Similarly to other frontier markets, the Maltese equity market is considered to have attractive economic fundamentals underpinned by higher historic GDP growth rates than its counterparts, together with a strong fiscal position and a lower volatility than what is generally perceived. Moreover, the Maltese market tends to offer diversification opportunities to a global portfolio.
One of the main aspects that an investor should look into when investing in the local equity market is to achieve medium- to long-term growth. In the last five years, the local equity market has offered a total gain of more than 17 per cent against the loss of approximately six per cent that was registered by the MSCI Europe Index (the reference index used throughout this article), which is an index measuring the performance of the European developed markets.
When one extends this analysis to a 10-year period, the local equity market would provide for a total return performance of over 50 per cent, which approximates to an annualised performance of over 4.3 per cent.
More recently, the COVID-19 pandemic left its mark over global markets and plummeted the European Developed Market Index to levels last seen in 2016. In this context, the local equity market has outperformed the European market by more than 11 per cent.
This leads me to highlight the low correlation that exists between the local equity market and other developed markets, and this is emphasised by the fact that although the local equity market had a negative performance during this turbulent period, the magnitude of the impact was much less adverse. During the volatile period major indices nosedived in the region of 25 per cent to 30 per cent region, whereas the local equity market fell by circa 17 per cent.
Statistically, the correlation between the local equity market and the European developed market is less than 0.5 on a 10-year period. In reality, a correlation coefficient less than 0.5 signifies a very weak relationship between the two markets. By investing in the locally equity market, one gets access to a totally different growth profile with very different market dynamics. It also provides a different type of investment environment compared to more developed and liquid markets.
Due to these characteristics, when diversifying in the local equity market, one can further balance the risk and reward profile of the overall portfolio. In addition, under normal circumstances, the local equity market offers a good dividend yield as local investors tend to be more oriented towards dividend paying securities. Therefore a greater potential for yield, even by stock picking certain equities, makes an excellent investment opportunity for those on the lookout for dividend stocks.
Nonetheless, during unprecedented times, companies can take a decision to either cancel, suspend or delay the dividend payments. We are presently going through this situation as many companies are curtailing their dividends to protect cash flows ahead of the uncertainty brought about by the pandemic.
Under normal circumstances, the local equity market offers a good dividend yield as local investors tend to be more oriented towards dividend paying securities
On a similar trend, if we look at the local corporate bond market, which can be considered to be a non-investment grade bond market due to the fact that bonds are not rated by a rating agency, it was also relatively resilient during this tough period. For instance, we have experienced sharp double-digit drops in global high yield to almost 16 per cent year-to-date as at end of March 2020, as opposed to the local corporate bond market, which fell by 3.6 per cent during the same period. At the same time, there were different bonds which reacted differently and those bonds which are exposed to sectors like tourism and retail were punished the most.
Moreover, from a credit perspective, bonds which have lower leverage and higher interest cover are the less impacted during this COVID-19 period.
Also, we have seen more visibility during this period where companies issued announcements to guide the market in terms of how their revenues are going to be impacted, any cost-cutting exercises that they may have or will be implemented and, to a certain extent, the assurance of some companies to pay their debt obligations was key.
One major risk in frontier markets is usually the lack of liquidity itself. This is also the case for the domestic Maltese market where investors usually find it difficult to execute trades rapidly in specific securities. Mutual funds investing in local markets can alleviate some of the liquidity pains faced by investors trying to navigate through direct trading as fund managers tend to be more active in the more liquid part of the market while holding an element of cash and liquidity buffer to mitigate against such risk.
Moreover, some assets are not accessible to retail investors, however, since funds pool the investment of a large number of investors, investors will be able to participate in the performance of such companies.
Also, as frontier markets securities tend to be more thinly traded, insufficient liquidity may result in wider bid-ask spreads which may give rise to illiquidity and, possibly, a concern for short-term traders. Collective investment schemes are structured as open-ended funds which allow investors to exit at the prevailing net asset value per share.
The writer and the company have obtained the information contained in this document from sources they believe to be reliable but they have not independently verified the information contained herein and therefore its accuracy cannot be guaranteed. The writer and the company make no guarantees, representations or warranties and accept no responsibility or liability as to the accuracy or completeness of the information contained in this document.
Clayton Scicluna is portofolio manager at BOV Asset Management Ltd