Wale Agbeyangi, Managing Director, Cordros Capital, on foreign investors in the wake of the financial crisis

Frontier markets gained popularity amongst foreign investors before the global financial crisis of 2009. These countries’ economic prospects were improving and more so, the level of liquidity in the global economy encouraged investors to take risks. These markets were recognised as the next generation of emerging markets, less established than BRICS (Brazil, Russia, India, China and South Africa), but with a greater upside potential for investors. However, the risks of investing in these relatively untapped markets included lack of information and illiquidity. The potential upside outweighed the downside until 2009, when a sharp withdrawal of capital from most frontier markets ensued. Thus began the “flight to quality” that saw investors jettison their high-risk, high-return assets in favour of safer investments such as developed market treasury securities. It was initially believed the frontier markets would escape relatively unscathed due to the low correlation between them and their developed and emerging market relations. However, they showed some volatility as global correlations tightened across asset classes, driven by foreign investor sell-offs.

The crisis destabilised the global financial system and forced governments to bail out their markets. The rescue packages were mainly centred on loosening monetary and fiscal policies to support the financial system and economy. A sharp decline in yields followed and curbed the appetite of fixed-income investors. Investors watched and waited to see how effective government bailouts would prove. During this period, investors also sought shelter by investing in “safe” commodities that would protect their portfolio from inflation. Many frontier markets have abundant natural resources and benefitted from rising commodity prices as demand soared. This is notably true in oil and gas.

In recent years, investors have been cautiously approaching the frontier markets. Despite the increase in correlations of the short-term, investors with long-term investment strategies recognised the benefits of diversifying globally through frontier markets. Investors recognise the significant risks associated with frontier markets and are increasingly scrutinising country-specific risks; these investors are also more willing to place bets that these markets will follow in the footsteps of successful emerging market countries. In addition, the increased capital flows to frontier markets is diminishing the risks traditionally associated with liquidity and also market inefficiency, as governments respond to investor interest with reforms.

The trickle back into frontier markets was first felt in the fixed-income markets. Severe cuts in interest rates across most leading developed markets translated to relatively poor investment returns in these markets. Investors ready to take on more risk, though still within the fixed-income sector, looked to frontier markets to satisfy their appetite. The interest rate in the US fell from 5.25% to 0.25% during the crisis, and remains at 0.25%. In the UK, rates were as high as 5.75% and were cut to 0.5% during the crisis. The European Central Bank cut its rate from 4.25% to 1% during the crisis, but is now at 0.5% following more recent cuts.

By contrast, interest rates in frontier markets were considerably higher. The lowest interest rate, the monetary policy rate (MPR), reported in Nigeria during the crisis period was 6% in the second half of 2009. The MPR is now up to 12%, offering a much more attractive opportunity for foreign investors. Similar chances were presented in other frontier markets, resulting in capital inflows to these markets.

At the end of 2012, the focus of foreign investors shifted from fixed-income securities to equities. This was caused by investors’ expectations of a “great rotation” from bonds into equities from 2013 due to the implications of tightening of monetary policies in developed markets. Demand for frontier market fixed-income securities has declined, sending yields up, and their equity markets are benefitting. Frontier markets were among the best performing equity markets in early 2013. In fact, six of the top 10 performing equity markets were frontier markets, with Nigeria sixth overall.