If you must Invest In frontIer markets, don't do It alone

If you must Invest In frontIer markets, don't do It alone

Less than a week after Tunisia's ex-president Zine El Abidine Ben Ali fled a revolution, Tunisia's bond ratings were slashed on Wednesday by Moody's Investors Service to a level just above "junk" status while authorities kept stock markets closed.

Suddenly, a country that had been building up a reputation as open to foreign investment, passing out oil and gas exploration permits and signing infrastructure contracts with companies such as SNC-Lavalin Inc. ($340-million in November 2010 for a thermal power plant), is closed for business, the latest sobering reminder of just how unpredictable and risky investments can be overseas in emerging and frontier markets.

Pierre Lapointe, global macro strategist with Brockhouse Cooper, said not all emerging markets are made equal, especially as investors try to find the next "it" market after the BRICs.

"Country diversification is always a positive for a portfolio, but some are riskier than others," he said.

While it is possible for investors to buy directly into another country's stock exchange, Mr. Lapointe recommends individual investors look to one of the many country or region-specific ETFs or mutual funds as a less risky way into it. After all, it is hard enough to keep track of more than a handful of individual stocks in their portfolio anyway. Regardless of the composition, investors should max out their holdings at about 10%. "Let's face it, we're a global broker and even we don't have antennae everywhere," he said.

One way to keep track of countries is through the Alliant Political and Economic Risk Ratings series. The index series, which includes an overall index, an emerging markets index and subindexes for some 175 countries, looks at eight risk factors including trade credit, currency, legal and regulatory risk, sovereign defaults, civil unrest, war and terrorism, creating a ranking out of 100. The highest-ranked country is Bermuda at 90, while the lowest include Iraq, Pakistan, the West Bank and Gaza region, Zimbabwe and Afghanistan, tied at 10. Tunisia comes in at 64.2, which is actually ahead of China, Russia and India, and only slightly behind Brazil.

Pierre Fournier, geopolitical analyst with National Bank Financial in Montreal, is skeptical of Africa as a whole, however. "There's a lot of people who treat Africa as the next go-to investing destination, but we've been very skeptical of the region for a few years now. Tunisia is a recent example but there are many others: Zimbabwe, the Ivory Coast, the Congo, the referendum in Sudan."

The continent attracts mining and energy exploration companies looking to strike it big, be it for diamonds, copper, gold or other metals.

The problem is, commodity plays require 20 to 30 years and involve billions in capital. That is a lot of commitment to make when you cannot be certain a country's government will be there in a week, much less 30 years. And companies are often subject to the whims of the local government, as Canadian First Quantum Minerals Ltd. found out last August when the Democratic Republic of Congo seized its assets there after the company invested some $800-million developing the Kolwezi copper project.

"Even if some of that risk is priced in, why take that risk?" Mr. Fournier said.

Mr. Fournier is bullish on South America, where the majority of countries are mature democracies. There will also be plenty of infrastructure spending, making resource, energy, infrastructure and engineering companies all of interest.

China's market, meanwhile, is becoming more difficult to work in, as foreign companies face intense local competition. India, about 15 years behind on the development curve, is a more attractive proposition. South Korea, Thailand and Taiwan have potential, while Vietnam and Indonesia are immature markets that may come into play as manufacturers move out of China due to the rising yuan, he said.

montrealgazette.com