Sri Lanka may have seen an end to its 26-year civil war in 2009, but it remains an archetypal frontier market, with low market liquidity and a government that many see as questionable.
That’s not to mention the exodus that has hit emerging markets in recent months as a result of the US Federal Reserve’s planned halt to quantitative easing.
A recent delegation of senior officials has been on the road recently to promote the benefits of investing in the country, but it may have its work cut out.
Foreign net inflows into domestic equities totalled $300 million in 2012, compared with $130.1 million in the year to September 9, according to Bloomberg.
Yet the opportunities are hard to ignore, and long-term investors who can stomach some near-term volatility are advised to take a closer look at Sri Lanka, said representatives for the country earlier this week.
Four years on from the civil war, the country is effectively a clean slate, argues Krishan Balendra, chairman of the Colombo Stock Exchange (CSE), the main stock exchange in Sri Lanka, noting the main appeal for investors now is its growth story.
(He was accompanied to Hong Kong by representatives from the country’s central bank and its Securities and Exchange Commission (SEC).)
Last year, the domestic economy grew by 6.4% with GDP growth forecast to hit 7.5% for 2013. In addition, average per capita annual income is $3,000, and is forecast to grow to $4,000 by 2016. (The 2012 figures for Indonesia and Thailand were $3,600 and $5,500, respectively.)
“Every frontier market has its niche, whether that may be textiles in Bangladesh or natural resources in Mongolia. For Sri Lanka, it is tourism,” says Thomas Hugger, CEO of frontier-markets asset manager Asia Frontier Capital. “This is a sector I am positive on, although it is looking expensive.”
The hotel and travels industry in Sri Lanka were trading at price-to-earnings (p/e) ratios of close to 40x in June, and well above the overall 10x p/e average in 2010 for the rest of the market.
Hugger aims to increase the firm’s $4 million AFC Asia Frontier Fund’s holdings in Sri Lankan companies. The strategy is up 10.29% from January to August 30.
There has been investment into the country’s tourism sector – in 2010, Hong Kong-based Shangri-La Hotel and Resorts announced a hotel development complex estimated to be worth $500 million. Doors will open in 2014.
But the weakening Sri Lankan rupee is a cause for concern – it has fallen 4% year-to-date to 132.25 to the dollar, and some anticipate further depreciation as the greenback is expected to strengthen.
Another issue is the lack of liquidity on the exchange, which has a market capitalisation of $18 billion. Companies within the index are only required to list 5% of their shares. Such a low free-float makes doing block trades and exiting positions difficult.
One proposal the SEC made in May is to increase the free-float to 10%, while another is to encourage more companies to list. Balendra says the exchange is meeting several profitable state-owned enterprises, but declined to name them.
Ultimately, the most difficult job for Sri Lanka promoters of the country is to convince investors to buy into a country that has spent most of the past three decades fighting.
“I was working in a private bank investing for private clients [during the civil war], and some were worried over the issue of investing in a war zone,” says Hugger. “But when you invest in a war-zone market, sooner or later it will end. It is just how long you can [handle] the noise.”
There are also ethical concerns about investing in a country when its leaders “are not looking after human rights” issues, he adds.
The promotional roadshow has already been to Mumbai and Dubai, will move onto Singapore later this month and may also take in New York and London.