27th August 2015
With China imploding, Latin America in heavy decline and Russia seemingly on a path of global exclusion, the emerging market growth of yesterday is looking increasingly unattractive writes Chelsea Financial Services managing director and Mindful Money columnist Darius McDermott.
So where could emerging market managers turn to now, what is the next generation of countries to move into the investment spotlight? In the first of a new series, we look at the next generation of emerging markets and see what opportunities lie ahead for investors hoping to get to the frontier of the investment world.
After landmark talks, it looks as though Iran will have its sanctions lifted after making concessions and promises on its nuclear programme, which will open the economy back up to the world’s investors.
Iran has had sanctions enforced since the revolution of 1979, where the US backed Shah was overthrown by an Islamic Republic. These were enhanced further through the years as an Iranian nuclear programme expanded and relations with the U.S. declined markedly.
However, the elections in 2013 brought in President Hassan Rouhani, replacing the hardline conservative Ahmadinejad. This brought about a change to a more liberal, open-minded government wanting to reconnect with the world. As such, in July this year, an agreement was made to lift sanctions. If this does go through, the country is likely to see considerable foreign investment which is expected to considerably boost the economy.
One of the most obvious areas of strength in Iran is the oil and gas reserves. About 9% of all oil reserves in the world are in Iran, making it the second largest reserve behind Russia. Having already delivered pipelines to neighbours such as Pakistan, Iraq and Oman, there are now plans a foot to move into the European market and compete with Russia. However, with global supply outstripping demand at present, gas and oil prices have fallen dramatically, therefore external investment for this project will be difficult to come by.
The strong growth sectors of the Iranian economy are manufacturing and mining – currently at 6.7% and 9.8% respectively – with Iran’s industry minister also wanting to prioritise these areas. Two specific areas he has specified are car production, understandable in a country of 70m people, but only making 1m cars, and intriguingly, a $20bn commitment to mining exploration, a fairly contrarian step considering the falling price of commodities, but perhaps a sign of commitment to developing the infrastructure of this industry for future growth.
Iran’s demographics are also very supportive of growth. Over half the population are under 30, there are high levels of youth literacy and it has world-leading academic research growth. Though these areas aren’t an immediate focus, the advantages of having a highly literate, youthful population has aided the country into becoming just the 9th in creating a domestic space programme. They are also one of the world leaders in nanotechnology and biomedical science, demonstrating the intelligence potential Iran could have.
When you couple all of this to Tehran having a well developed stock exchange, with a total market cap of over $170bn and nearly 340 companies, it can be obvious to see why investors are making moves early to try and secure the best deals. Industry experts believe the economy could make up to 40% of the frontier market benchmark.
So how can investors get involved? Significant regulations around sanctions for most foreign investors has made direct investment very difficult at present, but many emerging market funds are assessing ways to gain some exposure. Charlemagne Capital for example, have announced they intend to offer a fund in the near future, and Michael Levy of the Barings Frontier Markets fund has also proclaimed his excitement about the opportunities available.
A good starting point may be to find funds with exposure to firms operating in the region, who are likely to see an upturn in business with Iran coming to the markets. Both the aforementioned Barings Frontier Markets fund, and the Templeton Frontier Markets have over 30% exposure to the Middle East & North Africa (MENA) sector*, much of which is in the financial sector, one of the largest sufferers of the sanctions programme. This could offer some exposure to the potential uplift, without having to wait for direct investment.
However, while there is potential for future opportunities, there are still hurdles to overcome first. As with all emerging economies, there is inherent risk, especially as politics can change so quickly in these regions.
The primary aspect is that the deal is not yet certain. It has been announced, but needs concessions on both sides to happen, and even then, won’t go through until 2016 at the earliest. While some may see this as a good time to analyse opportunities without having to commit to an investment, it still creates uncertainty and could feasibly be stopped by the Republicans in the US Congress.
Culturally too, Iran has some issues. Despite the youthful demographics, there is still a considerable proportion of the population whose memories of the international isolation are still fresh, and such a quick change may meet resistance.
There is also the language barrier to consider. The vast majority of company reports are in Persian, the native language, which could cause difficulty when trying to analyse companies. Furthermore, the currency is the Rial, but prices are often listed in multiples of ten, known as the toman, making a sharp eye and division skills a useful quality.
Overall though, Iran could be a fascinating opportunity. It may be too early now for most investors, but it’s certainly worth putting on the radar for those prepared to take on the higher risk, but hoping to capitalise on the first mover advantage. This situation is almost unique, as the economy has been ‘emerging’, both in terms of infrastructure and intellectually for years, and as such, has the potential to make a new frontier in investing.