Source: Financial Times
For the past decade or so, investors have used the term “frontier markets” (FMs) to describe a group of up-and-coming equity and bond markets that are smaller and less liquid than the emerging markets (EMs), but with the potential to grow rapidly.
Proponents of FM investing argue that such markets should outperform EMs as they play catch-up with the rest of the world. Indeed, the world’s 10 fastest-growing economies in 2016 disproportionately hailed from the frontier, including Iraq, Côte d’Ivoire, Laos, Tanzania, Cambodia, Bangladesh and Senegal.
However, there is a problem: the universe of investible frontier markets and stocks is shrinking, at least as defined by index providers such as MSCI. Such providers, who classify markets as frontier, emerging and developed, have been moving countries out of FM into EM.
Three years ago, MSCI elevated UAE and Qatar; Pakistan was next to depart for EM, in May this year. Although, in its annual review that followed, MSCI decided not to promote Argentina to EM, it is probably a matter of time before it does so.
This would not be such a problem for FM if there were a “bench” of up-and-coming new markets ready to replenish the depleted ranks. Alas, such fresh blood is in short supply. As a result, MSCI FM’s market capitalisation has declined from 5 per cent of EM a decade ago to 2.3 per cent, and from 50 basis points of the AC World index to 24 bps, with the removal of Pakistan.
This also makes the index less liquid; combined average daily value traded for the index members is down by half over the decade, to just $200m, ex-Pakistan.
All is not lost for frontier markets as an asset class, however. In places, there is evidence that equity market development is still under way.
One such place is Tanzania, where South Africa’s Vodacom Group is in the process of a $220m initial public offering, expected to close in mid-August.
This is the outcome of a longstanding government mandate for all Tanzanian telecoms operators to list a 25 per cent stake on the local stock exchange. Although this requirement has been on the books for some time, it was only after the election of President John Magifuli in 2015 that pressure to comply increased.
Now other telecoms operators are expected to follow Vodacom’s lead, while Tanzania’s mining companies are subject to a similar requirement. In theory, this could see companies such as Acacia Mining, the London-listed gold miner with three mines in the country, pursue a similar path. However, the prospects for this now look highly uncertain following the government’s issuance of a multibillion tax bill to Acacia, alongside new legislation that raises the spectre of renegotiation of mining contracts.
Until now, Tanzania has been too small to qualify for the MSCI FM index: both market capitalisation ($4.6bn before the Vodacom listing) and trading volume (less than $1m a day) are very low, with trading mostly limited to a couple of banks and a brewery. MSCI has never maintained an index for Tanzania, not even one of the “stand alone” indices that it has set up for small or illiquid markets.
In addition to the small size of its market, there are other hurdles that international investors face in Tanzania, including a lack of custodians and limited research.
However, the Vodacom IPO, possibly followed by other telecoms operators and some of the mining companies, could see the Tanzanian equity market grow to more than twice its previous size, with a commensurate increase in trading volumes and foreign interest.
That would position it well as a candidate for the MSCI FM index. And while Tanzania’s entry alone would not offset the loss of Pakistan to EM, similar progress in other markets, from Ghana to Iraq to Ukraine, could set the frontier asset class growing again.
As far as Tanzania is concerned, investors face a mix of positive and negative trends. Encouraging factors include solid growth dynamics, reasonable macroeconomic fundamentals and a strong pipeline of infrastructure spending. Against this must be set Mr Magifuli’s interventionist approach to economic development, with a particularly aggressive stance towards foreign-owned mining companies.
And while Mr Magifuli’s support for domestic equity offerings is encouraging, it is not guaranteed to succeed. The list of companies being asked to float their shares is ambitious — over 80 firms in the telecoms sector alone — and it is not clear where the funds will come from to finance the sales, given a limited pool of domestic investible savings.
The Vodacom IPO, initially expected to close in April, has been delayed significantly, for the very reason that the offering’s size was so large relative to the domestic investor base. This problem could be even more acute for subsequent offerings. While foreign participation in the Vodacom IPO was not initially allowed, this position was reversed last month. But the belated way in which this was done — and the lack of an international roadshow for the offering — suggests a reluctance to allow foreign investment to play a major role in Tanzania’s new equity offerings.
For now, we’ll await news of the completion of the Vodacom IPO and the share’s subsequent performance on the exchange. The ultimate success of this offering and subsequent ones in Tanzania — and elsewhere in frontier markets — could be a useful signal for the future course of equity development on the frontier.
Andrew Howell is the frontier markets equity strategist for Citi Research