Global Investing

Frontier markets: safe haven for stability seekers

Frontier markets have an air of adventure and unpredictability about them. One is tempted to ask: Who knows what will happen next?

The figures tell a different story.

In fact, emerging markets overtook frontier markets in terms of volatility of returns as long ago as June 2006, as a recent HSBC report shows. And a more significant milestone was passed a year later, in June 2007, when even developed markets overtook frontier markets in terms of volatility of returns.

Since then, frontier markets have without fail stayed more stable than developed and emerging markets. In 2012, the gap between the closely-correlated developed/emerging markets bloc and frontier markets widened even further as returns in the latter seem to be becoming even more stable. According to David Wickham, EM investment director at HSBC Global Asset Management:

Low correlations across frontier market countries, and indeed with commodity prices, can surprisingly result in low volatility. While it may sound counterintuitive, the volatility of frontier markets can, in fact, be less than emerging and developed markets.  One needs to have a truly global approach in order to reap these potential low cross-country correlation benefits.

What is meant by a low cross-country correlation is that a frontier market such as Kenya is less likely to be impacted by a blow-up in, say, Hungary or even another frontier market such as Nigeria. That makes FM  less prone to swings.

Quarter-end rebalancing: A myth?

With world stocks up more than 10  percent since the start of the year, it must be tempting for investors to cash in their gains before the quarter-end/fiscal year-end. Or is it really?

JP Morgan, which analysed equity buying of institutional investors including pension funds, insurance companies and investment funds in the United States, euro zone, Japan and the UK, finds that there is no empirical evidence of quarterly rebalancing by pension funds or insurance companies.

Below are the charts showing their findings on the amount of equity buying as a share of equity holdings in each quarter against the difference between equity return and the return on total assets. If pension funds and insurance companies do not rebalance at all, the amount of equity buying should be unaffected by the relative return of equities against total assets. And this is the result they found in Chart 1.