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1Elm Street Group at Morgan Stanley

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2The Michael Shearin Group Morgan Stanley: Managed currencies attract money to frontier markets

Frontier markets with managed exchange rates from Dubai to Vietnam are luring equity investors fleeing the currency turmoil in larger developing economies.

Funds that buy shares in the less-developed nations posted inflows of $407 million in the first six weeks of 2014, while $21 billion was pulled from emerging markets, EPFR Global data show. A gain of about 3 percent in the MSCI Frontier Market Index this year pushed stocks to a 2008 high Feb. 19, even as slower China growth and the Federal Reserve’s plan to trim bond buying weighed on developing and developed-nation gauges.

Benchmark stock indexes in the United Arab Emirates, Qatar and Vietnam, whose central banks control local currencies, are among the 10 best performers this year within global equity gauges tracked by Bloomberg. While investors dump emerging- market currencies including the Turkish lira, Hungary’s forint and Brazil’s real, bourses in those nations languished with the world’s worst performers in 2014.

“Half of MSCI frontier have effectively fixed exchange rates to the dollar,” Charles Robertson, London-based global chief economist at Renaissance Capital, said by e-mail on Feb. 17. Strong economic growth also heightened interest, he said.

A currency rout triggered by political instability from Ukraine to Turkey and the fallout from the Fed’s tapering plan cut into equity returns. A Bloomberg gauge tracking 20 developing-nation currencies and the MSCI Emerging Markets Index are down 1.7 percent and 4.3 percent respectively in 2014.

Equities in Qatar, the world’s largest exporter of liquefied natural gas, have rallied 14 percent this year, while Abu Dhabi’s gauge has gained 15 percent and Dubai’s benchmark posted returns of 24 percent, the most among 50 of the world’s largest equity markets. The Persian Gulf countries keep their currencies pegged to the dollar because earnings from energy exports are denominated in the U.S. currency.

Shares in Dubai are benefiting from an economic recovery as the regional business hub gears up to host the World Expo in 2020 with $8 billion of infrastructure spending. The event, which traces its roots to London’s Great Exhibition of 1851, gave Paris its Eiffel Tower in 1889 and drew 73 million visitors to Shanghai in 2010. Qatar’s government forecasts a current- account surplus of about 23 percent of gross domestic product this year and growth of 4.6 percent.

Persian Gulf “markets enjoy a current account surplus and have never relied on global financing,” Rami Sidani, the Dubai- based head of Middle East and North Africa investments at Schroder Investment Management Ltd., said by e-mail on Feb. 18. “Their dollar-based economies mean that they do not present any currency risk.”

Fixed exchange rates have also helped spur a rally in Tunisian and Vietnamese shares this year, Sidani said.

Managed exchange rates in countries with less financial prowess to defend them have posed risks to the dollar- denominated returns of investors as countries from Argentina to Kazakhstan scale back support for their currencies.

Kazakhstan, whose biggest trading partner is Russia, devalued the tenge by the most since 2009 on Feb. 11, citing pressure on its currency from a weaker ruble. The nation’s benchmark, up 18 percent in 2014, dropped the most in a month the next day.

Nigeria’s benchmark stock index has fallen 7.3 percent this year as the central bank comes under pressure to tap into reserves and defend the naira. The currency weakened to a record low versus the dollar today after the government suspended central bank Governor Lamido Sanusi.

Pegged exchange-rates may “get overvalued relative to peers, thereby undermining the country’s competitiveness,” Benoit Anne, head of emerging-market research at Societe Generale in London, said by e-mail on Feb. 18.

Turkish policy makers were forced to raise interest rates in a surprise meeting late January to halt a selloff that drove the lira to record lows following a government corruption probe. Russia this week canceled its bond auctions on concern a wealth fund top-up plan will blunt central bank support for the ruble, which also sank to a record.

The International Monetary Fund said Feb. 19 risks of prolonged turmoil in developing nations are threatening the world’s economic prospects.

The U.A.E. last year had a surplus of about 15 percent of GDP, beating forecasts. Vietnam’s economy grew 5.42 percent in 2013, faster than a 5.25 percent pace in the previous year, as the nation boosted exports.

“Frontier-market countries in general are still in the sweet spot of their economic cycles versus a number of emerging markets,” Andrew Brudenell, a London-based money manager at HSBC Global Asset Management, which oversees about $550 million in frontier markets, said by e-mail Feb. 18.

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