March 5, 2014

For Investors Heading For The Frontier: Active Management Adds

Nile Capital presents pan Africa mutual fund
The once-vaunted BRICs have lost their mojo, at least temporarily, as the place to look for stock market diversification. Since April 2011, emerging market equities have generated negative returns.
Surprisingly, part of this void has been filled by the strong performance of frontier markets. In 2013, the gap between performance of the MSCI Frontier Markets Index (25.90 percent) and the MSCI Emerging Markets Index (-2.60 percent) was the widest since 2005.

For institutional and individual investors alike, frontier markets are becoming a viable asset class to include in a well-diversified portfolio, and high rates of economic growth are the main attraction. Of the 30 fastest growing economies in the world (measured by real GDP growth), 23 are frontier markets.

The easiest way to implement a frontier market allocation is to participate in an index fund. Just as investors flocked into emerging markets a decade ago through passively managed vehicles such as iShares MSCI Emerging Marketing Fund, they now are showing interest in frontier index funds such as iShares MSCI Frontier 100 Fund (FM). With a goal of tracking the MSCI Frontier Markets Index, FM has grown rapidly in recent months, surpassing $500 million in assets.

Buyer beware.

Three Advantages Of Active Management
Is an index fund the best choice for participating in frontier market growth?

We believe the dynamics of frontier markets favor active management over indexing. Nile Capital Management, one of the few firms to actively manage frontier market funds, has demonstrated three key advantages an active manager can identify and exploit in frontier markets.

1. Portfolio Stability – Nile seeks to identify well-managed companies operating on the African continent, and then hold their stocks over extended periods. In comparison, index funds can be relatively unstable. Currently, the top three country weights in FM are Kuwait (18 percent), UAE (17 percent) and Qatar (16 percent). However, in May the MSCI index methodology will reclassify UAE and Qatar from the frontier to the emerging category. Millions of dollars invested in FM will then be reshuffled among other frontier markets, for reasons unrelated to frontier market growth or company profitability. Since frontier markets are dynamic, index re-classifications occur frequently and can be unsettling to investors.

2. Diversification – About 54 percent of the weight of the MSCI Frontier Markets Index is in the financials sector. This does not represent the diverse economic activities that are driving frontier market economies, especially the three themes that we seek to include: natural resources; infrastructure growth and a rising consumer sector. Across the African continent, we see countries with uncorrelated economic cycles, and we are identifying attractive companies operating under diverse business models.

3. Population and demographics – The high economic growth of frontier market economies is directly related to population and demographic trends. Africa’s population, currently estimated at one billion people, is projected to double by 2040. The average age of the continent’s people is 21, compared to 45 for developed countries. The average GDP per capita in Sub-Saharan Africa is $1,400 compared to $30,000 for the Arab States of the Gulf Corporation Council. (GDP per capita in the US is $51,000).
Of course, it’s the younger generation that forms new households, creates families, and drives consumer sector growth. An active manager can emphasize countries with emerging consumer economies such as Nigeria and Uganda. In comparison, a frontier index fund may be heavily weighted toward more mature economies such as Kuwait, the United Arab Emirates, Qatar and even Saudi Arabia (in some classifications).

In summary, we believe the smartest way to invest in the frontier is to take a long-term perspective and focus on well-managed companies trading at attractive valuations. Our portfolio concentrates on about 30-40 companies, and we look for opportunities to identify businesses trading below intrinsic value. We are very comfortable with the valuations of our leading companies, some of which are not covered by any Wall Street analysts. Indeed, the frontier markets are much less “efficient” than developed or emerging markets.
We believe frontier market knowledge and in-depth research gives active managers an edge in these markets, relative to a passive indexed approach.
Nile Capital Management
We Know Africa: From Cairo to Cape Town
For more information please call 646-367-2820

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