Vietnam, Zambia Overtake BRIC Stocks as `Frontier' Markets Soar

The smallest emerging stock markets are elbowing aside Brazil, Russia, India and China to become the world's best performers.

An index of 22 so-called frontier countries rose 12 percent in January, the fastest-ever start to a year. Five of them, including Vietnam, Ukraine and Croatia, are among this year's top 10 markets. A measure of BRIC stocks fell after a 53 percent gain in 2006 made Indian and Chinese shares the most expensive among the biggest emerging nations.

JPMorgan Chase & Co., Templeton Asset Management Ltd. and Julius Baer Holding AG started funds in the past six months to buy shares in the smallest economies, betting they will outperform larger developing markets that have rallied for four straight years.

``We've started to go into some of the frontier markets,'' said Terrence Gray, New York-based managing director of emerging markets at DWS Scudder, which manages $114 billion. ``We're just trying to find better value.''

Gray bought shares of KazMunaiGaz Exploration & Production in September when the unit of Kazakhstan's state oil and gas company raised $2 billion in the nation's largest initial public offering. He may invest in banks and agricultural commodity producers in Mauritius, Nigeria and Zambia, after cutting his firm's holdings in China and India last year.

Less is More

Frontier markets, as defined by Standard & Poor's, are dominated by companies too small and too thinly traded to be ``investable'' for most fund managers. The acronym BRIC was coined by Jim O'Neill, chief economist at Goldman Sachs Group Inc., in November 2001. He said Brazil, Russia, India and China would join the U.S. and Japan as the biggest economies in the world by 2050, eclipsing most of today's developed nations.

The S&P/IFCG Frontier Markets Composite Index has gained 35 percent in the past 12 months, compared with a 28 percent increase in the Morgan Stanley Capital International BRIC Index and 12 percent advance for the S&P 500.

Last month's surge in the 272-member frontier markets index, whose members have a median market value of $241 million, was the biggest gain in January since S&P's calculations started in 1996.

Frontier stocks are cheaper than shares in India and China - - which trade at an average 26 and 40 times earnings, respectively -- though they are becoming more expensive.

Stocks in the S&P/IFCG Index traded at an average 17 times earnings last month, near the highest ever and 40 percent higher than the average over its 11-year history. The price-earnings ratio for S&P/IFCG index is also about 10 percent higher than for the MSCI Emerging Markets Index.

Market Risks

Frontier markets have been valued at an 18 percent discount on average during the past decade. Stocks in Bangladesh, Bulgaria, Ivory Coast, Mauritius and Slovenia rose last month to their highest price-earnings ratios this decade.

``Everybody is so positive and bullish that, as a consequence, valuations have become very rich,'' said Patrick Scheuber, head of equities at Swisscanto in Zurich. ``We are not at the beginning of a cycle, but rather at the end of it.'' His firm, managing $1.6 billion, recently sold holdings in Vietnam.

Investors are courting greater economic and political risk by buying stocks in countries that are among the least developed in the world. Zimbabwe, for instance, is mired in an eighth year of recession. The inflation rate surged to a record 1,594 percent last month as the government printed money to pay off debts. The Zimbabwe dollar has fallen as much as 42 percent since Jan. 20.

In Nigeria, attacks have forced Royal Dutch Shell Plc's unit to halt production of about 500,000 barrels of oil a day, almost a quarter of the country's current output.

Luring Investors

``One has to kick the tires if you are looking for returns,'' said Tim Drinkall, who manages about $200 million at Gustavia Capital Management in Stockholm. Six months ago, Drinkall spent 12 hours on a bus to visit Sojaprotein AD, a Serbian soybean processor, before buying the stock. His Gustavia Greater Russia fund has been adding shares in Ukraine and Kazakhstan, favoring them over companies in Russia.

Accelerating economic growth, the prospect that more governments will embrace capitalism and an increase in initial public offerings have lured more money to frontier markets.

Vietnamese Rally

Vietnam's Ho Chi Minh City Securities Trading Center VN Index has jumped 45 percent this year, the biggest gain among the 83 benchmarks tracked by Bloomberg. PetroVietnam Drilling & Well Services Joint-Stock Co., the nation's fifth largest company by market value, paced the advance.

The Vietnamese economy may have Southeast Asia's fastest growth in 2007. The government expects 8.5 percent expansion, up from 8.2 percent in 2006. Last month, the government said it will sell stakes in three of the biggest state-owned banks this year.

In Ukraine, the world's second best-performing market, the PFTS Index has risen 37 percent. The government plans to raise $2 billion from sales of state-run companies this year, an 18-fold increase from 2006. The offerings will include shares in VAT UkrTelecom, the national telephone company.

The Nigeria Stock Exchange's All-Share index rose 25 percent as new shares, which doubled to $11 billion last year, helped boost demand. Transnational Corp. of Nigeria Plc, whose investors include President Olusegun Obasanjo, sold 60 billion naira ($468 million) of stock in Nigeria's largest ever IPO.

China, India

Investors are losing some of their enthusiasm for China and India, the world's two fastest-growing major economies, a Merrill Lynch & Co. survey showed. More money managers planned to cut stakes in Chinese companies on a net basis for the first time in at least four months, and India is the region's least favored market, according to the Feb. 14 survey.

An index of Chinese stocks traded in Hong Kong has tumbled 3.7 percent after a 94 percent gain in 2006. India's Sensitive Index quadrupled during the past four years. Gains slowed to 4.1 percent this year.

Investors are less enamored with Russia as well. The dollar- denominated RTS Index lost 1.3 percent this year after surging 71 percent last year. Brazil's Bovespa index has gained 3.1 percent.

Merrill's monthly survey showed 14 percent of fund managers investing in Asia said they would boost holdings in frontier markets. The firm asked investors who manage a total of $680 billion about their plans for the first time.

Spencer White, Merrill's Hong Kong-based Asia equity strategist, wrote in a note last week that such interest in frontier markets ``would have been unthinkable'' a year ago.

What's Next

``It's natural that people start saying, `What's the next up-and-coming market,''' said Cliff Quisenberry, the Seattle- based manager of the $848 million Eaton Vance Tax-Managed Emerging Markets Fund. Quisenberry has been investing in frontier markets since the mid-1990s. They now account for 12 percent of the fund's assets spanning more than 10 smaller countries including Vietnam, Botswana, Lithuania and Qatar.

By comparison, frontier markets account for just 2 percent of the total market value of non-developed countries.

Mark Mobius, who oversees about $30 billion in emerging- market equities at Templeton, opened a fund in October to invest in companies with market values of less than $1 billion, located in countries such as Vietnam, Bulgaria and Romania.

JF Asset Management Ltd., a unit of JPMorgan, set up a Vietnam stock fund in November. The $97 million JF Vietnam Opportunities Fund has risen 29 percent this year. Two months ago, Julius Baer, Switzerland's biggest independent money manager, began a new $41 million stock fund which will invest in Ukraine, Bulgaria, Romania, Georgia and Kazakhstan.

Assets surged almost 10-fold since Julius Baer started selling the Black Sea fund to institutions.

Fewer Links

For some emerging-market investors, buying shares in frontier markets helps to reduce risk because the stocks are less correlated to the swings in the global markets.

The S&P/IFCG frontier markets index has shown correlations of 0.42 and 0.46 during the past five years with MSCI's World Index of developed markets and the emerging-markets index, respectively, according to data compiled by Bloomberg.

Emerging markets had a 0.85 correlation with developed markets, based on a comparison of their stock indexes. A reading of 1 means that markets move in lockstep with each other and 0 shows they aren't connected at all.

``There is a general appetite to push risk tolerance even further,'' said Neil Gregson, head of emerging-market equities at Credit Suisse Asset Management in London, which manages $1.6 trillion and invests in Romania and Kazakhstan. ``There's been a boom in emerging markets and investors are asking for more.''

source:www.bloomberg.com