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IMPORTANT
WARNING:
The contents of this report have been compiled in good
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to investors, but do not constitute investment advice
or recommendations. Investors should not rely upon the
information given in order to choose types or routes
of investment but should make their own independent
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has taken reasonable care in researching and presenting
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taken or not taken as a result.
In its April,
2007, Global Financial Stability Report the IMF is generally
reassuring, although pointing to some downside risks,
and in particular seems bullish on the situation in
emerging markets.
Favorable global economic prospects, particularly strong
momentum in the euro area and in emerging markets led
by China and India, continue to serve as a strong foundation
for global financial stability, said the Report. As
the IMF sees it, low interest rates and low volatility
in many mature markets have encouraged investors to
seek higher-yielding assets in some emerging markets.
Capital inflows to some emerging markets have therefore
risen rapidly.
In general, the IMF welcomes these strong private capital
inflows as they reflect a reallocation of capital to
more productive investments. However, the shift to
private sector debt flows, especially bank-based flows
into emerging Europe and portfolio flows into other
regions, including sub-Saharan Africa, shows that foreign
investors are taking more risk and an abrupt reversal
cannot be ruled out, warns the institution.
Emerging
Markets Performance
The
numbers certainly bear out the IMF's optimism. The Morgan
Stanley Capital International Emerging Markets index
set new records in February and in April. The index
climbed 32% in 2006 and is up more than 3% so far this
year. It has gained an average of more than 24% annually
over the last five years.
The
MSCI Emerging Markets Free (US dollar) index rose by
3.7% in March. Latin American stocks, led by Brazil
and Mexico, outperformed. The EMEA region also performed
well, particularly in Poland and the Czech Republic.
Asian stock markets generated positive returns, apart
from minor losses in Thailand and Taiwan (capital return,
local currency). Despite further steps from the Chinese
government to slow domestic economic growth, the Chinese
SE Shanghai Composite index still produced double-digit
returns. In fact there is a boom going on in domestic
Chinese stock markets.
The
bottom line seems to be that the emerging market economies
grow faster than the rest of the world, so that prices
on their exchanges and in the investible indices that
track them tend to outperform markets in developed countries.
Emerging
market funds manage a total of at least $450 billion,
an amount that has risen by $60 billion since the current
bull market took off in 2003.
Fund
managers are mixed in their expectations. Some say that
a large proportion of risk has been taken out of emerging
markets by better economic management,
radically lower country debt, more flexible currencies,
better tax and budget policies, and greater corporate
transparency.
Others
are not so sure, and believe that emerging market prices
are getting 'toppy', despite their 20% discount to developed
world markets. The Jeremiahs point to political risk,
as well. But they seem to be in a minority.
What
is true of equities is also true of bonds.
Over the past 10 years, emerging market sovereign (government)
bonds have outperformed both US corporate bonds and
the S&P 500.
Between
1994 and May 2004, JP Morgan's Global Emerging Markets
Bond Index rose 248%, compared to a return of less than
102% for US corporate bonds and 193% for the S&P
500.
2003
was the year in which emerging market investments began
their stellar rise. Emerging market equities soared
by 52% in 2003 according to the MCSI emerging markets
index, when a record $12.5 billion was poured into the
961 funds tracked by the index. Asian markets performed
particularly well. Thailand's stock market experienced
85% growth during 2003 (in sterling terms) with Indonesia
posting similarly impressive gains, posting a return
of 79.3%. Other significant performers included Taiwan's
bourse which saw growth of 31.3%.
By
comparison, equity markets in the more established financial
centres returned much more modest gains. Stock markets
in the US managed growth of 26.4% in 2003, whilst London's
markets rose a relatively small 13.6%.
A
poll of 299 fund managers undertaken in February, 2004
by investment bank Merrill Lynch indicated general optimism
about emerging markets, and it turned out to be justified.
The Morgan Stanley Capital International Emerging Markets
index has gained an average of more than 24% annually
over the last five years.
Look
back further, however, and you'll come up against a
scary series of defaults and emerging market crises
such as
the Russian debt default in 1998, which brought down
one of the world's largest hedge funds in Long Term
Capital Management and sparked fears within the US government
of a meltdown in the banking system. Other examples
are the Asian financial crisis of 1997/1998 and Argentina's
debt default in 2001. Even the jailing of former Yukos
CEO Mikhail Kordokovsky on fraud and tax evasion charges
in October, 2003 caused the entire Russian stock market
to fall 15% in one week.
Could
it happen again? That's the question a long-term emerging
markets investor has to ask, and that's the issue that
underlies the persistent discount of emerging markets
stocks to those in the developed world.
What
exactly is an emerging market?
Many
international agencies consider all non-high income
countries to be "Emerging Markets", stressing
the potential of all nations to develop. Others include
only those countries that meet certain levels of economic
development and in which local equity and debt markets
are operating. In general, Emerging Markets countries
are characterized by an underdeveloped or developing
commercial and financial infrastructure, with significant
potential for economic growth and eased capital market
participation by foreign investors. Countries generally
considered to be Emerging Markets possess some, but
not necessarily all, of the following characteristics:
-
Per capita GNP of less than US $9,656 (a World Bank
definition of low- and middle-income economies);
-
Recent or relatively recent economic liberalization
(including, but not limited to, a reduction in the
state's role in the economy, privatization of previously
state-owned companies, and/or removal of foreign exchange
controls and obstacles to foreign investment);
-
Debt ratings below investment grade by major international
ratings agencies and a recent history of defaulting
on, or rescheduling of, sovereign debt;
-
Recent liberalization of the political system and
a move towards greater public participation in the
political process; and
-
Non-membership in the Organization of Economic Co-operation
and Development (OECD).
Countries that are usually considered classic examples
of Emerging Markets include Argentina, Brazil, India,
Mexico, China, Central and Eastern European nations
and Russia. Others that may be considered borderline
cases, possessing fewer of the above characteristics,
include Greece, Portugal, and Turkey.
Countries
which meet many of the definitions above, but which
have not yet been the focus of significant foreign investment,
are often referred to as "pre-Emerging Markets"
or "emerging Emerging Markets". These countries
include most of Africa, some Central American nations,
and a number of the former Soviet republics.
Hedge
Funds Are Believers
Recent
months have seen plenty of evidence that hedge funds
are fans of emerging markets.
Reporting
on 2006 performance In January 2007, Oliver Schupp,
President of the Credit Suisse Tremont Index, LLC, said:
"The majority of hedge fund sectors ended December on
a positive note with the Managed Futures sector as the
best performing sector in December, up 4.05% and the
Emerging Markets sector as the best performing sector
for 2006 up 20.49%.”
And
in February, investors surveyed by Tara Capital said
that confidence remains high for Emerging Markets hedge
funds, the hedge fund advisory firm has announced. Geneva-based
Tara Capital had just released the results of its fourteenth
installment of the quarterly Hedge Fund Strategy Barometer
(HFSB). The Barometer’s findings are based upon the
plans and opinions of some of Europe’s largest hedge
fund investors, with $86.5 billion of assets invested
in hedge funds. Support for Emerging Markets funds was
strong, with a particularly high level of interest for
funds dedicated to the Asian region.
In
April, HedgeFund.net
(HFN) announced the launch of a new hedge fund benchmark
for funds that invest in Latin America. The
HFN Latin America Average launched with 80 constituent
investment vehicles, including 43 that invest specifically
in Brazil, and another 37 that invest in broader emerging
markets in Latin America. As of April 4, the HFN Latin
America Average had an estimated return of 1.42% for
February, and final returns of 1.66% for January 2007
YTD and 29.86% for 2006 - all of which were the best
performing regional averages tracked by HFN.
HFN
has commenced tracking a growing number of funds investing
in Latin America. While most of the funds are based
near their investments in Latin America, a minority
invests from afar, including Hong Kong, Switzerland,
the United Kingdom and the USA. "The
addition of the HFN Latin America Average comes at a
time when investors in the US and abroad are increasingly
looking to emerging markets - Brazil and the Latin American
region in particular - for alternative investment opportunities,"
explained Donald C. Cacciapaglia, Chairman and Chief
Executive Officer of HedgeFund.net.
"The
creation of the Latin America Average is a response
to ongoing and increased fund and investor demand for
the ability to monitor performance of Latin America-focused
funds against a benchmark," Cacciapaglia added.
The
GCC Is Flavour Of The Month
The
sustained interest of hedge funds in emerging markets
is echoed across the financial landscape, with many
bank and other institutions behaving as if emerging
markets will form a long-term part of their investment
horizons. But nowhere is it more marked than in the
GCC, and particularly in Dubai.
In
April 2007 Deutsche Bank announced the expansion of
its 'aXess' equity products to include markets of the
Gulf Cooperation Council (GCC). The bank's aXess service
is a suite of structured equity products that address
the demand of international investors by providing full
economic exposure to a wide range of markets across
the globe.
In justification
of the move, the bank said that not only are the GCC
markets some of the fastest-growing in the world, they
possess one of the fairest valuation levels and have
low correlation with other markets, thus providing good
opportunities for diversification. By deploying aXess
into the GCC, Deutsche Bank said it is facilitating
local investment by international investors.
Deutsche
Bank aXess products allow investors to obtain immediate
exposure to the performance of local shares via a Luxembourg
listed instrument which is settled via Euroclear in
US Dollars. Deutsche Bank acts as market maker and provides
comprehensive price transparency. This aXess product
suite expands on Deutsche's equity derivative and swap
offering for the region. Deutsche Bank will initially
provide access to Dubai, Abu Dhabi, Bahrain and Qatar.
Kerim
Derhalli, Global Head of Emerging Markets Equities for
Deutsche Bank commented: "Providing 'aXess' to the GCC
builds on our extensive strategic commitment to the
Middle East and North Africa. By furthering Deutsche
Bank's innovative and market leading product offering
we continue to strengthen our premium emerging markets
position."
Also
in April,
international derivatives exchange Eurex planned to
launch derivatives on Russian underlyings denominated
in US dollars, enabling investors to trade emerging
markets derivatives on the Eurex platform for the first
time.
On
23 April, Eurex was due to introduce a future on the
RDXxt (RDX extended index), an index calculated by the
Wiener Boerse AG (Vienna stock exchange) which contains
the 15 largest Russian depositary receipts (DRs) traded
on the London Stock Exchange (LSE). This move will allow
Eurex to meet the growing demand for a liquid and cost-effective
hedging instrument for investments in Russian equities.
Settlement will be made in cash, with one index point
worth US$25. The future has a maximum maturity of nine
months, with expiration dates in March, June, September
and December.
The
RDXxt index is being calculated by the Vienna stock
exchange from the beginning of March 2007; it meets
both the US regulators' definition of a broad index,
making it of interest to US investors, and the UCITS
regulations, which are significant for European financial
products.
In
addition to the index future, Eurex said it would be
listing single stock futures on all 15 index constituents
and four new options on Russian equities Gazprom, Lukoil,
Norilsk Nickel and Surgutneftegaz on 23 April. A contract
for the single stock futures comprises 50, 100 or 500
shares, depending on the underlying. The contracts have
maximum terms of three years with monthly expiration
dates and two annual expiration dates in December. At
present, Eurex trades 370 single stock futures including
all stocks listed on the German DAX blue chip index,
the Dow Jones Euro STOXX 50 index and the Swiss SMI
index.
The
options contracts cover 50 or 100 shares and have a
maximum maturity of 12 months. They are based on the
DRs listed on the LSE. Eurex is Europe’s leading equity
options exchange with an offering of over 190 equity
options from nine countries.
"With
these products our customers can participate immediately
in the rapidly expanding Russian market," said Eurex
CEO Andreas Preuss. "We are offering our clients attractive
investment and diversification opportunities in one
of the most important emerging markets."
Michael
Buhl, Joint CEO of the Vienna stock exchange said, "As
one of the leading providers of indices for the Russian
market, we are pleased that Eurex is using the RDXxt
as an underlying." According to Buhl, the RDXxt is specially
designed for the futures market and US investors.
In
March, 2007, Citigold
Corporation Limited, the Australian gold mining company,
became the first company from the East Asia/Pacific
region to list on the Dubai International Financial
Exchange (DIFX).
Commenting
on the move, John Foley, Chairman of Citigold stated:
"As the region's international exchange, the DIFX is
the ideal gateway for Citigold to connect with regional
investors. Our listing of ordinary shares on the DIFX
makes Citigold a leader in the international capital
markets, just as we are at the forefront of the Australian
gold mining industry.”
Computershare,
the world's largest share registry, has created an innovative
link that allows brokers and investors around the world
to easily trade Citigold’s shares on either the DIFX
or the Australian Stock Exchange (ASX), where Citigold
shares have been listed since 1993.
Per E. Larsson,
Chief Executive of the DIFX, stated that: “We welcome
Citigold as the first company from its region to list
on the DIFX. The exchange now has eight equity listings
and these come from companies around the world, from
Bahrain to South Africa and from Switzerland to India.
The connection with the ASX through Computershare is
the DIFX's first such dual listing link with an exchange
outside the Middle East."
Mark Lynch,
Managing Director and CEO of Citigold, added: “With
the gold market in Dubai becoming a highly sophisticated
market and the DIFX emerging as a trusted international
stock exchange, we are confident that the opportunity
to invest in gold stocks on the DIFX will be well received.”
Paul Conn,
President of Global Capital Markets at Computershare
noted: "We are pleased to launch this cross border service
for Citigold and the DIFX, and to extend it to other
issuers that choose to dual list on the DIFX to gain
access to investment and liquidity in the Middle East
region. We also look forward to creating further links
between DIFX and other markets around the world, as
market demand warrants.”
Hamed Ali,
Executive Officer of the DIFX, observed: “As well as
looking forward to further listings from companies around
the world, the DIFX is preparing for more listings from
prominent firms in its own region. These will satisfy
investor demand for a diversified product range and
enable the issuers to reach a new investor base."
Citigold,
which has its regional headquarters in Dubai, currently
has nearly 50 UAE-based investors on its share register,
who account for over 3% of Citigold stock. Citigold
said it expects this figure to increase following the
listing on the DIFX.
Emerging
In The City
Of
course it's not just in emerging market stock markets
themselves that local companies choose to list. There
have always been plenty of Global Depositary Receipts
and American Depositary Receipts for companies with
illiquid domestic markets, and large Russian, Chinese
or Latin American companies frequently list directly
on major stock exchanges, offering an alternative play
for emerging markets investors.
Now,
according to offshore law firm, Walkers, offshore listings
on the London Stock Exchange's Alternative Investment
Market (AIM), an international market for smaller growing
companies, are on the rise.
Walkers reports
that it is seeing more interest from companies in India,
China, and other emerging markets who want to gain the
benefits of offshore listings by accessing the exchange
through Jersey and the British Virgin Islands.
“AIM offers
a tremendous amount of liquidity to smaller companies,
as well as access to institutional investors who often
turn into mentors and partners,” observed Hiren Patel,
a partner in Walkers’ Jersey office who did the first
offshore AIM listing for a Chinese company in 2004.
“It’s a win-win
situation since AIM has lower listing fees compared
to other exchanges and investors often see significant
return on their investments in emerging markets which
AIM can access. There are clear tax advantages, on top
of the benefits of AIM listing, if the listing is done
through an offshore jurisdiction such as Jersey or the
BVI," Patel added.
According
to Walkers, offshore listings for Indian companies are
expected to increase exponentially in 2007. In 2006,
11 Indian companies listed through London on the exchange,
raising more than GBP1 billion (US$1.97 billion). Seven
of these listings were from offshore jurisdictions,
up from only one in 2005.
Walkers notes
that India is increasingly viewed as an emerging market
and changes in the country’s regulatory regime allow
both inward and outward investments. The Reserve Bank
of India recently relaxed rules around the conversion
of the rupee, which also simplifies investments and
opens up more opportunities in Europe for Indian companies.
Asian companies have also seen the benefits of listing
on AIM, with 43 companies listed on the exchange, 25
added in 2006 alone.
“We’ve done
ten offshore listings for Chinese companies in the last
18 months,” Patel continued. “The flexibility and clear
path to an IPO are attractive to virtually any company.
However, for countries such as China where foreign investment
may be more challenging, an offshore listing on AIM
opens up many more opportunities.”
Walkers predicts
that the new authorisation process enacted earlier this
month by the Jersey Financial Services Commission for
closed-ended funds that are or will be listed on designated
stock exchanges will further boost AIM listings in this
jurisdiction. The changes will streamline the authorisation
process, which will benefit investors and entrepreneurs.
Stock
Markets In Emerging Economies
There
are more than 30 stockmarkets in countries which could
broadly be considered as 'emerging', and it's not possible
to cover them all here (but see the Lowtax Network Intelligence
Report On Offshore Stock Exchanges on sale from www.lowtaxlibrary.com).
Recent
highlights include the announcement by the Bahamas International
Securities Exchange (BISX) that Credit Suisse Wealth
Management Limited has been approved as a BISX Sponsor
Member for the listing of mutual funds on the exchange,
the growing importance of Hong Kong in Asian capital-raising,
and the new convertibility of the Russian rouble.
Simultaneously
with its application for Sponsor Membership, Credit
Suisse submitted an application to list the Protection
Strategy Fund Limited SAC and its three classes of shares
on the BISX mutual fund listing facility. This fund
was also approved for listing and will now have its
information disseminated via the BISX website.
Commenting
on his company's approval as a BISX Sponsor Member,
Michael Ranson, Credit Suisse Wealth Management Limited
CEO, stated that: "Credit Suisse Wealth Management Limited
is pleased to join BISX as a Sponsor Member and is very
much looking forward to a close working relationship
with BISX in connection with our sponsorship and related
listing activities."
Credit Suisse
becomes the fourth Sponsor Member to join BISX, and
brings to the Exchange a wealth of international experience
in the areas of fund administration, wealth management
and private banking.
BISX Chief
Executive Officer Keith Davies added: "We are pleased
with being able to start 2007 in such a positive manner.
By Credit Suisse joining BISX as a Sponsor Member, they
are now able to bring mutual fund listings directly
to BISX, and by extension BISX is able to direct the
many business inquiries it receives to its newest member,
particularly given its extensive business capability."
"We believe
that this affiliation gives Credit Suisse the opportunity
to offer more services to their wealth management clients,
and by becoming a member of our exchange, we expect
to give their company a higher level of creditability
with respect to regulation and compliance."
The Protection
Strategy Fund Limited SAC becomes the twelfth mutual
fund to list on BISX. This is the first Segregated Accounts
Company to be added to BISX, and demonstrates the ability
of BISX to list funds of varied capital structures.
The Accounts of the Protection Strategy Fund will each
have their Net Asset Values listed on BISX and posted
on the Exchange's website. The 3 accounts are:
- Protection
Class A Emerging Markets Segregated Account, which
seeks capital appreciation by investing in fixed income
instruments and financial products related to less
developed countries, particularly Latin American countries.
- Protection
G-7 Fixed Income Class B Segregated Account, which
seeks capital appreciation by investing in a variety
of fixed-income instruments and financial products
primarily in G-7 fixed income markets.
- Protection
Class C Equities Segregated Account, which seeks capital
appreciation by investing mainly in emerging market
countries securities markets, especially that of Brazil,
as well as in derivative products thereof.
Davies concluded:
"We are pleased with the addition of the Protection
Strategy Fund Limited SAC and its three Segregated Accounts
to BISX. The value and visibility that accrues to funds
from being connected with a regulated exchange such
as BISX gives investors the comfort that they desire
when examining investment opportunities. By partnering
with Credit Suisse Wealth Management, the Fund delivered
the high standard mutual fund instrument that BISX requires
for all of its mutual fund listings."
One
of the most obvious objects of emerging market interest
has always been Hong Kong, and the more so since it
became the focal point for mainland Chinese and other
Asian listings. In February, Hong Kong's Securities
and Futures Commission said that the Territory still
possessed some of the characteristics of an emerging
market, and warned that the Hang Seng Index generally
has higher volatility than New York's or London's indices.
In
its latest Dr Wise column, the Commission observed
that the city carries an increasing number of listed
companies from emerging economies, with many of the
emerging market's risks.
The
commission said there are some causes for volatility
in emerging markets such as unexpected market events,
government intervention and speculative investment behaviour.
Emerging
market investments are also often less liquid than the
developed ones. This is mainly because some emerging
economies restrict fund repatriation by foreign investors,
who are limited on the frequency and amount of investment
and its withdrawal.
The Commission
concluded by suggesting that as many emerging markets
are still in the process of building accountability
within the system, their legal and reporting framework
may be either too lax or too zealous, and individual
companies or industries may still be reliant on government
support.
Finally,
in January, RBC
Capital Markets, the corporate and investment banking
arm of Royal Bank of Canada Financial Group, announced
the completion of two of the first ever bonds denominated
in Russian rubles (RUB).
"When RUB
became an eligible settlement currency on January 15,
we wanted to be there to meet investor interest in Russian
rubles," announced Avril Pomper, RBC Capital Markets'
head of fixed income distribution, Europe.
"We're very
active in local currencies, and we're seeing that investors
are willing to diversify away from traditional currencies
like the euro and yen into emerging markets like Turkey
and Iceland," Pomper added.
The first
issue was RUB2 billion (US$75.4 million) with a five
year term issued by the European Bank of Reconstruction
and Development. The second issue was RUB2 billion a
four year term issued by Nordic Investment Bank.
As
the 15th largest debt underwriter globally, RBC Capital
Markets is a leader in Sterling and non-core dollar
markets, with a growing presence in Euros and US dollars,
and the leader in US Negotiated Municipal bonds. Trading
hubs in London, New York, Sydney, Tokyo Chicago, and
Toronto provide 24-hour pricing.
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