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Investors Clinic: Stuart Culverhouse on Frontier Markets

The third in a special series of CNBC investors’ clinics, Stuart Culverhouse, chief economist at frontier market investment bank Exotix, answered your questions on the opportunities in frontier market investment.

British economist Stuart Culverhouse has had a broad and varied career in emerging and frontier markets, having advised the UK Government on economic policy and spent nearly a decade in the private investment sector.

Before becoming chief economist at Exotix in 2006, Stuart was economic adviser to the UK Government, where he covered Latin America and East Africa for the Export Credits Guarantee Department, the UK’s official export credit agency.

Before that he covered Latin America at Her Majesty’s Treasury, where he also worked on the UK economy, debt management and private public partnerships. He moved to HMT from Goldman Sachs , where he started his career in the economics department.

What was the difference between frontier fixed income markets and frontier equity markets in 2011?

SC: The market performance last year was very segregated. Fixed income—external debt markets in particular, had a good year despite what we saw in the global environment with Greece and also with concerns about global growth. But we saw returns on some of the frontier bonds that we cover of 20 percent, which was not bad. If you’re looking at diversification ... then the frontier markets were quite good. We saw good performance in Latin American names and Caribbean names like Venezuela and Ecuador, Uruguay but also Dubai, the Republic of Congo, the Seychelles.

How did all this happen given the withdrawal of liquidity from the markets?

SC: Coming out of the global crisis, there is still some value in the frontier markets because people started first looking at the more mainstream emerging markets and then moving down the spectrum. But I think also it reflects ... strong fundamentals. A lot of the markets we are talking about are not as leveraged as some of the developed countries, they have stronger fundamentals. They only have a few bonds—one or two—so the refinancing needs that they have are not as large. I think a lot of investors are taking comfort from various particular safeties.

Emerging equity markets showed more upside than frontier markets last year – why was that?

SC: Since the financial crisis, emerging markets rebounded pretty strongly. The frontier index has been pretty flat and not enjoyed the same recovery. I think it’s partly liquidity coming out of the global crisis—people are still concerned about liquidity. If you are going through to the frontier equities index, they tend to be smaller, less liquid, turnover is lower. We think that should improve—growth is still pretty solid in a number of these countries so we should expect to pick up going forward.

With a lot of investors still cautious after the Dubai crash, why are you still buying UAE sovereign bonds?

SC: The fixed income has seen a strong rally since 2009—remember we had the Dubai World standstill and that created a lot of chaos. Since then, I think the strength of Abu Dhabi in supporting Dubai and some of the turnarounds that we have seen in Dubai GREs have helped the credit story. Dubai Sovereign has a seven percent yield which is three hundred basis points over Abu Dhabi. If you believe that Abu Dhabi will stand behind Dubai—which we do—then we think that’s an attractive value. And you are getting 12 percent yield on a GRE like Dubai Holding which is obviously very closely connected to the state, diverse interest in property, finance and investments—it owns the Jumeirah Group—and we think that, even on a standalone basis, is a really good credit.

So, two types of frontier market – equity markets versus fixed income. Which one is best to invest in?

SC: In the near term we are likely to see better performance in bonds and fixed income space, just because of the ongoing nature of the global uncertainty that we have—the liquidity issues etc—I think there are still some returns to be had in the fixed income side. You have to select your countries – there are some political risk issues in some frontiers at the moment, they have to be avoided. But I think there is still some upside to be had in frontier markets.

Why are the immensely rich countries of the Gulf taking so long to get to emerging market status?

SC: In terms of emerging market definitions, you can argue many different things. There is a particular definition in the equity sense of … what you mean by an emerging market or frontier market. In order to progress from the frontier to the emerging market index—and countries might say "we are not frontier, we have high per capita income" —but you are talking about a technical definition. The requirements to move up have to do with liquidity, free float, disclosures—things like that. Although income per capita may be high and you have active corporate sectors, these things can be a barrier to progressing up to emerging market status. People will differ—it is a gray area.

What are the prospects for Burma?

SC: We are hearing a lot more about it. I think the large reform agenda since the Junta changed has been quite tremendous. It is on the periphery of our radar now. The investable opportunities are fairly limited—I believe there is talk of a stock market at some point or collaborations with various Asian markets. We’ll see if these things come to fruition. Not easy to invest at the moment unless you’re in private equity.

In some of these countries there are political risks and concerns over liquidity and the rule of law – in a crisis the investor wants to be able to withdraw funds. Isn’t there an FX risk in places with non-core currencies?

SC: Liquidity is going to be an issue—it’s an issue with emerging markets and it’s certainly an issue with frontier countries. You can get in—we saw this rush of capital before the crisis and when the crisis came you weren’t able to repatriate your foreign exchange. We are still suffering the relics from that. Liquidity is also a factor and turnover is quite low on some of these exchanges.

Given these issues, shouldn’t we be a little more conservative about frontier investment while there are still issues in the global economy?

SC: I think you have to differentiate across the emerging markets, they are not all homogenous. Some will be attractive, some will be high risk. At one level—unless the global economy suffers a further deterioration or we get a tail risk event in Greece and the euro zone etc. And then if growth bumbles along, we’ll expect a pickup next year and a massive policy stimulus. So then I think a lot of the investment you are getting in Eastern Europe and around the peripheral developed countries will actually be displaced into emerging markets and by association then into frontier—so almost frontiers might be a beneficiary of that re-allocation to some degree. Now it doesn’t have the size to deal with all of it. But it should be a marginal beneficiary.

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