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% 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% 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 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.
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% in the past 12 months, compared with a 28% increase in the Morgan Stanley Capital International BRIC Index and 12% 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% higher than the average over its 11-year history.
The price-earnings ratio for S&P/IFCG index is also about 10% higher than for the MSCI Emerging Markets Index.
Frontier markets have been valued at an 18% 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... 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, rather at the end of it.”
His firm, managing $1.6 billion, has just 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% last month as the government printed money to pay off debts. The Zimbabwe dollar has fallen as much as 42% since 20 January.
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. “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 firms 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.