Frontier markets turn up the heat

FRONTIER market investment has come a long way since its beginning. Investors who were followed, bugged and had their passports confiscated and had to make emergency landings 10 to 15 years ago now pass through airports with ease and sometimes even without visas and are welcomed with open arms by people eager to hear their story. LaGuardia is probably the best example of all this.

But the question is, what has changed over the past 10 to 15 years for countries to be so accommodating? “It’s just two things,” LaGuardia says, “globalisation and privatisation”. These two and a change of mindset in the late 1900s have let the cat out of the box and frontier markets are today defined as smaller, less accessible markets in the emerging markets.

“Frontier markets are warm now and are going to be hot in no time. We are now looking at the next emerging market; the next BRIC.”

The frontier markets the investors are after have a large natural resource base. In Sri Lanka, market capitalisation and liquidity of frontier companies are on the rise.  Market capitalisation, which was US$ 12 billion at the end of the war period, is now US$ 20 billion, whereas liquidity too has shot up from a couple of million dollars at the end of war to US$ 20 million.

Driving frontier markets

The growth and the driver in the infrastructure in frontier countries is infrastructure. LaGuardia notes that for development of the country and growth of GDP, infrastructure is a key attribute. Privatisation from both the government and non government sectors coupled with features such as the two billion people working in the market who will be drivers of growth, low cost labour and the age structure is taken into account as key economic drivers.

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“In Sri Lanka the age structure of the working population is young — it is an entrepreneurial, highly-educated crowd. Our offices are in Hanoi, Colombo and Dhaka, which shows the importance of these markets, which have manufacturing high on their agendas.”

Speaking of the expected growth from the frontier markets, LaGuardia draws in examples from Bangladesh and Brazil. “We started investing in Bangladesh in 2004 and the liquidity then was about US$ 3 to 4 million per day. Six years later it is close to US$ 300-400 million per day. And in Brazil the market capitalisation to GDP was about 25 per cent in 1996 whereas in 2008 it went up to 80 per cent. That is the growth we expect from frontier markets,” he asserted.

Why invest in frontier markets?

“Investing in frontier markets is all about people, people and more people.” In a frontier marker there is no leverage from a sovereign perspective and personal debt is low; therefore there is no need to go through deleveraging markets. There is growth with statistics showing that frontier markets grow three times faster than developed markets.

There is also diversification, low base effect (infrastructure, privatisation-market cap to GDP), favourable demographics — large source of cheap labour, young population and a large base of untapped natural resources, which is a source of wealth for development.

Risks and challenges

With frontier markets come a whole lot of risks. The biggest, however, is the liquidity problem. Then come political and social stability, which is a huge advantage to Sri Lanka as the doubts of the country’s stability are no longer existent among international businessmen. Lankan political stability is predicted to hold for the next five years, he said.

Whether the regulatory environment is consistent is also a key issue. Moreover, currency and the corruption levels in the country will also be critically analysed.

When it comes to challenges, the access to information and low transparency are top of the list. Most often, the lack of information bridges a gap between the perception and reality. LaGuardia stated that in Sri Lanka, however, the information was freely available, which further calls out for more investors to come in.

Foreign ownership limits, high transaction costs, capital controls, liquidity and developing legal framework (investor safeguards) also poses a hurdle to achieve their goals.

Benefits

Benefits of foreign investors in the market are many. It lowers the cost of funding for companies. Mobilises domestic savings and allocates capital efficiently and facilitates exchange of goods and services.

“The economic benefits from accelerating capital market development are also sizable,” he said. “There is also greater liquidity for market participants and improved corporate governance and transparency.”

Benefits to individual companies through frontier markets include the alternative source of capital to debt to fund expansion and growth, generating greater public awareness, diversifying investor base, owners can monetise part of their ownership stake as well as liquidity guarantee and reducing investment concentration risk.