Frontier Stocks Lose in Best Rally Since '91 as Growth Slows

The best start to a year for stocks in two decades is leaving the smallest markets behind, a sign of reduced investor confidence in the least-developed economies.

All eight of the world’s worst-performing equity indexes this year are in frontier countries, where the average stock- market value of $30 billion is about 95 percent less than in emerging nations.

While the MSCI All-Country World Index jumped 11 percent, gauges in Bangladesh and Sri Lanka sank at least 9 percent as interest rates increased. Nigeria’s stock index fell 1.8 percent after union strikes and attacks by Islamic militants. Frontier-nation stocks trade at the lowest valuations since at least 2008 versus emerging-market shares.

Falling valuations reflect concern that growth in the smallest economies, which expanded about 20 percent slower than larger developing nations on average during the past three years, won’t accelerate in 2012. Bank Julius Baer & Co. says the losses create buying opportunities for long-term investors. Ashmore EMM LLC has been cutting frontier-market holdings and Oversea-Chinese Banking Corp. is avoiding the stocks.

“On a purely tactical basis, we have actually reduced exposure in frontier markets,” said Antoine van Agtmael, who coined the term “emerging markets” in 1981 and now oversees about $7.1 billion as chairman of Ashmore EMM in Arlington, Virginia. “The larger, more liquid markets offered relatively more compelling investment opportunities.”

Emerging-Market Rally

The 25-country MSCI Frontier Markets Index increased 2.8 percent this year, trailing the emerging-market measure by about 13 percentage points. Nigeria’s Union Bank of Nigeria, Bangladesh’s Dhaka Electric Supply Co. and Sri Lanka’s Lanka Orix Finance Co. declined more than 29 percent, countering gains in Vietnamese shares including Bao Viet Holdings and Vietnam Dairy Products Joint-Stock Co.

MSCI Inc.’s gauge of shares in 21 emerging countries, which have an average stock-market capitalization of $603 billion, surged 15 percent this year as Brazil reduced its benchmark interest rate to the lowest level in 18 months and China cut banks’ reserve requirements.

A new three-year lending program from the European Central Bank and data showing a rebound in the U.S. job market eased concern that developing-nation exports will slow.

The price-to-reported earnings ratio for the frontier index, comprised of companies with an average market value of $2.6 billion, dropped to 10.7 from 16 a year ago and trades at a 10 percent discount to the emerging-market measure, made up of companies with a mean market capitalization of $12 billion.

‘Macro Risk’

“I would go for quality as opposed to underperformance,” said Vasu Menon, a vice-president of wealth management at Oversea-Chinese Banking, the second-largest financial services group in Southeast Asia. “It’s a year you don’t want to add on another layer of risk on top of macro risk.”

Frontier markets have smaller economies and worse rankings on gauges of business climate and corruption than emerging markets. They also have lower trading volumes, which make it more difficult for investors to sell shares.

The average annual gross domestic product for nations in the frontier index is $118 billion, compared with $994 billion for the emerging-market gauge, according to data compiled by Bloomberg and the International Monetary Fund. Frontier countries have an average ranking of 74 in the World Bank’s ease of doing business index, compared with 70 for emerging markets.

Their mean ranking of 82 in Transparency International’s corruption perceptions index is worse than the 75 average for emerging countries.

Liquidity Trap

Less than $15 million of shares changed hands each day on Sri Lanka’s Colombo Stock Exchange during the past month, compared with $12 billion on the Shanghai Stock Exchange in China, the biggest emerging market, according to data compiled by Bloomberg.

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