Making money — both for itself and, on occasion, even for customers — is no longer enough for the asset management industry.
Being seen to do the right thing for society seems to have equal status, hence the scramble by fund managers to signal devotion to the all-conquering creed of environmental, social and corporate governance-based investment.
Arguably, though, some of the fund managers that have done most to improve the lot of humanity have not been trying to participate in this orgy of ESG.
After all, what, within the power of a fund manager, could be more beneficial than pouring money into the poorest countries with functional stock markets, helping lower their companies’ cost of capital and spurring economic growth where it is most needed?
Frontier funds (and their investors) do precisely this, pumping money into the likes of Nigeria, Kenya, Senegal and Ivory Coast — the mainstream emerging markets equity index ignores sub-Saharan Africa except South Africa — as well as Bangladesh, Vietnam and Sri Lanka.
This feel-good story has also felt good for investors since 2010, producing three times the returns of the mainstream EM index as assets have tripled to about $20bn.
Yet it is in jeopardy. Last month’s annual index review by MSCI, the US group that controls the dominant frontier index, led to cries of “oblivion”, “existential crisis” and the potential “twilight” of the index.
The cause of the angst was MSCI’s decision to promote Argentina from frontier to EM status next year and earmark Kuwait for a possible upgrade in 2020. Assuming Kuwait gets the nod, the frontier index, which has already been stripped of the United Arab Emirates, Qatar, Pakistan, Ukraine and Bulgaria since 2014, would lose 38.4 per cent of its market capitalisation.
Vietnam would become an outsized 25 per cent of the frontier firmament, based on current prices. If it too was promoted, as many observers think is likely, the index would be left with just 45.5 per cent of its current market cap, and even less of its liquidity, given that no countries are being groomed for entry.
“This probably makes the MSCI FM index ever more irrelevant,” pushing it “closer to oblivion,” said Hasnain Malik, head of equity research at Exotix Capital, an investment bank that focuses on emerging markets.
In one sense, MSCI’s actions are understandable. Its rules state that if a bourse boasts an adequate number of large and liquid stocks it should be included in either its emerging or developed market indices. Promoted countries are simply being rewarded for meeting these requirements.
What is lacking, though, is any sign of a master plan from MSCI. Its approach treats the frontier basket as a nursery for future EMs. This is fine in itself but is indifferent as to whether the resulting index is a worthwhile or usable benchmark, either for active or passive managers.
The frontier index has always been an oddity. Alongside the nations mentioned above, it includes middle-income countries such as Slovenia, Estonia and Bahrain, which just happen to have small stock markets.
Yet this slightly random combination has its attractions, such as a higher dividend yield (3.9 per cent), return on equity (13.8 per cent) and consensus earnings growth forecast than either developed or emerging equities, as well as low correlation to other indices, according to data from Andrew Howell, frontier market strategist at Citi.
These attributes partly stem from the fact that frontier markets are under-owned by international investors, which is likely to become more marked still if the frontier concept withers on the vine.
Maybe the solution is for fund managers and their overseers to have the courage to invest more off-benchmark, and for investors to give them the freedom to do so.
Perhaps then more capital will flow “downhill” to poorer countries, as economic theory suggests it should, whether or not a mid-sized New York company decides to keep its frontier index in good working order.
By Steve Johnson