Emerging markets specialist tips Middle East property and Kazakh financials

The head of fixed income at Silk Invest, which specialises in frontier markets, talks to Credit about risks and opportunities in areas that other investors neglect.

John Bates, Silk Invest

With many advanced economies reporting sluggish growth, investors are increasingly turning to the developing world for opportunities. The so-called ‘frontier’ markets have been beneficiaries of the trend.

The term frontier has been variously defined, but generally refers to countries lacking the economic development and liquid capital markets of larger emerging nations. John Bates, London-based head of fixed income at frontier market fund Silk Invest, says his specialist mandate allows him to take advantage of opportunities that typically go unnoticed by larger funds.

“While a lot of the countries we look at are extremely resource-rich and populous, they don’t appear on any of the main benchmark indices, which means they have traditionally been off the radar for international investors,” he says.

He points to North Africa and Sub-Saharan Africa making up only 3% and 6% respectively of debt listed on the JP Morgan Emerging Market Bond Index (Embi) as an example of how those regions are under-represented. “Take Ghana: it produces 60% of the world’s cocoa beans and has healthy demographics, but doesn’t appear on any benchmark indices because its domestic financial market is undeveloped,” Bates says.

Bates’ portfolio, which has an average credit rating of B+/B1, is largely composed of bonds from regions linked by the historic Silk Road: Central Asia, the Middle East, North Africa and Sub-Saharan Africa. Sovereign and quasi-sovereign debt makes up 70% of the portfolio, with the remainder corporate credit.

Areas of interest

Bates is currently looking at opportunities in two sectors: Middle East property and Kazakh financials. In Kazakhstan, the financial sector is emerging from a period of restructuring, during which the government tackled a credit bubble and consolidated 36 banks into 11. Bates identifies debt from Alliance Bank as attractive: a seven-year bond from the bank (rated B- by S&P), issued in March at a coupon of 10.5%, was trading at 10.92% on September 20.

“Alliance Bank, which is now 67% owned by the government, is trading at sub-par levels. The government has said it’s going to look after it – so it is now effectively a quasi-sovereign – but in terms of pricing it seems to have lagged the other banks that the government has supported,” says Bates.

Middle East property, meanwhile, has been volatile since the announcement of a $26 billion debt restructuring by state-owned holding company Dubai World in December 2009, which triggered a deterioration in investor confidence. Bates thinks bonds from other companies in the region have reached attractive levels as a result.

His top pick is Abu Dhabi’s Tourism Development and Investment Company (TDIC). “The company has scaled back its pipeline of projects to a more realistic level, and has put in an investor-friendly management team. There’s also an explicit statement of support from the Abu Dhabi government. If you look at the yield on TDIC bonds, you’re getting a reasonable premium over the government despite the fact that, with the support, it’s de facto government risk,” Bates says.

A five-year, US dollar-denominated bond from TDIC, rated AA by Standard & Poor’s, yielded 3.95% on September 20, much higher than the 2.23% offered on a sovereign bond from Abu Dhabi. “That’s one of a number of cases where we like quasi-sovereign rather than sovereign risk, because you get a nice kicker above the sovereign curve,” Bates adds.

Though Bates admits many investors would baulk at some of the more exotic jurisdictions he looks at, he insists the yields on offer compensate for the risks in most cases. The risks include corruption and poor financial disclosure. Bates says this necessitates greater due diligence than traditional emerging market investors would be used to, with an emphasis on qualitative analysis.

“The analysis process for frontier markets becomes weighted more towards qualitative than quantitative, where in traditional markets it’s the other way around,” Bates says. “It’s about actually going down there and visiting these countries, and meeting the people involved. We also have a network of people on the ground. It’s important to find out what’s in the local newspapers and what local businesspeople are saying. That’s where you may discover an opportunity, because often you find the risks are being misperceived by the market.”

Vital Statistics

What was your first job? Computer game translator at EA Sports

What was the last thing you listened to on your iPod? Led Zeppelin – Mothership

What would you take a day off from work to do? Take my wife and dog for a long walk in the countryside

What would be your dream job? Lead guitarist in a rock band