October 17, 2013
|Oliver Bell, manager of the T. Rowe Price Africa & Middle East Fund.|
Emerging markets have performed poorly for the last couple of years as economic growth has moderated and corporate earnings have been disappointing. However, frontier markets have performed better than many emerging markets as investors have recognized that robust domestic economic growth can translate into strong corporate earnings growth.
Within the frontier market universe, the African and Middle Eastern markets have been the main drivers of outperformance, while Asian and Latin American frontier markets have lagged.
Oliver Bell, T. Rowe Price's leading expert in frontier markets and manager of the T. Rowe Price Africa & Middle East Fund, discusses why he believes that both African and Middle Eastern markets will continue to offer the best opportunities for frontier market investors.
Robust top-down fundamentals…
The African and Middle Eastern markets have made large economic strides in recent years as their economies and capital markets have liberalized. The impressive reforms many countries have undertaken over the last two decades have resulted in smaller public and private deficits, more prudent use of commodity windfalls, lower inflation, reduced debt levels, and higher international reserves.
The region boasts a population of more than 1 billion people, with 60% under the age of 24,1 and it is forecast to grow at a 5%2 average annual rate for the next five years. In fact, the region is forecast to have the world's largest workforce by 2040,2 which is expected to fuel domestic demand and gross domestic product (GDP) growth.
While the region has faced myriad political and economic problems, it has made notable progress on both fronts. Africa's inflation rate has declined significantly and stood at 6% in 2012, down from 26% in the 1970s and 19% in the 1980s. A huge debt-relief program in Africa has also helped bring down debt-to-GDP ratios to manageable levels, dropping to 20%. Most tellingly, foreign investment is pouring into the region, with China contributing $100 billion—one-third of its entire foreign direct investment—during the 2005-2010 period.
…And a more positive political backdrop…
The uncertain political environment has long been considered a reason to limit investment in the Africa and Middle East region. Encouragingly, we have seen greater political stability in recent years from a number of countries. Over the last decade, the region has undergone a dramatic transformation as countries have emerged from civil wars and toppled dictators. Between 2011 and the end of 2013, 50 of the 65 countries in the region will have conducted a democratic election.
We are also witnessing a new generation of political and business leaders focused on planting the seeds of economic growth by introducing measures to promote businesses and foreign investments.
What about troubled countries such as Libya and Syria? They do not dampen our excitement about the opportunities in this rapidly changing region. Though we do not discount the enormous challenges both countries face, we believe they will have little, if any, impact on the growth prospects of the region overall. Additionally, with 65 countries in the investable universe, there is no problem finding interesting investment opportunities.
Still, news of unrest anywhere is hard to shake. One of the greatest challenges we face is assessing the risks and the opportunities.
…Are feeding into superior earnings growth for companies
We believe the robust top-down fundamentals and the broad structural changes across the region have created enormous opportunities for investors. A number of companies could deliver at least 20% annual earnings growth for the foreseeable future. At this stage, however, they're not being valued correctly given the opportunities these companies possess and the structural changes and tailwinds they are likely to have for years as countries continue to reform.
A wealth of opportunity spans the region…
Within the region, we are investing in countries that investors don't usually hear about in the media. Saudi Arabia, South Africa, the United Arab Emirates (UAE), Qatar, and Nigeria are some of the most fertile investment areas.
Saudi Arabia has been spending aggressively internally, with plans to spend nearly $700 billion on infrastructure projects across the kingdom. In addition, the Saudi government granted civil servants pay raises and introduced monthly unemployment benefits, among other initiatives, to placate the public. In other words, leaders are promoting spending now to ensure that they remain in power in the future. These measures can benefit investors, too.
Saudi Arabia is also building several "economic cities" across the country, and the government is making major financial commitments to develop the country's electricity grid, waterworks, and telecommunications network. Saudi banks, in particular, are an especially good investment opportunity as financing constitutes step one in any infrastructure project. Meanwhile, with the Saudi riyal pegged to the U.S. dollar, any increase in U.S. interest rates should prove beneficial to the banks.
Qatar is on the verge of a mega-buildout ahead of its hosting of the FIFA World Cup soccer tournament in 2022. All tournament-related construction must be finished at least two years prior to the games, and many winning infrastructure bids are being announced this year. The country is expected to spend at least $140 billion on transportation infrastructure projects, including roads, a metro system, and an airport expansion. Banks and infrastructure-related companies are likely to be significant beneficiaries of heightened government spending.
In the United Arab Emirates, many companies are benefiting from a faster-than-expected and broadening recovery in the property and banking sectors, driven by the UAE's emergence as a trade and transportation hub, increasing tourism, and by Dubai's safe-haven appeal amid continued unrest in some Middle East countries. Also, Qatar and the UAE are increasingly likely to garner greater attention from global emerging market investors following MSCI's upgrade of these countries to emerging markets, effective May 2014.
South Africa offers one of the best ways to access African opportunities. The country has several companies with some of the best management teams in the emerging markets universe, a well-developed financial system, and companies with successful penetration into other African countries where growth is stronger. These companies can often provide exposure to parts of Africa that are otherwise inaccessible to investors due to a lack of liquidity or a stock market.
…But fundamental research and a long-term commitment are critical...
Many of these markets are young, which invites a set of challenges. Therefore, bottom-up fundamental research is imperative to understanding both the opportunities in and the risks associated with this nascent asset class. We believe that investors should approach investment in the Africa and Middle East region with a long-term focus.
As you might expect, market information is often sparse, local regulations are varied and complex, and research coverage by analysts and brokerage firms is limited. However, these were obstacles that emerging markets encountered 20 years ago. Challenges such as these can create opportunities for investors to uncover neglected companies with healthy or improving operations.
…And the potential for rewards is strong
Overall, the investment opportunity set in Africa and the Middle East is growing. Africa and the Middle East is one of the fastest-growing regions in the world, and the increasing ability of companies to harness that growth for profitability creates great opportunities for long-term investors willing to accept the risks.
Investments in emerging markets are subject to abrupt and severe price declines. The economic and political structures of developing nations, in most cases, do not compare favorably with the U.S. or other developed countries in terms of wealth and stability, and their financial markets often lack liquidity. Because of the concentration in highly developing economies, the fund involves a high degree of risk. Share prices are subject to market risk, as well as risks associated with unfavorable currency exchange rates and political or economic certainty abroad. In addition, the fund's non-diversified status means it can invest more of its assets in a smaller number of companies than diversified funds.
This information is provided for informational and educational purposes only and is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. Past performance cannot guarantee future results. The views contained herein are as of October 2013 and may have changed since that time.
2 International Monetary Fund (IMF)