Mongolia tops the charts in risky frontier markets

Frontier markets do not often work better for investors than Mongolia has over the last two years. Its stock market clocked up the best returns in the world in 2010 when share prices climbed 121 per cent and it was the second-best performing bourse last year with a rise of 73 per cent.

Aside from its well performing functional stock exchange, Mongolia has a strong freely traded currency and operates a liberal regime for investors. Foreign direct investment is reported to encounter few restrictions.

The potential for realising huge gains has not gone unnoticed by fund managers. Both Singapore-based Khan Investment Management and Hong Kong-based Quam Asset Management launched Mongolia investment funds in the second half of last year.

However, neither has made the bold statement that is implicit in the most recent launch – the FMG Mongolia Fund , unveiled in January. While Khan’s fund ranges across real estate, private equity and bonds and Quam’s fund bases its investments on the Silk Road index that includes overseas listed companies with exposure to Mongolia, FMG is obstinately investing only in stocks listed on the Mongolian Stock Exchange, which has a tiny market capitalisation of about $1.5bn.

“Any risk you can dream of, or you’ve heard of, is probably here,” says Johan Kahm, founder of FMG, about his new fund launch.

The stock market trades for two hours a day, five days a week, but Mr Kahm says: “It’s one of these things where you can acquire shares more or less by appointment.” Although there is an electronic board with quoted prices, Mr Kahm says the quotes are meaningless because there is no volume.

Instead, he says, FMG will receive a phone call from a broker and decide whether to buy or sell, having independently made a decision about what a fair price ought to be.

While FMG, an emerging market specialist, is a multi-manager and started its existence managing funds of hedge funds, Mr Kahm says there is no advantage in operating through other managers or funds in frontier markets such as Mongolia. Instead, he says, FMG sat down with some local people and went through the published information about the largest companies on the Mongolian stock exchange and chose just 10 companies for its initial investment. “We’ll do more as things grow,” he says.

At the moment 40 per cent of the fund’s holdings are in coal mining and 60 per cent in the non-metals industry. Surprisingly, its largest holding is in a vodka and beer producer and it is one of only two holdings that Mr Kahm and the FMG team have visited.

“There are some people who think for research you’ve got to go out and kick tyres,” says Mr Kahm. But he has learned from experience that there is little to be gained by this sort of visit. “Either they don’t tell you the truth, or they tell you nothing because they’re not allowed to tell you anything.” Instead, he says, he prefers to read the balance sheets and find out a little bit of history about the company.

Mongolia itself has dazzling prospects. Its tiny population of less than 3m is sitting on huge deposits of coal, copper, uranium and iron. It shares a border with its largest customer, China. But Mr Khan says if China slows significantly, resources can still be sold to Russia, which Mongolia also borders, or Japan and Korea.
And improvements are also expected at the Mongolia Stock Exchange, which has hired the London Stock Exchange to help bring it up to international standards.

The FMG Mongolia fund has so far raised $500,000 on top of Mr Kahn’s personal commitment of the same amount. FMG is aiming to raise $25m, mainly from wealthy private investors from whom he demands a minimum investment of $10,000. Fees are set at the typical 2 and 20 (2 per cent of assets and 20 per cent of profits), dropping to 1.5 and 10 for investments over $100,000.

Investors should not expect a hard sell, however. “I don’t want anyone to invest unless they can afford to lose it, because this is high risk,” says Mr Kahm. However, he points to FMG’s success as an early mover in the Russia market. “The key was you had the guts to do it. That’s when the money was made,” he says.

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