general appetite to push risk tolerance even
further,'' said Neil Gregson, head of emerging-market equities at
Credit Suisse Asset Management in London, which manages $1.6
trillion and invests in Romania and Kazakhstan. ``There's been a
boom in emerging markets and investors are asking for more.''
By Alexis Xydias and Michael Tsang
Feb. 19 (Bloomberg) -- The smallest emerging stock markets
are elbowing aside Brazil, Russia, India and China to become the
world's best performers.
An index of 22 so-called frontier countries rose 12 percent
in January, the fastest-ever start to a year. Five of them,
including Vietnam, Ukraine and Croatia, are among this year's top
10 markets. A measure of BRIC stocks fell after a 53 percent gain
in 2006 made Indian and Chinese shares the most expensive among
the biggest emerging nations.
JPMorgan Chase & Co., Templeton Asset Management Ltd. and
Julius Baer Holding AG started funds in the past six months to
buy shares in the smallest economies, betting they will
outperform larger developing markets that have rallied for four
straight years.
``We've started to go into some of the frontier markets,''
said Terrence Gray, New York-based managing director of emerging
markets at DWS Scudder, which manages $114 billion. ``We're just
trying to find better value.''
Gray bought shares of KazMunaiGaz Exploration & Production
in September when the unit of Kazakhstan's state oil and gas
company raised $2 billion in the nation's largest initial public
offering. He may invest in banks and agricultural commodity
producers in Mauritius, Nigeria and Zambia, after cutting his
firm's holdings in China and India last year.
Less is More
Frontier markets, as defined by Standard & Poor's, are
dominated by companies too small and too thinly traded to be
``investable'' for most fund managers. The acronym BRIC was
coined by Jim O'Neill, chief economist at Goldman Sachs Group
Inc., in November 2001. He said Brazil, Russia, India and China
would join the U.S. and Japan as the biggest economies in the
world by 2050, eclipsing most of today's developed nations.
The S&P/IFCG Frontier Markets Composite Index has gained 35
percent in the past 12 months, compared with a 28 percent
increase in the Morgan Stanley Capital International BRIC Index
and 12 percent advance for the S&P 500.
Last month's surge in the 272-member frontier markets index,
whose members have a median market value of $241 million, was the
biggest gain in January since S&P's calculations started in 1996.
Frontier stocks are cheaper than shares in India and China -
- which trade at an average 26 and 40 times earnings,
respectively -- though they are becoming more expensive.
Stocks in the S&P/IFCG Index traded at an average 17 times
earnings last month, near the highest ever and 40 percent higher
than the average over its 11-year history. The price-earnings
ratio for S&P/IFCG index is also about 10 percent higher than for
the MSCI Emerging Markets Index.
Market Risks
Frontier markets have been valued at an 18 percent discount
on average during the past decade. Stocks in Bangladesh,
Bulgaria, Ivory Coast, Mauritius and Slovenia rose last month to
their highest price-earnings ratios this decade.
``Everybody is so positive and bullish that, as a
consequence, valuations have become very rich,'' said Patrick
Scheuber, head of equities at Swisscanto in Zurich. ``We are not
at the beginning of a cycle, but rather at the end of it.'' His
firm, managing $1.6 billion, recently sold holdings in Vietnam.
Investors are courting greater economic and political risk
by buying stocks in countries that are among the least developed
in the world. Zimbabwe, for instance, is mired in an eighth year
of recession. The inflation rate surged to a record 1,594 percent
last month as the government printed money to pay off debts. The
Zimbabwe dollar has fallen as much as 42 percent since Jan. 20.
In Nigeria, attacks have forced Royal Dutch Shell Plc's unit
to halt production of about 500,000 barrels of oil a day, almost
a quarter of the country's current output.
Luring Investors
``One has to kick the tires if you are looking for
returns,'' said Tim Drinkall, who manages about $200 million at
Gustavia Capital Management in Stockholm. Six months ago,
Drinkall spent 12 hours on a bus to visit Sojaprotein AD, a
Serbian soybean processor, before buying the stock. His Gustavia
Greater Russia fund has been adding shares in Ukraine and
Kazakhstan, favoring them over companies in Russia.
Accelerating economic growth, the prospect that more
governments will embrace capitalism and an increase in initial
public offerings have lured more money to frontier markets.
Vietnamese Rally
Vietnam's Ho Chi Minh City Securities Trading Center VN
Index has jumped 45 percent this year, the biggest gain among the
83 benchmarks tracked by Bloomberg. PetroVietnam Drilling & Well
Services Joint-Stock Co., the nation's fifth largest company by
market value, paced the advance.
The Vietnamese economy may have Southeast Asia's fastest
growth in 2007. The government expects 8.5 percent expansion, up
from 8.2 percent in 2006. Last month, the government said it will
sell stakes in three of the biggest state-owned banks this year.
In Ukraine, the world's second best-performing market, the
PFTS Index has risen 37 percent. The government plans to raise $2
billion from sales of state-run companies this year, an 18-fold
increase from 2006. The offerings will include shares in VAT
UkrTelecom, the national telephone company.
The Nigeria Stock Exchange's All-Share index rose 25 percent
as new shares, which doubled to $11 billion last year, helped
boost demand. Transnational Corp. of Nigeria Plc, whose investors
include President Olusegun Obasanjo, sold 60 billion naira ($468
million) of stock in Nigeria's largest ever IPO.
China, India
Investors are losing some of their enthusiasm for China and
India, the world's two fastest-growing major economies, a Merrill
Lynch & Co. survey showed. More money managers planned to cut
stakes in Chinese companies on a net basis for the first time in
at least four months, and India is the region's least favored
market, according to the Feb. 14 survey.
An index of Chinese stocks traded in Hong Kong has tumbled
3.7 percent after a 94 percent gain in 2006. India's Sensitive
Index quadrupled during the past four years. Gains slowed to 4.1
percent this year.
Investors are less enamored with Russia as well. The dollar-
denominated RTS Index lost 1.3 percent this year after surging 71
percent last year. Brazil's Bovespa index has gained 3.1 percent.
Merrill's monthly survey showed 14 percent of fund managers
investing in Asia said they would boost holdings in frontier
markets. The firm asked investors who manage a total of $680
billion about their plans for the first time.
Spencer White, Merrill's Hong Kong-based Asia equity
strategist, wrote in a note last week that such interest in
frontier markets ``would have been unthinkable'' a year ago.
What's Next
``It's natural that people start saying, `What's the next
up-and-coming market,''' said Cliff Quisenberry, the Seattle-
based manager of the $848 million Eaton Vance Tax-Managed
Emerging Markets Fund. Quisenberry has been investing in frontier
markets since the mid-1990s. They now account for 12 percent of
the fund's assets spanning more than 10 smaller countries
including Vietnam, Botswana, Lithuania and Qatar.
By comparison, frontier markets account for just 2 percent
of the total market value of non-developed countries.
Mark Mobius, who oversees about $30 billion in emerging-
market equities at Templeton, opened a fund in October to invest
in companies with market values of less than $1 billion, located
in countries such as Vietnam, Bulgaria and Romania.
JF Asset Management Ltd., a unit of JPMorgan, set up a
Vietnam stock fund in November. The $97 million JF Vietnam
Opportunities Fund has risen 29 percent this year. Two months
ago, Julius Baer, Switzerland's biggest independent money
manager, began a new $41 million stock fund which will invest in
Ukraine, Bulgaria, Romania, Georgia and Kazakhstan.
Assets surged almost 10-fold since Julius Baer started
selling the Black Sea fund to institutions.
Fewer Links
For some emerging-market investors, buying shares in
frontier markets helps to reduce risk because the stocks are less
correlated to the swings in the global markets.
The S&P/IFCG frontier markets index has shown correlations
of 0.42 and 0.46 during the past five years with MSCI's World
Index of developed markets and the emerging-markets index,
respectively, according to data compiled by Bloomberg.
Emerging markets had a 0.85 correlation with developed
markets, based on a comparison of their stock indexes. A reading
of 1 means that markets move in lockstep with each other and 0
shows they aren't connected at all.
``There is a general appetite to push risk tolerance even
further,'' said Neil Gregson, head of emerging-market equities at
Credit Suisse Asset Management in London, which manages $1.6
trillion and invests in Romania and Kazakhstan. ``There's been a
boom in emerging markets and investors are asking for more.''