BRIC Bust Fuels Investor Rush Into Frontier-Market ETFs
As investors dump emerging-market equities at an unprecedented clip, they’re turning more and more to frontier markets in search of the next growth story.
No exchange-traded fund focused on developing nations has grown faster in the past year than BlackRock Inc. (BLK)’s iShares MSCI Frontier 100 fund, whose biggest holdings are in Kuwait and Qatar. Assets under management surged nine-fold to $594 million, fueled by $465 million of inflows and returns of 23 percent. In contrast, BlackRock and Vanguard Group Inc.’s flagship emerging-market exchange-traded funds have seen investors pull a record $26 billion in the period, according to data compiled by Bloomberg. The MSCI BRIC Index is down 4 percent this quarter, even as it is poised for its best week of gains this week.
While Brazil, Russia, India and China led the global economy out of the 2008 financial crisis, investors have been fleeing the biggest developing nations as their growth sputters. The Hang Seng China Enterprises Index is in a bear market, Brazil suffered its first credit-rating cut in a decade, and Russia is facing international sanctions for its Crimea takeover. Stocks are rallying, meanwhile, in places like Kenya, where oil discoveries are stoking growth, and Vietnam.
“Everybody is looking for the next China,” Jim Russell, who helps oversee $115 billion for U.S. Bank Wealth Management, said in an interview at Bloomberg’s headquarters in New York. “We think Africa is probably one of the areas. Where’s the growth geographically? It’s got to be in the frontier markets.”
Emerging-market stocks tripled in the 10 years through 2007, returning more than four times as much as the Standard & Poor’s 500 Index, as booming global demand for raw materials and the rise of middle classes drove growth. More recently, stocks from the so-called BRIC nations of Brazil, Russia, India and China slumped 7.1 percent in the past year -- compared with an 19 percent gain for the S&P 500 -- as investors lost confidence in their growth prospects.
Brazil’s Ibovespa entered a bear market earlier this month after an economic slowdown spurred S&P to lower its rating to the lowest investment grade. While President Dilma Rousseff has tried to boost the economy through tax cuts and subsidized loans from state-run lenders, analysts surveyed by the central bank see growth slowing to just 1.7 percent this year from as high as 7.6 percent in 2010.
Goldman Sachs Group Inc. said last week that China will expand 7.3 percent this year, below the government’s 7.5 percent target. The world’s largest developing economy is being held back by challenges that include pollution, surging lending outside the regulated banking system and growing risk of company defaults. Shanghai Chaori Solar Energy Science & Technology Co. became the first onshore bond issuer to renege on obligations earlier this month.
Russia’s Micex index has dropped 11 percent this year amid escalating tensions after its annexation of Crimea. Sanctions imposed by the U.S. and the European Union are pushing the country toward a recession in the second and third quarters as the intensity of their economic penalties increases, according to banks including state-run VTB Capital.
“Traditional emerging markets have struggled under what are very secular changes, and investors have responded to this by a reallocation in their portfolios,” Christopher Wolfe, chief investment officer at Bank of America Merrill Lynch’s private banking and investment group, said by phone. Merrill Lynch oversees $1.9 trillion in client balances. “Frontier markets may be where emerging markets were in late ’80s and early ’90s. You’re really looking for the next 10 to 15 years.”
Investors have moved $81.2 million into U.S.-based emerging market equity exchange-traded funds over the last five days, cutting outflows for the past year to $21.6 billion, according to data compiled by Bloomberg. BlackRock’s flagship emerging market ETF, the world’s second-largest by assets, added $144 million on March 26, its first day of inflows since October. MSCI’s BRIC Index has gained 5.5 percent this week, while the Ibovespa has climbed 5.7 percent.
“For several years we had been relatively bearish on emerging markets in general and Turkey in particular, but in the last few months we have turned more bullish,” Sam Vecht, London-based manager at BlackRock Emerging Europe Trust Plc, said in e-mailed comments March 17. Investors getting out of emerging markets now risk repeating the mistakes of 2009 to 2011, when many were too late to share in the biggest gains, he said.
BlackRock’s frontier markets fund invests just over half its assets in securities from Kuwait, Qatar and the United Arab Emirates. It also counts stakes in companies from Nigeria, Argentina, Kenya and Vietnam among its largest holdings.
The ETF is up 7.1 percent this year, compared with a 0.7 percent advance for the S&P 500 and a 1.6 percent decline for the MSCI Emerging Markets index.
Asset managers are buying frontier markets as they seek to mitigate risk by investing in securities that don’t move in lockstep with global stocks, according to David Wickham, a senior product specialist at HSBC Global Asset Management, which oversees $427.8 billion in assets.
The MSCI Frontier Emerging Markets Index has a five-year correlation coefficient of 0.63 relative to the U.S. benchmark equity gauge, compared to 0.76 for MSCI’s emerging markets index, data compiled by Bloomberg show. A figure of 1 would indicate the two move in tandem.
“Frontier markets do behave differently from emerging markets,” Wickham said in an interview at the bank’s offices in New York. “It does give you nice diversification benefits because you do have low cross-country correlations.”
MSCI, the New York-based provider of stock market indexes, says markets classified as frontier need to be accessible to foreign investors and in countries not going through extreme economic and political instability. Frontier markets are a subset of emerging markets, and in general tend to have more relaxed liquidity and market-cap requirements, MSCI says.
HSBC, which manages $650 million of frontier-market assets, is overweight the Middle East and also favors Pakistan and Vietnam, Wickham said. The London-based bank has been reducing its stake in Nigeria and Kenya.
Vietnam’s Ho Chi Minh Stock Index (VNINDEX) has soared 18 percent this year as economists forecast growth will reach 5.6 percent in 2014 and quicken to 5.85 percent next year. Exports jumped 12.3 percent in the first two months of the year from the same period in 2013 as higher costs and wages in China prompt companies to set up manufacturing elsewhere in Asia.
The Kuwait Stock Exchange Weighted Index has climbed 7.5 percent this year, extending a two-year streak of gains. About 21 percent of BlackRock’s frontier fund is invested in the nation of 2.7 million that’s smaller than New Jersey. Benchmark gauges for Qatar and the United Arab Emirates have climbed 34 percent and 13 percent in the last year.
Lower volatility in frontier markets relative to developed and emerging-market assets will continue to lure capital, according to Jennifer Hsui, who helps oversee BlackRock’s frontier market fund. The MSCI Frontier Emerging Markets Index’s 180-day volatility, a measure of price swings, was 8.04 yesterday, compared with 10.7 for the S&P 500 and 12.7 for MSCI’s emerging markets index.
Hsui’s ETF has had only two weeks with outflows since its inception in 2012, according to data compiled by Bloomberg.
“Frontier markets really complete the international investment set” for asset managers, she said in a telephone interview from New York. “People are equating them to where emerging markets were 20 years ago, and thinking about the growth opportunities from there.”