Merrill Lynch Global Research has introduced a new frontier equity index, which is designed to identify the largest and most liquid stocks in frontier markets.
A “frontier market” is a developing economy with an undeveloped equity market.
The Merrill Lynch Frontier Index is composed of 50 stocks in the frontier markets of Europe, the Middle East, Africa and Asia, reflecting 17 countries, including the United Arab Emirates (UAE), Kuwait, Nigeria, Morocco, Pakistan, Kazakhstan, Vietnam and Cyprus.
“The ultimate goal for many investors in 2008 is to find assets which are not closely linked to the fortunes of Wall Street. Frontier market returns are far less correlated to the performance of the S&P 500 than emerging and developed equity markets,” says Michael Hartnett, chief global emerging markets equity strategist, Merrill Lynch.
In frontier markets, during the period of February 2000 to December 2007, the monthly correlation of returns for the S&P 500 was 32%, compared to 73% for emerging markets and 96% for developed markets.
Stocks listed in the Middle East make up 50% of the new index, followed by a 22.6% share for Asia, 14.1% for Europe and 13.3% for Africa. The top three countries represented in the index are the UAE, Kuwait and Pakistan. Banks dominate the index, followed by financial services companies and oil and gas firms.
The hallmarks of frontier markets include under-capitalisation and weaker regulatory frameworks, as well as lower levels of foreign ownership, borrowing and transparency. Frontier markets have outperformed both emerging and developed equity markets since January 2000, with 20% annualised returns, compared to 12% for emerging markets and 1% for developed markets. While market risk is high in frontier markets, they also have strong economic growth potential.
To be included in the index, stocks must have a market capitalisation of at least $500 million, a three-month average daily turnover of at least $750,000 and a foreign ownership limit above 15%. The composition of the index will be reviewed twice a year, in February and August.
“Frontier equity markets offer investors a unique opportunity to diversify their portfolio as well as to benefit from what we believe will be the markets’ significant long-term growth potential. Merrill Lynch is determined to offer both its institutional and individual clients the greatest range of equity products linked to frontier equity markets, including this index,” says Henry Hall, head of Global Emerging Market Equity Linked Sales, Structuring and Financing, EMEA.