Emerging market risk has become more tolerated by investors, and it has led to solid returns. Frontier markets, however, are less popular. The returns tend to be higher but the volatility is concerning.
Reversal or Insulation?
Equity Markets existing in frontier markets are not developed enough. A majority of them lack financial regulation, which leads to incidences of market abuse. As a result, investors have chosen to diversify their allocation into the private equity industry, especially on the African continent. According to a Bloomberg article, emerging markets have rivalled developed markets in returns, and outperformed frontier markets over the past years.
A sustainable frontier fund, launched by a Swedish asset manager, Tundra Fonder, returned 6.8% YTD and 11% for the year, beating 97% of its competitors in Sweden. Some of the companies yielding these returns were located in Africa, most notably in Nigeria and Egypt.
The two-week stock market sell-off in February affected emerging markets, as seen in the 10% drop compared to the 6% in frontier markets. Historically, frontier markets have constantly proven to be an insulation from external shocks and liquidity events in emerging and developed markets. This is due to a large reliance on commodities, which generally tend to perform well in times of economic upheaval.
In 2017, there were 49 exits in the African private equity industry, according to data provided by the Africa Private Equity and Venture Capital Association. There is a noticeable trend of increasing exits across the industry, as private equity investments in Africa have vastly outperformed public markets in the region by over 70%.
Development Partners International reported an IRR of 25% on a $1.1bn capital deployment, net of fees. This was one of the few exceptions; private equity funds in Africa have reported an IRR of 6% over a 5 year period due to currency devaluations and volatile swings in commodity prices. In more developed markets, the median private equity fund has been outperforming the S&P 500 by about 1% per year, while the average fund beat it by 1% – 2.5%.
African countries are also on pace to record rapid economic growth. This creates a situation where an extremely large and growing population (1bn estimated) would require infrastructure and services. This creates a lot of opportunities for foreign investors.
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