Investing in Emerging and Frontier Markets Investing in Emerging and Frontier Markets Edited by Kamar Jaffer E U R B O O M O O K N S E Y Published by Euromoney Institutional Investor PLC Nestor House, Playhouse Yard London EC4V 5EX United Kingdom Tel: +44 (0)20 7779 8999 or USA 11 800 437 9997 Fax: +44 (0)20 7779 8300 www.euromoneybooks.com E-mail: [email protected] Copyright © 2013 Euromoney Institutional Investor PLC and the individual contributors ISBN 978 1 78137 103 9 This publication is not included in the CLA Licence and must not be copied without the permission of the publisher. All rights reserved. No part of this publication may be reproduced or used in any form (graphic, electronic or mechanical, including photocopying, recording, taping or information storage and retrieval systems) without permission by the publisher. This publication is designed to provide accurate and authoritative information with regard to the subject matter covered. 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Typeset by Phoenix Photosetting, Chatham, Kent Contents Foreword xv Preface xvii Emerging and frontier markets xvii Harnessing the potential of the middle class xvii Rising capitalisation and increased diversification xviii Emerging market debt xix A broader investor base xix Compelling valuations xx Risks in emerging and frontier markets xx Conclusion xxi Acknowledgements xxiii About the editor xxv About the contributors xxvii 1 The growing weight and influence of frontier markets 1 Dr Mark Mobius, Templeton Emerging Markets Group Tomorrow’s emerging markets 1 A way to diversify 2 Long-term growth potential 2 Africa – a continent of opportunity 3 Risks investors should consider 5 Liquidity and low market capitalisation 6 On-the-ground research 6 Accessing frontier markets 6 Conclusion 7 2 The outlook for emerging and frontier markets 8 Charles Robertson, Renaissance Capital 3 The role of emerging markets’ sovereign wealth funds 17 Dr Eliot Kalter, E M Strategies Inc. and Dr Patrick Schena, The Fletcher School Introduction 17 Minding the institutional void 18 Surging SWFs in emerging economies and the paradox of outbound investment 22 The development agenda and the tensions of inward investment 32 Filling the void: reflections on a way forward 34 4 The importance of micro, small and medium enterprises in emerging markets 38 Khaleel Ahmed, IFC The importance of small and medium enterprises 38 v Contents Definitions 38 Composition of the industry 40 The missing middle 41 Issues and challenges facing the SME sector in emerging markets 41 The SME finance gap 42 Non-financial barriers 45 Weaknesses in credit delivery and support by financial institutions 45 Policy interventions designed to expand SME finance 46 The World Bank Group/IFC 47 IFI engagement with SMEs 48 Annex 4.1 50 First mover advantage: Bank Muscat targeted Oman’s unbanked SME market 50 Serving the female-headed SME segment: Access Bank Plc Nigeria 50 ICICI Bank 51 5 The regionalisation of emerging debt and equity capital markets 53 Julian Perlmutter and Piers Summerfield, Simmons & Simmons LLP Recent developments and emerging trends in the dim sum bond market 53 Steady growth of the young dim sum bond market 53 Overview of the current dim sum bond market – certain distinctive features 54 The maturity profile of dim sum bond issuances 54 The geographical diversification of dim sum bond issuers and investors 55 More ‘rated’ dim sum bond issuances 56 Dim sum bond market trends in 2013 and beyond 56 Recent developments and emerging trends in Middle Eastern debt capital markets 57 Recent developments and emerging trends in Kenyan debt capital markets 61 Recent developments and emerging trends in the Nigerian debt and equity markets 63 Conclusion 65 6 Risks and return expectations for emerging and frontier markets 66 Allan Conway, Schroders Historic performance 66 Near-term prospects 67 Long-term outlook 72 Risks 76 7 Portfolio allocation, diversification and risks across emerging and frontier markets 78 Matthew Annenberg and Robin Anderson, Principal Global Investors Motivation 78 Diversification benefits and risks to frontier market investing 79 Benchmarks 83 Portfolio 89 Conclusion 92 vi Contents 8 Looking beyond external emerging market debt 95 Michael Gomez, PIMCO Local debt will continue to stand out 98 Investment implications 100 9 Exchange-traded funds and the opening up of emerging markets 101 Manooj Mistry, Deutsche Bank The general benefits of accessing emerging markets via ETFs 101 The challenges of creating ETFs on emerging markets indices 102 ETF product structures 102 Size, scope and turnover of the market 103 Frontier market ETFs 106 Active asset allocation to emerging markets using ETFs 106 10 Market regulation and supervision in emerging and frontier markets 107 Kai-Niklas Schneider, Clifford Chance LLP and Leen Qablawi, Latham & Watkins LLP Introduction 107 Emerging and frontier markets 107 Regulatory approaches 108 Basic principles 109 Regulation in emerging and frontier markets 109 Which approach works best? 111 Principles versus rules-based approach 111 One-size-fits-all approach 111 Conclusion 112 11 Growing power of emerging market titans 114 Sohail Jaffer, FWU Group Role reversal in emerging market foreign direct investment flows 114 The growing importance of emerging market-based transnational corporations 114 Go out 117 Private equity and sovereign wealth fund drivers of FDI 117 Outlook for increased ‘south-south’ investment flows 118 Commodity security as a driver of FDI 119 Risks impacting FDI flows 120 The risk of resource nationalisation 121 Security concerns: real or imagined? 121 12 Private equity in growth markets: changing patterns, emerging trends 124 Sarah Alexander, The Abraaj Group Lessons from the first generation 125 A fundamental and lasting shift 125 Global growth markets opportunity 125 Private equity – access to the growth economy 126 vii Contents Institutional investor goals 126 Industry maturation – delivering returns 127 Local support and participation 128 A long runway 129 Looking ahead – market and fund-size diversification 129 13 Doing valuations in emerging markets 130 Pär-Ola Hansson, Ernst & Young The preferred approach to emerging-market valuation 130 Why the DCF model is preferable for emerging markets 131 Consistency and building in advantages 133 Limits of the guideline companies/multiples approach 133 The bridge: justifying paying a premium 135 Summary 135 14 Family businesses in emerging markets 136 Antonios Koutsoukis, Credit Suisse Advantages of family businesses 136 Growing the family business 137 Governance risks in family businesses 138 Adapting to change 141 Bibliography 142 15 Growth of Islamic finance in emerging and frontier markets 143 Baljeet Kaur Grewel, Kuwait Finance House Introduction 143 Global Islamic finance industry 146 Islamic finance industry: products and services 147 Islamic finance: key development in emerging markets 148 GCC 148 Saudi Arabia 149 Oman 149 Kuwait 149 Qatar 149 Turkey 150 Asia 150 Indonesia 150 Malaysia 151 Africa 151 Nigeria 151 South Africa 152 Sudan 152 Islamic Development Bank’s role in promoting Islamic finance and SMEs 152 Outlook and potential for Islamic finance 153 viii Contents 16 Verging on emerging: the reasons for surging investor interest in global frontier markets asset management 155 David Wickham, HSBC Global Asset Management Commencement 155 Classifications: what are frontier markets? 156 Characteristics of global frontier markets: the 7Cs 158 Comprehensive universe 158 Change 161 Consumers 163 Commodity wealth 165 Correlations 166 Cash returns 168 Cheap valuations 169 Considerations: navigating the risks of global frontier markets 170 Political risks 170 Commodity risks 171 Liquidity risks 171 Sector risks 171 Currency risks 172 Capital allocations to frontier markets 173 Conclusion 174 17 Alternative