Fron onti tier er Mark arkets ts ValueX ueX Berk erksh shir ires es 2014 A clearer path By Brian Langis
Brian is reachable brianlangis@gmail.com @absolut_brian brianlangis.wordpress.com seekingalpha.com/author/brian-langis
Presentation Overview What are frontier markets? Why invest in frontier markets? When to invest? How to invest? Where to invest? Bonus – Super Exotic Extreme Investing Questions?
Why the Frontier Markets topic? Canada is 3- 4% of the world’s market cap The Toronto Stock Exchange is ~33% Energy, ~33% Financials, then three big telecoms U.S: ~5% of the world population. Not 100% of investments opportunities New opportunities + growth + diversification Not an “us vs them”. Developed world is still an excellent place to invest. But the world today is different than the world twenty years ago. Don’t want to be left behind.
What are Frontier Markets? Formally known as Third World Countries Early stage of development - Good economic growth potential. Next wave of emerging markets Young population, rising income, growing middle class Little market liquidity Marginally developed capital markets Yet to undergo much meaningful economic development, the potential for rapid growth and outsized returns make these markets interesting to high-risk investors. Source: Bloomberg L.P .
What are Frontier Markets in Numbers 30% of world’s population 13% of world’s GDP Less than 3% global market cap 70% of countries with stock exchanges are not represented by the MSCI All-Country World Index. 3% - Market Cap to GDP Ratios 23 of 25 fastest growing countries over the next 5 years are frontiers Source: IMF, Bloomberg, World Bank, MSCI index
Classifications The line is blurry MSCI - designates which group many economies belong to. South Korea, developed according to FTSE but emerging according to MSCI. FTSE, World Bank, IFC and others have different classifications system. EMs and FMs are often lumped together.
FMs vs EMs Emerging Markets: Already achieved economic lift-off Some economic output comparable to developed economies (China, Korea) Stronger institutions More correlation and integration with global market Not as cheap, many more investors, a lot more coverage Easy economic reforms already achieved More efficient markets
FMs vs EMs October 31, 2013 to October 31, 2014 iShares MSCI EM vs iShares MSCI FM Source: Yahoo! Finance
Developed Countries Most of the major asset classes appear fully valued Significant challenge of finding growth in a slow-growth world High levels of public and private debt Political dysfunction Aging populations among other problems Reliable legal framework, more transparent, fully liquid.
Perception vs Reality
Perception Highly indebted /Poor fiscal shape Poor Wild Wild West of investing Corruption, you have to bribe to get ahead Poor corporate governance Volatile Mismanagement Too commodity oriented Uneducated/Illiterate Malnourished kids, genocides, despots, disasters, despair
Reality Growing middle class. Wage increase. (Buying cars, home, goods) Lower debt-to-GDP ratios than developed markets. (Mostly infrastructure debt) Corporate governance is increasing IMF: Around 70% of world growth over the next few years will come from emerging markets. Low correlation to global assets Profits mostly dependent on local factors. The financial crisis and banking crisis was not a feature of African economies. Less volatile than Emerging Markets – FTSE Move from commodity-oriented growth to economies that emphasize innovation and knowledge.
Perception: True Size Photo Source: LeftL Peacefare.net Right: Kai Krause
Why Invest in Frontier Markets? It’s about showing up to the party early. First-mover advantage. You get a head start. There’s a lot of punch left to drink. You get the best deals before the herd shows up. (Selling to the herd should be profitable.) Capturing where the growth is going to be There are GREAT BUSINESSES THAT ARE CHEAP The point is to invest in the “BRICs” before it was cool. Imagine investing in after WWII Japan, or Korea, or Thailand forty years ago. It’s sounded crazy, very contrarian . Still a lot of untapped resources. Government reform efforts also present the potential for both earnings growth and revaluation for frontier-market companies.
Why Invests in Frontier Markets High need for infrastructure development Need FDI for everything Low cost workforce Low correlation to rich countries Attractive valuation Higher growth Financing options limited Technology leapfrog Reverse “brain drain” Remittance Very inefficient. Limited information with limited liquidity drive major price/valuation swings.
What To Look For? Having the right demographic is not enough You need legal framework. Can foreigners get a fair deal? Recourse. Open to foreign investors. Free market principles, pro-business Stable government/regime Quality of the potential investable companies. Development of capital markets Management/Partners The right policies. Pay attention to policies that encourage economic growth.
The Right Recipe South Korea – Asian miracle II Japan – Asian miracle I Singapore – no natural resources, rich country Thailand – Attracting high-tech Botswana – big strides in governance
The Wrong Recipe Argentina, the “Paris” of South -America, Formerly one of the richest country in the world. 1962 Myanmar, richest country in Asia. Greece 2012 Mongolia Current France?
When To Invest In FMs To Get the Best Bargains When the outlook is the most miserable Ignored due to multiple reasons The herd “hot money” hasn’t showed up yet. Interesting after a war, a crash, a recession, cycle bottom…etc. Major reforms on the way The reasons above give you the best deals, low PEs Stay out when there’s a mania.
Where To Look? World’s worst stock market returns The end of a recession. The end a bear commodity cycle. The end of a war. Look at foreign stock exchange listing. Look at 13F filings of funds or list of holdings Read portfolio manager comments Change in index component Domestic country newspapers/news sites
Resources Foreign stock exchange Foreign broker firms Foreign papers Industry association Fund investments disclosing Foreign Chamber of Commerce Foreign financial sites
“General” Risks Limited size, lack of liquidity, thinly traded Family run companies / Poor governance You can take on too much risk May not follow the same rules of disclosure as Western corporations. Capital control Monitor changes in index components. Geopolitical and currency risks are real. Factor in costs and fees. Export Dependencies Strong USD
“General” Risk Continues Ability to commit capital to any national market in large volume, they are also capable of withdrawing that capital quickly. Anything from signs of weak earnings growth to an unanticipated rate hike somewhere else in the world can trigger a shift in sentiment and precipitate capital flight. Be careful of countries too dependent on commodities
Advice Approach Macro factors such as GDP growth, the level of interest rates, et cetera are less important in deciding whether to invest in a given country. Be skeptical of local brokers/analysts Always bullish, otherwise is seen as a traitor Usually after own interest (Want money to increase fund size) If bearish, will lose job, potential government business, and corporate finance deals Academic papers – (guess who paid the academics) Don’t rely too much on statistics. GDP often understated. (Bartering, household, underground economy etc…) The emergence of the middle class in country X — these are gimmicks, just marketing stories for fund managers.
Advice Approach If direct stock picking, do not ignore management. Good management reduces a lot of the risk. Spend your time on businesses that you can understand better. Focus on the “Blue Chips”. Find the best companies in the world. Don’t be a cowboy. Would you invest in it even if it was American? Prefer dividend paying Co. Can fake earnings. Can’t fake dividend. Shareholder oriented. Pick a broker that is recommended by Westerners or has Western roots. Be careful of front selling. It’s good too double check with two different local brokers. Do business with the biggest bank Verify if the auditor is a familiar name
Difficulties/Headaches Friction or extra cost High commissions Taxes Duties, Stamp duty Share registration, custodian Language and culture
Management Approach management like you are building your fantasy football team. Study their history and experience, operating and capital allocation. You can hire firms for background check. Shareholder friendly? Be skeptical of strong family run companies
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