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Asian Frontier Markets: Potential Risks, Rewards

Udit Gambhir, 18 January 2019

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This article considers a recent conference discussion on the investing risks and potential in what are defined as "frontier markets" in Asia.

Emerging and frontier markets in Asia have not had the easiest time of it over the past year although there is considerable variation inside that broad statement. As 2019 gets under way, this publication is pleased to share these thoughts about the views of general and limited partners in investment funds. The writer is Udit Gambhir, SGG Group.

As always, the views of guest writers aren't necessarily shared by the editors and readers are most welcome to respond and continue debate. Email tom.burroughes@wealthbriefing.com

Where do we stand when it comes to exploring frontier markets in Asia, and what will it take for commercial LPs to feel more comfortable with them? Furthermore, how far up the risk scale should investors go in the chase for returns – are some markets simply a frontier too far?

These crucial questions were raised at the recent SuperReturn Asia conference, where I joined a panel with Genevieve Heng, director at Anthem Asia (a Myanmar fund), Jason Bajaj, co-founder and managing partner at The Osiris Group (focused on emerging and frontier investments) and Christian Forthuber, managing partner at BRT Capital Partners (a Bangladesh-focused private equity firm).

When referring to frontier markets, it is first important to clarify which markets we are talking about. A frontier market is more developed than the least developed but not yet at the level of the emerging economies. This may be due to various factors such as small size, high risk, excessive barriers to entry/exit, illiquid or relatively small financial markets with limited access to capital, and large currency fluctuations. In terms of current investor appetite, the 2018 A T Kearney Foreign Direct Investment Confidence Index notes that 39 per cent of investors surveyed were seeking to increase their investments in frontier markets, compared with 40 per cent in developing markets and 44 per cent in emerging markets. As for performance, an analysis by Bloomberg in February 2018 showed that frontier markets gave the best volatility-adjusted returns in 2017, compared with developed or emerging markets.

The MSCI Frontier Markets Index in Asia includes Bangladesh, Sri Lanka and Vietnam, while some Asian markets like Laos, Cambodia, Nepal and Myanmar are not tracked due to their extremely limited financial and capital markets. Surprisingly, Pakistan has been ranked alongside China, India, Korea, Taiwan and remaining ASEAN countries as an emerging economy since May 2017, even though many local factors in Pakistan are no different from those in Vietnam or Bangladesh – except perhaps the size and liquidity of the financial markets.

During the panel session, our speakers expressed differing views on the precise meaning of "frontier market", as the textbook definition does not necessarily do justice to the vibrancy in many markets – especially in the Asian context. It was suggested that application of the "frontier" label may also vary depending on the investment category. The frontier market identity of certain Asian countries seems clear if an investor’s focus is on liquid securities, which  invariably require an infrastructure with an exchange and regulatory oversight.

However, when making direct private investments, a lot of Asian economies tend to be similar in their requirements and restrictions, so these investors need not consider their focus market "frontier" except in terms of the higher level of risk.  

Regarding the categorization of different countries, if we simply focus on risk and access to foreign capital, then the group considered that Myanmar and Cambodia should indeed be frontier but not in the same bucket as Nepal or Laos. The latter present far fewer opportunities and are still some way off having a framework for different types of capital and investments. It was further considered that Vietnam should move over to "emerging economy" status given the marked improvement in performance made over the last few years; the country now has a stable currency, high liquidity and diversity in financial markets, as well as large amounts of foreign investments. In the same way, there has been significant improvement in Pakistan, Myanmar and Bangladesh over the past five years, even if there have been some developments that have tended to overshadow the positive. Where many of these markets (including Vietnam) come up short is in terms of the scope of investable assets or listed companies, with a few big local blue chip firms taking an exorbitantly large share of total market value. However, for the next three to five years, the panellists concurred that these markets will be the ones to watch out for.

With regard to private capital and equity, the group felt that the next alpha will be derived from these frontier markets as we are seeing stagnating opportunities for raised capital in emerging Asia due to high valuations, tax taken by local authorities and competition issues. While these frontier economies provide a multitude of opportunities in different sectors, they embark on development with limited local capital. Keeping a close eye on government and regulations is critical as this is by far the greatest risk beyond the investor’s control.

Panellist Jason Bajaj highlighted that: “this year’s difficult equity market performance has reinforced the need for non-correlated returns across the capital structure. The availability of assets which are "uncorrelated" with mainstream market movements has long been one of the attractions of investing in emerging economies, and private equity has helped create a "safe-haven" investment strategy capturing secular alpha in these markets today”.

It was noted in the discussion that all of these economies had excellent potential, with large populations and a majority aged below 35, low labour costs, and upwardly mobile people moving from rural to urban areas and away from traditional occupations such as farming and fishing.  The local populations and states of development are similar to what was seen in emerging Asian countries around 15 years ago, although today connectivity is far superior due to the growth of ASEAN and the high penetration of computer, mobile and data services that aid industry as well as people-to-people contact – bringing awareness and also the ability to voice opinions or dissent. Taken together, while political risk remains, the other parameters of risk seem comparable or lower than 15 years ago with the young population driving change.

Bajaj further elaborated that “key Asian frontier markets continue to capture the most attractive secular trend globally, with domestic consumption growth in low and lower-middle income Asian economies building the largest middle class in human history. For these young, vibrant populations, getting access to and consuming essentials in food, healthcare, energy, mobile data, housing, SME financing, amongst others – these core appetites don’t change based on developing or emerging market volatility”.

In terms of identifying frontier economies that hold particular promise for the future, the panel considered that Bangladesh and Pakistan stand out among these markets with their extremely large populations and high numbers of consumers. Both countries have taken huge strides forward in democratically electing their representatives, and this should help broaden the pool of candidates as well as provide stability in governance and policy – important factors for any future development. It was noted that Myanmar had been moving in a positive direction until the recent Rohingya-related issues, which led to a freeze in capital availability. This is likely to remain a feature of the landscape for some time since the incidents really shook the investor confidence that had just begun to grow as Myanmar shed the "pariah" tag it held while under military rule.

So what does the future hold for potential investors in frontier markets? Regulations, transparency, government policy and compliance requirements continue to be the main hurdles in these economies. That said, Asian countries have always had quite onerous requirements for foreign investors, but this does seem to be improving, and there will be a vital role for secure and professional investment hubs such as Singapore in facilitating investments in these markets. Access to reliable information also continues to be an area of deep concern to investors, which leads to a trust deficit. However, it has been noted that, more recently, a significant amount of time is being spent on due diligence processes and, in the opinion of the group, this is a positive development. This well-spent time improves understanding and helps investors and investees come together, leading to better, more collaborative decision-making and greater assurance that capital is being deployed for the best purposes, resulting in expansion or value creation.  

Overall, it was concluded that regardless of the higher degree of risk – and the typical nuances of economies beginning the process of integrating with and accessing global capital flows – a balanced portfolio must have some allocations for such markets. Besides diversification, they provide opportunities to obtain a higher return on capital. Such investments would also eventually help in streamlining access, process and regulations. The combination of favourable demographics and urbanization, improving infrastructure, rising income and consumerism will surely provide new investment opportunities and drive real returns for international investors over the long term. And it is important to remember that the first mover usually does have a huge advantage.

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