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Douglas Clayton’s Leopard Capital, which last year launched Cambodia’s first multi-sector investment fund, announced the launch of a Leopard Sri Lanka Fund LP for early 2010.   “After several decades of civil war, peace has finally returned to the beautiful island of Sri Lanka, and a new investment cycle and growth upswing has begun.  Leopard Sri Lanka Fund will provide expansion capital and strategic guidance to mid-market Sri Lankan companies, and also help some expand their businesses into other frontier economies,” the firm notes.  Leopard Sri Lanka will be headed by Colombo-based managers Nirosh De Silva and Ramanan Govindasamy.

Investor confidence in the island is high, as country visits surged this summer and plans emerged to expand hotel and resort facilities.  Moreover, official reserves surpassed the $4 billion mark in September–roughly equivalent to over 4.4 months of imports–and is Sri Lanka’s highest ever reserves level.  The Central Bank noted that this level should strengthen in coming months on the back of increased foreign exchange inflows.  Finally, the country’s exchange remains up over 40% since the offical cessation of violence in May.


Citing Dubai’s deteriorating credit worthiness–government debt is expected to reach some 40% of GDP by year’s end–Fitch placed the UAE’s largest telecoms firm, Etisalat, which is 60.03% owned by the UAE and is the second-largest operator in the MENA region by market capitalization, on watch with a negative outlook. The firm’s AA- credit rating could be downgraded, Fitch warned, if government officials did not further articulate its willingness to cover the company’s debts (some commentators astutely noted that what this is in fact asking is to what extent will Abu Dhabi’s massive oil reserves further insure its arguably profligate sibling). “While the [UAE’s] sovereign credit remains strong, the lack of clarity on the process for non-budgetary financial transfers between the UAE federal government, central bank and individual emirates, is a source of weakness,” the rating agency noted.

The downgrading of Etisalat, however, would be curious, and almost certainly arbitraged away. The company enjoys a share price to operating cash flow ratio of 8, and a beta of .63, meaning it is less volatile than the overall market. Most important to its prospects for sustained profit growth, however, is a growing portfolio of overseas assets. This is especially vital to operations as the UAE’s mobile penetration rate has now exceeded 209%, meaning every single resident of the country currently has two lines to his or her name. While 90% of its revenues are UAE-derived, Etisalat is poised to capture emerging market share: in addition to the seventeen countries it currently operates in, the company acquired an Indian operator earlier this year and has submitted bids in Sri Lanka and Libya.

From September’s Business Diary Botswana:

Derivatives market helps farmers weather storm and smooth returns In “Fool’s Gold,” Financial Times global markets commentator Gillian Tett writes that “versions of derivatives trading have existed for centuries,” citing “rudimentary examples of futures and options contracts found on clay tablets from Mesopotamia dating back to 1750 B.C.” And the relatively modern practice of futures and later options trading to hedge against price volatility–used by farmers in order to lock in the price of a crop as it is planted, and thus negating the risk that prices will drop before it is harvested–began as early as 1849, when the Chicago Board of Trade opened. Yet within frontier markets the use of derivative contracts amongst farmers has been notoriously fickle, despite the obvious benefits that such techniques would bring not only food producers, but ultimately consumers. A 2006 paper published by the University of Pretoria’s Department of Economics, for instance, concluded that “the problems concerning food and income insecurity [would] be reduced if farmers [could] adopt derivative contracting on a large scale, since the producers [would] then be able to produce the staple food on a continuous basis at relatively profitable levels.” In Botswana’s case, a mature derivatives market could ultimately ignite a moribund industry whose waning impact is readily felt even in the face of robust GDP. According to the World Bank, despite the country’s seismic growth rates during the 1990s, the prevalence of hunger actually increased. Since then, the agricultural sector’s output has continued to disappoint, hampered by lackluster farming technologies and practices, sporadic rainfall and rampant disease outbreaks. Such degree of inefficient food production leaves not only consumers vulnerable, but state coffers as well. Per the Ministry of Agriculture, current annual arable production levels are only between 15-20% for cereals, and 45% for fruits and vegetables–meaning that imports must pick up the slack. Moreover, the risk of large-scale calamity due to, say, drought, leaves a given country’s fiscal surplus in a perilous position should wide-scale humanitarian intervention become necessary. And with food inflation a near certainty in the long-run, given a rise in price of major commodities related to food production due to growing world demographics, coupled with an ever-diminishing amount of farmland-per-person and an increasing scarcity of cheap, fresh water, it is no wonder that a lagging agricultural sector is continually singled out by worried Botswana officials.

Facilitating the sector’s resurgence, however, may be the emergence of Bourse Africa, a Pan-African commodities and derivatives exchange that will have a technology hub in Botswana and will link to other exchanges in the continent, and which is expected to be operational this month. The exchange, which in sponsored and coordinated by Financial Technologies India Limited (FTIL), a global leader in creating and operating financial markets that also owns MCX India, the Mumbai-based, world’s 8th largest commodities exchange, will trade contracts for agricultural commodities, oil and metals across Africa with a hub and spoke model centered in Botswana. According to Adam Gross, its Head of Strategy, the exchange will be of greatest benefit to farmers. “[Farmers] will understand the real value of what they produce. They get bad prices on the world market,” he said, noting that they will be taught about market information and how to execute orders and risk management. Additionally, the Exchange notes: “it has been demonstrated in academic literature how exposure to price volatility encourages commodity producers to pursue risk-minimizing strategies with the consequence that investment in production is limited and the cultivation of higher revenue but higher risk products remain off-limits. Whilst this is particularly the case for rural producers and informal sector workers, even a relatively sophisticated private sector enterprise can be critically wounded by sharply rising prices for fuel or essential raw materials, or a significant year-on-year drop in realized prices. Moreover, volatility has particularly damaging effects on poor people in low-income countries whose ability to cope is limited by shallow financial sectors and political and economic constraints that place limits on the type and nature of government interventions.” One specific subset of the agricultural derivatives industry centers around weather risk management. Per research by the World Bank, while international food prices have fallen, local food prices in many countries haven’t followed suit. While below their 2008 peaks, major food grain prices are still above average; maize is 50% more expensive than its average price between 2003 and 2006, and rice prices are 100% higher, for instance. One explanation is that production and supply cannot always be neatly correlated to fit demand; extraneous random variables such as weather patterns have an integral impact on a given crop’s yield. Per one academic paper, “weather is undeniably one of the most important sources of risk in agriculture, and it seems that fluctuations of temperature and precipitation have even increased in the last decade [and will continue to increase?] due to global climate changes.”

Sensing the need to help farmers manage this risk and to reduce the impact of drought in developing countries, the World Bank last year launched a series of financial intermediation services to low-income client countries of the International Development Association (IDA), and added to the range of risk-management tools available to middle-income client countries of the International Bank for Reconstruction and Development (IBRD), to help transfer risks to the financial markets. Such “index insurance” is tied to an objectively measurable indicator (e.g., rainfall, temperature, humidity, crop yields), in lieu of loss. At present, the use of rainfall totals to hedge against drought-related crop loss is the most prevalent derivative found in developing markets. In September 2008, the Bank reported, Malawi became one of the first countries to use a weather derivative financial product–index-based weather derivatives, in which “payments are triggered by adverse weather events according to pre-specified conditions.” In practice, it explained, “the Bank enters into mirroring transactions with the client country and a financial market counterpart. In the event of a severe weather event, client countries receive a payout from the Bank, the total value of which would be based on an index used as an estimate of the financial impact. This would be funded with the payout that the Bank would receive from the mirroring transaction.” In Malawi’s case, the World Bank Treasury acted as an intermediary on behalf of the government to ease and expedite its access to the international weather derivatives market–thus reducing transaction costs. “If there is significant drought in the country, the government will get a payout whose level is determined by the size of the premium paid and the severity of the drought. This payout may be used to help purchase grain to resolve supply shortfalls or to distribute grain from national strategic grain stocks,” commented David Rohrbach, a senior economist at World Bank’s Malawi office. Concurrent with the Malawi deal, the World Bank also began to support weather index insurance initiatives across Thailand, Bangladesh, Senegal, Burkina Faso, Kenya, Jamaica and Fiji. And in Indonesia, per its website, the Bank and IFC are completing a “feasibility study on a crop insurance pilot for maize small farmers.” While not an innovative product per se–weather market and index-based insurance products in agriculture have grown rapidly over the past decade and are widely used by private companies to manage risk–their adoption in developing countries is relatively novel. Skeptics, however, note that the long-term future of weather derivatives will ultimately depend on what improvements can be made to their pricing. “Because weather cannot be traded, that is, the market for weather risk is incomplete, a straightforward application of standard pricing models for financial derivatives is impossible. Actually, the poor transparency of pricing algorithms employed by sellers is considered a major cause of the slow development of weather markets,” stated a paper published last November by the American Journal of Agricultural Economics. That said, proponents such as Rohrbach point to an already burgeoning global industry (which now exceeds some $32 billion, including energy firms that make up roughly 36% of the market) and posit that “as the international weather derivatives market becomes accustomed to these transactions, the World Bank expects [a variety of governments] to begin pursuing such transactions independently.”

As the once universally-sacred Efficient Market Hypothesis (EMH) continues to fester unceremoniously in economic purgatory post-crisis, behavioral finance–which might tend to support the notion that short-term price action, far from being rational, is highly inefficient and emotional, continues to gain credence among economists and fund managers alike.  Speaking in 2005, Dr. John Porter of Barclay’s Capital in London for instance remarked that “psychology is by far the most important area in the markets.  Markets people want to be quantitative and model human behavior, but the problem is human behavior is not stable.  When people interact as groups, human behavior becomes subjugated to that of the overall group.”  Moreover, Robert J. Johnson, senior managing director at CFA Institute, noted in Monday’s FT that in fact behavioral finance is documented to have created profitable trading opportunities.  “At its core, the discipline of value investing is largely based on behavioral finance principles.  Implementing strict value-based or contrarian investment philosophy can require exceptional fortitude, especially in volatile markets where it might be difficult to convince investors of its wisdom.”

The burgeoning field seems particularly relevant, in my opinion, to frontier investing, which is defined in part by illiquidity and relative volatility.  Yet in his November 2008 research paper, “Investing in the Unknown and the Unknowable -Behavioral Finance in Frontier Markets,” Larry Speidell, founding partner, CEO and chief investment officer of the San Diego-based Frontier Market Asset Management, notes that the relatively large presence of neuro-based biases in frontier investing underpins the sector’s high risk premia potential as well:

“Behavioral biases and opportunities are abundant in frontier markets.  Foreign investors are prone to view them through the prism of personal prejudice and media hysteria, making it difficult for them to even travel to frontier countries, let alone invest in their markets.  Those professionals who do venture out on the frontier find it difficult to travel light, without the comfort of all the data that have made more developed markets so efficient.  Meanwhile, local investors are lacking in analytical tools and are prey to rumors, leaving the brokers to make fat commissions while their customers chase rumors.  Investors who can avoid the crowd, evaluate the asymmetry of knowledge, and deal with decision making under uncertainty have an opportunity in frontier markets.”

Behavioral-based volatility in illiquid markets can be a boon to long-term investors who are apt and able to lower their price base rather than rashly seek-out skeptical buyers.  The recent bank-kerfuffle continues to keep the Nigerian Stock Exchange into a kink, for instance, but prudent heads may yet prevail; as Silk Invest’s Baldwin Berges wrote in this week’s newsletter to investors, “Nigeria’s local investors remain nervous and have been putting more pressure on the market. We have to keep listening for that thud that will tell us we have reached the bottom. [But] when it turns, it will go fast…some patience may be required but we believe it is justified by the potential upside to be had in Nigeria.”

Shares in Chilean glass products maker Cristalerias de Chile–which has a market capitalization of roughly $700 million and produces glass bottles and containers mainly for the food and beverage industry–rose 15% on Friday after the firm announced an agreement to sell its 20% stake in cable television operator VTR–the nation’s largest cable-television and broadband provider–to Celfin Capital for $303 million (roughly 7x EBITDA, per one analyst). A week earlier the company placed two series of five-and 20-year inflation-linked bonds worth a total 41.46 billion Chilean pesos ($75.3 million). One condition of the VTR sale is its possible future listing on the local stock market. VTR is currently in the process of bidding on a 3G wireless license which would allow it to enter the mobile telecoms market starting in 2010.

Cristalerias shares are still undervalued and thus make a sensible addition (following an expected short-term pullback) to our mock frontier portfolio; the case for the firm is strengthened as it represents a proxy on domestic demand growth against a backdrop of a stable nation with sound fiscal practices–its latest current account surplus was $1.13 billion in the second quarter, or 2.9% of GDP.

Wonderful piece in Euromoney regarding the dichotomy of opinion among international investors in the ME vis a vis the research capabilities of the region’s domestic investment banks and equity research houses, most of which have found themselves “struggling to meet their debt obligations.” While many portfolio managers still swear by local expertise, others are more skeptical, noting that research is only as valuable as the individual analyst standing behind it, and that the downturn has led to an exodus of some of the best talent.

Some other interesting points are made in the article that form the foundation of frontier investing and stand repeating:

  • “As businesses in the Middle East continue to move away from the family owned and operated model and place greater portions of their companies in the hands of public shareholders, a higher level of corporate transparency, scrutiny and research will be required. With increased coverage from both local and global firms, Middle Eastern equity markets will become deeper and more liquid as time goes on.”

  • “Despite the recent setbacks in the region’s financial sector, [Mahdi Mattar, head of research and chief economist at the Dubai-based Shuaa Capital] still believes in the growth opportunities that the Middle East presents, ‘with valuation at discount, especially after the severe sell-off of last year, and the regional equity markets offering some highly attractive value plays'”.

  • Will Manuel, head of [Central Eastern Europe, Middle East and Africa] equity research at HSBC, “says that the [ME’s] prospects are good, as equities in the GCC and Egypt become a large bloc of the global emerging market benchmark indices, such as the MSCI Emerging Markets Index. As more Middle Eastern stocks move into the emerging market benchmarks, increased trading volume in the Gulf region is bound to follow, particularly among institutional investors.”

A reminder that winners for the 2009 Africa Investor Index Series Awards will be announced on September 21st at an invitation-only gala ceremony on the trading floor of the New York Stock Exchange.

According to various reports, central bankers from Saudi Arabia–whose capital Riyadh is slated as the home of a planned future regional central bank–are increasingly pessimistic as to the odds of the once much bally-hooed 2010 transition to a single Gulf currency and monetary union across the six-member GCC.  This despite the fact that prices rose 10.5% in the Kingdom in April, the fastest pace in over three decades, and UAE inflation touched the 20-year peak of 11.1% last year.  In the meantime, dollar pegs forced various countries to mirror declining U.S. interest rates despite windfall oil profits and domestic price increases.  Yet certain countries, such as Kuwait and Syria, have already dropped their dollar ties.  Moreover, there is scant evidence that dropping the peg did much for Kuwait’s inflationary pressures.  Some analysts reckon, for instance, that inflation is less tied to fuel and more tied to factors such as food prices, construction materials such as cement, and other key commodities.

Meanwhile, investor confidence in the Gulf is predicated upon a hearty balance of payments which is predicated largely on resources such as crude oil or, in Qatar’s case, LNG.  Yet as OPEC noted last fall, “retreat of the U.S. and European economy has a negative affect on the balance of payments in GCC countries.”  That is to say that investing on the basis of the region’s reserves is still just a proxy on global demand.  The real question may be at what point said demand rests less on the West, and more on the BRICs.  Until it surely does, Gulf finances arguably remain flimsy and its markets will be that much more volatile.


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