LONDON (Reuters) - Hard to enter and hard to leave, frontier stock markets from Bulgaria to Pakistan have attracted investors who are in for the long haul, keeping them clear of the worst of the markets storm.
While these less-developed emerging markets suffer from a lack of liquidity, with buyers and sellers struggling to match up at times, that can be a bonus when nervous investors are dashing for the exits elsewhere.
More liquid emerging market stocks .MSCIEF have slumped 15 percent since May 22, when U.S. Federal Reserve Chairman Ben Bernanke fuelled expectations the Fed will scale back its bond-buying program, reducing the appeal of high-yielding assets.
Those stocks plummeted last week after the Fed laid out a timetable for withdrawing the stimulus, with concern about China’s economy and interbank funding adding further pressure.
Frontier stocks .dMI7400000PUS, in contrast, have fallen only 3 percent since May 22, outperforming even the S&P 500 .SPX, although Nigerian stocks .NGSEINDEX fell 6 percent in one week this month when valuations were seen as overstretched.
Part of the allure for asset managers is that these markets stand to benefit from growth fuelled by natural resources and young populations with increasing spending power.
While they may not be easy stocks to trade, investors know that and accept the risk in view of the long-term rewards.
“Markets do not tend to move. Investors understand this is much more of a long-term bet,” said Philip Poole, head of global strategy at HSBC Asset Management.
While emerging market stocks are down 16 percent this year, frontier markets are up more than 10 percent, although they did underperform last year.
Frontier equity funds have seen buoyant inflows of nearly $3 billion this year, according to Boston-based fund tracker EPFR - nearly half of all emerging-plus-frontier fund inflows.
One advantage of frontier market stocks is that they tend to be less correlated with both global markets and each another, making them an attractive diversification play.
(For graphic, see link.reuters.com/zyh97s)
The MSCI Pakistan index .dMIPK00000PUS, for example, has only a 0.55 correlation with the MSCI Kazakhstan index .dMIKZ00000PUS, according to Datastream, where 1 indicates full correlation.
While larger markets have dropped in the past few weeks, some frontier markets have climbed. Dubai .DFMGI, Abu Dhabi .ADI and Qatar .QSI have gained after MSCI this month upgraded the United Arab Emirates and Qatar to its flagship emerging market index, against which $1.4 trillion is benchmarked.
Other frontier markets which have performed well this year include off-index plays like Saudi Arabia .TASI and Iraq.
Templeton, which manages $4 billion in frontier market assets, where many frontier funds only total $100-200 million, has a 12 percent exposure to Saudi Arabia in its frontiers fund.
“If you have a long-term investment horizon of 10 years or more, you cannot ignore (frontier markets),” said Carlos von Hardenberg, frontier stocks fund manager at Templeton.
Frontier market fans say their index is more heavily weighted than the energy-heavy emerging markets index to growth stocks in consumer goods and financial services, which cater for the rising middle class in these economies.
Like emerging markets, they are also benefiting from intra-regional trade.
“There is more trade between frontier markets and emerging markets than a few years back. They do not have too much debt. They have freely floating currencies,” said Sven Richter, frontier market fund manager at Renaissance Asset Managers.
But even where liquidity is relatively small and the exit channels narrow, overpriced stocks can still suffer.
When international consumer names like Nestle Nigeria (NESTLE.LG) were showing overstretched valuations of 35 times earnings or more a few weeks ago, it was time for the few investors there were to bail out of Nigeria.
“We do not think fundamentals justify those valuations,” said Ronak Gadhia, equity analyst for sub-Saharan Africa at frontier markets broker Exotix. “We definitely have a lot more sell than buy recommendations.”
As rising U.S. Treasury yields increase the attraction of U.S. debt, investors may also be less inclined to battle the liquidity hurdle to access frontier markets.
Jeff Shen, head of emerging equities at Blackrock, the world’s largest asset manager, told a recent briefing that the fund had found it hard to invest $200,000 in a day across a range of frontier markets because of liquidity issues, adding:
“I am not sure (frontier markets) are ready for prime-time investing.”
But for those who struggle to get in, there are others who may struggle to get out, keeping these markets afloat.
“When the market gets itself into a tizz, people tend to sell the stuff they can sell,” said Angus Halkett, emerging markets fund manager at Stone Harbor.
“When you get a bout of risk-off, this stuff tends to outperform because it does not trade.”
Additional reporting by Sujata Rao; Editing by Hugh Lawson