Investor appetite for emerging markets is dwindling as worries about rising inflation and falling equity markets grow, particularly in China and India. But frontier markets such as Africa and the Middle East are still flavour of the month, say fund managers. (PDF)

“African markets are not immune to the doldrums in global stock markets but have not performed as badly as emerging markets such as India and China,” says John Mackie, head of Africa funds at Stanlib Asset Management.

Emerging market equity outflows reached nearly $22bn (£11bn, €14bn) in the year to date to mid-July, and those in June alone topped $9bn, according to EPFR Global, a Boston-based company that tracks international fund flows.

In the same period, inflows into Africa regional equity funds have totalled $247m, while China equity funds have seen outflows of nearly $4bn, despite inflows in the past week. India has also seen investors withdraw $1bn from funds.

Appetite for Middle East and North Africa funds is also strong. Since the beginning of the year Mena funds have seen inflows every week according to EPFR, with net inflows of $1.3bn in the year to date.

Alexander Shalash, head of emerging markets at Julius Baer, says: “We believe north Africa has come of age with inward investment growing, which has helped develop local industries. There is more confidence due to economic reforms, a better banking climate and a growing credit sector.”

Until the start of the year emerging markets were seen as a safe haven compared with US and European markets, providing a source of high returns. But as these economies begin to overheat, investors have taken fright. Many going into emerging markets were looking for short-term gains, which has led to outflows in more difficult times. But when it comes to Africa investors are thinking more long-term says Mr Shalash.

Stanlib’s Mr Mackie agrees. “Investors are here for the long haul and growth prospects.” He reports steady inflows to Stanlib’s Standard Africa Equity Fund since it was set up nearly a year ago, and says the fund has returned nearly 10 per cent since launch. He is seeing growing interest in the fund from European, US, Middle Eastern and African pension funds as they look to diversify.

In the past, Africa has attracted more retail than institutional investors as the latter have shied away from some of the continent’s small and illiquid stock markets. But now that emerging markets are losing their gloss, attitudes to frontier markets are beginning to change, say fund managers.

Frontier markets are popular with investors because they are largely uncorrelated with global markets, with other emerging markets, and with each other, says Brad Durham, managing director of EPFR Global.

“That’s been a big draw for institutional investors in the last couple of years, especially since the advent of the subprime and toxic credit crisis when investors are looking for places to hide,” he says.

Julius Baer, which rolled out its Northern Africa Fund last September and recently launched it in the UK, has seen the fund grow from just $15m at the beginning of the year to $170m, with investment largely coming from the institutional side.

On the back of strong investor interest in the Middle East, Schroders aims to roll out a frontier fund next year focusing on the region as well as on sub-Saharan Africa and other frontier markets. Investec Asset Management, which has $30bn invested in the Mena region, has also just launched a Middle East North Africa fund.

Earlier this month HSBC Global Asset Management opened its new Frontiers Fund, previously only available to HSBC Private Bank clients, to institutional and wealthy investors. More than 43 per cent of the fund is exposed to the Middle East and 20 per cent to Africa.

Allan Conway, head of emerging market equities at Schroders, says investors seeking growth will have to consider frontier markets. “Most pension funds have stopped at emerging markets but if they want to maintain good returns they are going to have to be more adventurous,” he says.

In the past six months, the MSCI emerging market index has fallen nearly 13 per cent in dollar terms, while the S&P/IFC index for the Middle East and Africa has dropped less than 5 per cent. Both regions are benefiting from being commodities exporters.

But Africa experts say the region is more than a commodities attraction. Chinese interest and investment in Africa’s resources is providing a catalyst for growth in other industries such as financial services, telecoms and tourism says John Green, pan-Africa managing director at Investec Asset Management.

Mr Green believes it is important that Africa develops these other industries as commodity demand will dissipate to some extent over the next 10-20 years. Investec has not seen any significant outflows from the region or investors taking profits. “We would expect that returns generated are about 15-20 per cent annually in a well-diversified portfolio,” he says.

Markets in some countries are on high price/earnings valuations but fund managers see good opportunities in Morocco, where political risk is low, and Zambia, which has been boosted by several initial public offerings recently. Some also see good value in Egypt and Nigeria after a recent flurry of profit-taking. Mr Green likes Tanzania, where he sees tourism and good economic policy fuelling growth.

Opinions on where to find the best opportunities may vary, but most experts agree that investors should look to the long term and also have a stomach for risk.

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