Managing EMERGING Sovereign Risks in Frontier ECONOMIES by Dr. Emmanuel Moore ABOLO

MANAGING EMERGING SOVEREIGN
RISKS IN FRONTIER ECONOMIES
DR EMMANUEL MOORE ABOLO
CHIEF RISK & COMPLIANCE OFFICER
NIGERIAN EXPORT-IMPORT BANK
Thursday, April 5, 2018MANAGING SOVEREIGN RISKS IN FRONTIER ECONOMIES--DR ABOLO MOORE 1

CONTENT
 WHAT ARE FRONTIER MARKETS?
 CLASSIFICATION OF FRONTIER MARKETS
 INVESTMENT CASE FOR FRONTIER MARKETS
 FRONTIER MARKETS HAVE COMPETITIVE EDGE
 CURRENT ENVIRONMENT MAY PROVIDE ADDITIONAL BENEFITS
 WHAT IS SOVEREIGN OR COUNTRY RISK?
 MANAGING POLITICAL & SOVEREIGN RISKS IN FRONTIER MARKETS

WHAT ARE FRONTIER MARKETS?......
 A frontier market is a type of developing country which is more developed than the
least developing countries, but too small to be generally considered an emerging market.The term is an
economic term which was coined by International Finance Corporation’s Farida Khambata in 1992.
 The term is commonly usedto describe the equity markets of the smaller and less accessible, but still
"investable", countries of the developing world.The frontier, or pre-emerging equity markets are typically
pursued by investors seeking high, long-run return potential as well as low correlations with other
markets.
 Some frontier market countries were emerging markets in the past, but have regressed to frontier status.
 The term began use when the IFC Emerging Markets Database (EMDB), led by Farida Khambata, began
publishing data on smaller markets in 1992. Khambata coined the term “Frontier Markets” for this set of
indices.
 Standard and Poor's bought EMDB from IFC in 1999 and in October 2007, S&P launched the first
investable index, the Select Frontier Index (30 of the largest companies from 11 countries) and the
Extended Frontier Index (150 companies from 27 countries0.

WHAT ARE FRONTIER MARKETS?
 Subsequently, MSCI Barra began a rival frontier market index, and in early 2008, Deutsche Bank launched
the first frontier market exchange-traded fund, on the London Stock Exchange.
 Frontier markets are a sub-set of emerging markets, which have market capitalizations that are small
and/or low annual turnover and/or market restrictions unsuitable for inclusion in the larger EM indexes
but nonetheless "demonstrate a relative openness to and accessibility for foreign investors" and are not
under "extreme economic and political instability.
 Members could be considered to fall roughly into three groups:
 Small countries of relatively high development level (such as Estonia) that are too small to be considered
emerging markets;
 Countries with investment restrictions that have begun to loosen as of the mid 2000s (such as the
countries of the Gulf Cooperation Council); and
 Countries at a lower development level than the existing "mainstream" emerging markets (such as Kenya
orVietnam).
 The term pre-emerging markets is sometimes used as a synonym for "frontier markets", emphasizing
the expectation that they will eventually "graduate" to "emerging market" status.

MOST OF THE WORLD’S STOCK EXCHANGES
ARE FRONTIER

FRONTIER = 30% OFWORLD’S POPULATION;
13% OFWORLD’S GDP, BUT <3% OF GLOBAL MARKET CAP

CLASSIFICATION OF FRONTIER MARKETS

INVESTMENT CASE FOR FRONTIER MARKETS…..
 Frontier Markets have lower market capitalization and liquidity than the more developed,
"traditional" emerging markets.The frontier equity markets are typically pursued by investors
seeking high, long term returns and low correlations with other markets.
 The implication of a country being labelled as Frontier is that, over time, the market will
become more liquid and exhibit similar risk and return characteristics as the larger, more
liquid developed emerging markets.
 Emerging market / frontier investors say investing in frontier assets would actually diversify
and reduce risk, which contradicts the general notion that risk would be added by including
those markets.This view has also been reinforced by other well-known investors such as
Thomas Huggerof Asia Frontier Capital Ltd. and Douglas Clayton of Leopard Capital.
 Those who have a focus on frontier markets have different views on what the future holds for
the inter-correlation of countries within the asset class.Whilst they share some economics
characteristics such as young, increasing educated populations the individual economies face
different internal and external forces.

INVESTMENT CASE FOR FRONTIER MARKETS
 Funds such as Asia Frontier Capital invest to find returns in countries that have increasing
trends in domestic consumption but see the overall growth drivers for each country as being
different. This investment thesis holds water as it is unlikely that a manufacturing based
economy, such as Bangladesh, would respond in the same way to external shocks as an island
nation where a large proportion of the economy is linked to tourism, such as Sri Lanka.
 Other investors such as DaMina Advisors, the leading global Africa-focused frontier markets
risk analysis firm has argued since 2010 that fundamentally all the world’s last remaining
frontier capital markets in Africa, Latin America and Asia will become synchronized – just as
the globally and culturally disparate largest emerging markets of Brazil, India, China and Russia
have become.
 There are also other non-managed ways to gain exposure to these markets that are more
generic such as investing in frontier market indices such as MSCI Frontier Index that only
invest in large liquid stocks.

THE FASTEST GROWING ECONOMIES ARE FRONTIER
COUNTRIES

FRONTIER MARKETS HAVE FAVORABLE RETURN
COMPONENTS

FRONTIER COMPANIES PAY MUCH HIGHER
DIVIDENDS

HIGHEST ROES IN EMERGING, FRONTIER MARKETS

CURRENT ENVIRONMENT MAY PROVIDE ADDITIONAL BENEFITS

WHAT IS SOVEREIGN OR COUNTRY RISK?...
 Sovereign credit risk is the risk of a government becoming unwilling or unable to meet its
loan obligations, as happened to Cyprus in 2013. Many countries faced sovereign risk in the
late-2000s global recession.
 The risk that a government could default on its debt (sovereign debt) or other obligations.
Also, the risk generally associated with investing in a particular country, or providing funds to
its government.Also called country risk---Financial Times
 Probability that the government of a country (or an agency backed by the government) will
refuse to comply with the terms of a loan agreement during economically difficult or
politically volatile times.Although sovereign nations don't "go broke," they can assert their
independence in any manner they choose, and cannot be sued without their assent. Sovereign
risk was a significant factor during 1970s after the oil shock when Argentina and Mexico
almost defaulted on their loans which had to be rescheduled.

WHAT IS SOVEREIGN OR COUNTRY RISK?
 A nation is a sovereign entity.Any risk arising on chances of a government failing to make debt
repayments or not honouring a loan agreement is a sovereign risk. Such practices can be
resorted to by a government in times of economic or political uncertainty or even to portray
an assertive stance misusing its independence.A government can resort to such practices by
easily altering any of its laws, thereby causing adverse losses to investors.
 A legal or political risk that an investment in another country will become worthless because
of political turmoil that causes the business environment to collapse or prompts another
government to take over and seize foreign assets.A lack of a strong and fair judicial system to
enforce contracts and the risk that a government might prevent or limit money from being
transferred out of the country to the businesses’ home country are other examples of
sovereign risks.Another type of sovereign risk occurs when a foreign government defaults on
debt that it owes to foreign banks or governmental-sponsored agencies such as the
International Monetary Fund.

MAJOR INDICES FROM PUBLIC SOURCES FOR CALCULATING COUNTRY/ SOVEREIGN RISK…
 Corruption Perceptions Index (CPI) –Transparency International .The CPI ranks over 170
countries according to the perception of corruption in the public sector.The index is an aggregate based
on an underlying collection of assessments and business opinion surveys carried out by various
independent institutions.
 Doing business rankings –The World Bank .The Doing Business rankings monitor the environment
for doing business across over 180 countries. For each economy, the ranking is calculated as the average of
the percentile rankings on each of 10 topics, including starting a business, dealing with construction
permits, registering property, getting credit, protecting investors, paying taxes, trading across borders,
enforcing contracts, resolving insolvency and obtaining an electricity supply.
 Global Competitiveness Index (GCI) – World Economic Forum (WEF) .The GCI analyses over
100 economic indicators to provide a comprehensive assessment of the competitiveness of an economy,
defined as ‘the set of institutions, policies, and factors that determine the level of productivity of a country’.
The index covers over 140 economies and the underlying indicators encompass areas such as labour
market efficiency, institutions, quality of infrastructure, technological readiness, business sophistication and
innovation.

MAJOR INDICES FROM PUBLIC SOURCES FOR CALCULATING COUNTRY RISK
 Gini coefficient (income inequality metric) – US Central Intelligence Agency
(CIA) .The Gini coefficient measures the degree of inequality in the distribution of family
income in a country.
 UN Human Development Index (HDI).The HDI is a composite index that measures a
country’s achievements in terms of health, knowledge, and income. Introduced as an
alternative to conventional measures of national development such as the rate of economic
growth, the HDI covers over 180 countries
 World Bank Political Risk Indicator. The World Bank political risk indicator is used as a
stable and predictive measure to assess political risk.This indictor assesses the following risk
dimensions:Voice & Accountability, Regulatory Quality, Political Stability, Rule of Law,
Government Effectiveness and Control of Corruption.

MANAGING POLITICAL & SOVEREIGN RISKS IN FRONTIER MARKETS…
 Frontier market stocks are often dominated by companies that are driven more by the local
economy than by global macro trends.
 When investing in countries where civil and political unrest can be common, there can be a
risk of market disruption. For example, an eruption of massive protests in Ukraine drove its
stock market down 3.5% between November 21 and December 17, 2013, but made almost
no ripple in other FMs.
 In fact, during that period the broader frontier index was up 1.7% and Ukraine’s nearest
frontier neighbour, Romania, saw its market rise by 1.3%.5 That’s because frontier markets
have had an unusually low correlation to each other. Spanning the Americas, Europe,Africa,
the Middle East and Asia, these far-flung economies have little in common beyond being in a
similarly early stage of development. A major development might roil the economy in
Nigeria or Argentina, but will have little or no effect in Estonia, Kuwait orVietnam.

 At the same time, frontier stock markets are often dominated by domestically oriented
sectors, such as banks, telecommunications and consumer companies that are driven more
by the local economy than by global macro trends.
 As a result, between January 1, 2009, and December 31, 2013, the average intercountry
correlation among MSCI Frontier Markets Index nations was 0.36 as compared with 0.63
for countries in the MSCI Emerging Markets Index and 0.76 for the MSCI EAFE Index.
 The takeaway is that, given the diversity of frontier markets and the low correlations among
them, gaining exposure via a strategy that invests across a broad cross section of FMs can
potentially help dampen the risk in any one country.
 Individually, frontier markets can be quite volatile. But because they are so diverse and
relatively uncorrelated, as a group they have actually been less volatile than the MSCI
Emerging Markets Index or the S&P 500 Index in recent years
 This low group volatility reinforces the belief that a broadly diversified approach to frontier
market investing is critical.

 Some risks can be partially mitigated through thoughtfully designed, diversified investment strategies.
 Frontier markets offer an unfolding opportunity for investors who are seeking growth along with global
diversification. But the risks of investing in these less mature markets need to be well understood.
 Frontier-market investors should: · Make sure they are thoroughly educated about the asset class and its
potential risks, including keeping up to date on developments in this fast-moving area of investment,
especially since the “frontier” label refers to a shifting roster of nations. For example, Qatar and the
United Arab Emirates graduated from frontier to emerging market status in 2014. ·
 Need to gain exposure to the asset class through a broadly diversified approach. · Incorporate an
allocation to frontier markets in a broadly diversified portfolio.There is no doubt that the risks and costs
of investing in frontier markets are greater than in emerging and developed markets.
 But when it comes to some risk factors, such as fiscal stability, frontier markets may be less risky than
many assume. Beyond that, some risks can be partly mitigated through thoughtfully designed, diversified
investment strategies. It is possible that in some situations, adding a frontier markets allocation to a
portfolio may actually lower its overall risk, given historically low correlations between FM, EM and
developed market indices.
 Additionally, frontier markets offer growth potential, and low correlations within markets and with
other asset classes, along with relatively attractive valuations. These nascent markets represent an
opportunity that growth-minded investors should not overlook.

MANAGING POLITICAL & SOVEREIGN RISKS IN FRONTIER MARKETS
 ENTER THE ECONOMIC INTELLIGENCE UNIT : COUNTRY RISK MODEL---
A USEFULTOOLTHAT DELIVERS:
 A Data Selection module that allows you to manipulate and download the underlying dataset.
 128 countries (emerging and developed markets).
 A textual Risk Overview of five risk categories.
 Ratings and data can be compared across countries and over time.
 Model weighting adjustment tools to create ratings tailored to your organisation’s needs.
 l 6 categories of risk ratings and scores.
 61 indicators with historical scores to 1997 (a full set is not available for all countries).
 Custom data feeds on request.
Thursday, April 5, 2018
MANAGING SOVEREIGN RISKS IN FRONTIER ECONOMIES—DR EMMANUEL
MOORE ABOLO
25

THANK YOU
QUESTIONS?
Thursday, April 5, 2018
MANAGING SOVEREIGN RISKS IN FRONTIER
ECONOMIES--DR EMMANUEL MOORE ABOLO
26

Managing EMERGING Sovereign Risks in Frontier ECONOMIES by Dr. Emmanuel Moore ABOLO

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Managing EMERGING Sovereign Risks in Frontier ECONOMIES by Dr. Emmanuel Moore ABOLO