The ongoing challenge of assessing Frontier Markets political risk

2013.12 Frontier Markets Political RiskI’m generalizing it, but frontier markets political risk is my main takeaway after reading through Clear Path Analysis’ just-released Investing in Frontier Markets 2013.

And if that doesn’t get you excited, don’t let that deter you from looking further as there’s a lot of other stuff in there that I’m totally glossing over.

Some highlights:

Asked what kind of investors are mostly interested in frontier markets and how they’re using the exposure, Yvonne Bakkum of FMO Investment Management had this to say:

“We are talking about a diversified African private equity proposition to U.S. institutional investors, and it strikes me that we hardly have to explain the Africa story to them. They seem very well aware of the fundamental attractiveness of Africa as an investment destination but, are still studying the best way to access that opportunity. What type of asset class, should they go through public markets or private equity and if so should they select funds themselves or use a fund of funds vehicle? These are the types of questions being asked but in most cases the interest still needs to translate into actual commitments. Some African institutions haven’t decided as to whether they should invest and there we see an interesting discrepancy between the investment professionals and their boards of trustees. Trustees tend to be more cautious and want to start with BRICs because they are the more advanced emerging markets or the ones closer to home, such as Latin America. This means that you don’t always get everybody aligned simultaneously.”

Oliver Bell, portfolio manager of Africa and Middle East strategy for T. Rowe Price wound up having a lot to say about East Africa, among which was this nugget on the key risks in investing in African markets:

“The key risk still remains around the politics and the economics but the two are quite strongly linked. The first risk is when you get a change of government. 50 of these countries have had elections in the last three years so we are no longer talking about despotic dictators – this has become a relatively democratic continent. The key risk is that if the opposition wins an election does power get handed over peacefully? We’ve just seen a transition of power in Kenya for example which was peaceful but five years ago the election transition was very brutal. The more times you go through the peaceful transition, the more entrenched the democracy becomes. In Ghana we’ve seen the handover of power peacefully a few times so you get the sense that democracy is now deeply rooted in their society.

Related to the politics is the economic fallout that can occur in the run up to elections, because you tend to find that the incumbents spend aggressively to ingratiate themselves with the electorate. The targets go out of the window leading to a larger fiscal deficit, which can lead to currency weakness and hence inflation. This knock-on effect usually corrects itself the year after an election but it remains one of those things that you need to be very aware of when investing in Africa. One other risk at the stock level that we assess, when considering an investment in a company, is whether there are any political connections that the company is benefitting from, as this is not sustainable in the long term, given that the politics can change quickly.”

And finally, Richard Fox, Fitch’s Head of Middle East and Africa Sovereigns, had this to say about MENA political risk:

“Political risk is a fact of life but it varies from country to country. And it doesn’t necessarily mean a country is off limits to investors. Going back to where we started, the World Bank Governance Indicators would put a country like Nigeria or Lebanon very low down on the political risk spectrum. Nevertheless, these countries have a track record of foreign investment receiving very good returns. Just because political risk is high doesn’t mean that people will not put their money there…

… You can have volatile political developments but this does not mean that they automatically affect financial markets. Despite the political ups and downs of Lebanon, including war, there has never been a default and people are allowed to withdraw their money freely which has worked very much in Lebanon’s favour. Environments can be very risky but if you have investors aware of and happy to take those risks then it isn’t really an issue. In most cases, risks can be priced.”

One Response to The ongoing challenge of assessing Frontier Markets political risk

  1. Specifically about Angola, although there is political risk, this only means that it is very important to partner with local entities in order to navigate the waters better.

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