Heavyweights in the frontiers market, these two newcomers will only make up less than 1% of the emerging market index, and have already seen a strong rise in valuations. In addition, other factors such as elections in many emerging market countries such as Brazil, South Africa and India create uncertainty and volatility within the space.
Frontier markets
Previously, Qatar and the UAE accounted for 36% of the MSCI frontier markets index.
“Frontier markets will now focus on other economies. Nigeria will become a dominant force with its weighting going up from 11.7-18.7%. Middle East exposure will decrease overall, with the exception of Kuwait whose share in the market jumps from 17.6-26.6%,” Gavin Haynes, managing director at Whitechurch Securities, said.
To qualify as an emerging market the stock market must contain at least three companies with a market cap greater than $1.26bn (£750m), and the stock market must be considered sufficiently open to foreign investment. To this end Qatar, increased its foreign investor share in the days leading up to the promotion on 30 May, and shares in both countries rallied on the news.
Valuations
For Elena Tedesco, director on the global emerging markets team at Hermes Fund Managers, the domestic drivers of Qatar and the UAE are attractive on a micro and macro level but the stocks are over-priced.
“We find the valuations stretched in the case of UAE and fair for Qatar. Hence we do not plan an investment at this stage,” she said.
When it comes to specific stocks in the market, they centre on the construction and infrastructure sector.
“UAE heavy weights are real estate companies such as Emaar and Aldar which benefit from demographic drivers and ample liquidity in the system. MSCI Qatar is dominated by banks that fight for deposits and for construction/infrastructure projects,” Tedesco said.
The rapid rise in certain share prices and unusually high valuations in some UAE stocks was also an increasing concern for Sam Vecht, manager of the BlackRock BSF Emerging Markets Absolute Return Fund.
“We much prefer the large number of frontier markets, where the macro-economic situation is robust or improving, where companies are growing fast, and valuations are compelling. While no investment in Frontier Markets is without risk, we would highlight Bangladesh, Romania, Saudi Arabia and Sri Lanka as looking particularly interesting at present,” he said.
Shifting markets
A key focus in the emerging markets this year are the elections that are being held across countries such as India, Brazil, South Africa and Nigeria which have and will continue to increase volatility and uncertainty.
“The volatility of elections was expected in the second half this year, but we’ve seen the effects in the first half already. For example, India moved faster than expected,” Samir Patel, portfolio manager on the Hermes Global Emerging Markets Fund said.
“Once the elections are out of the way, the emerging markets growth story continues. Two-thirds of the world’s population lives in emerging markets, growth is bound to continue,” he added.
Michael Paul, fund analyst at Brewin Dolphin, howevr, said the house view is still negative and with no plans of allocating to emerging markets.
“Valuations have gotten to the level where they are more attractive but emerging markets still have structural issues. The effect of tapering on markets as money gets repatriated to the US leaving emerging economies enforces our negative view on emerging markets,” he said.
A new phase
While investors are still wary about emerging markets, the story is evolving. Obvious structural risks such as uncertainty over election outcomes will likely continue to keep many investors away for the time being, but there is no doubt that the story is evolving. And, as we enter the second half of the year the mood is somewhat lighter than it was a few months ago and it remains a story to watch.
