• Reducing exposure to popular Middle Eastern territories
• Tapping Kenyan utilities and Kazakh financials

By Claire Milhench

Niche frontier markets manager Silk Invest is reducing exposure to frothy dollar-denominated Middle Eastern debt in favour of African bond markets, where it sees strong economic growth driving down bond yields.

"I am extremely positive on the outlook for Nigeria and Egypt where the economic fundamentals and prospects are largely mispriced, in our view," said John Bates, manager of the Silk Road Income Fund, which has some $34 million under management.

The fund LP68029775 was up 3.73 percent in the 12 months to end-October according to Lipper data, but slightly lagged funds in the Lipper Global "other" emerging markets bond sector by 1.86 percentage points.

It invests in both sovereign and corporate local currency and dollar-denominated bonds in the Middle East, Africa and the Caspian region, which covers Iran, Kazakhstan, Russia, Turkmenistan and Azerbaijan.

Bates has recently bought into the local Nigerian government bond market, whilst in Egypt he cited automotive supplier GB Auto, which has issued a local currency bond with a 12 percent coupon, as having performed well.

"These are nascent markets that are off-benchmark, so there's a premium for the illiquidity and political risk," said Daniel Broby, chief investment officer of Silk Invest.

"We think you can diversify away that political risk and capture the long-term industrialisation of these countries."

Positive fundamentals such as growing productivity and reserves and reduced indebtedness are expected to result in yield compression and gains for bond investors.

Bates said he was currently trying to avoid investing in markets being driven by global yield dynamics, such as the more established emerging markets.

He recently shifted out of some U.S. dollar-denominated holdings in the Middle East which he believes have become over-heated as investors chase yield in higher risk markets.

He has moved into less well-trodden frontier markets such as Morocco where the risk of a sell-off is lower.

QUALITY CORPORATES

Despite the frontier focus, the fund's holdings have an average rating of BB+, because in frontier markets it is only the higher quality companies that can issue bonds globally. "These come at extremely attractive valuations," said Broby.

The fund currently holds Kenya Electricity Generating Company, which issued a 25 billion Kenyan shilling ($310.6 million) 12.5 percent bond at the end of 2009. This has gained about 15 percent in cash price terms.

Other corporate holdings include financials, real estate, transport and mining.

In the Caspian region, Broby said there were some interesting opportunities in Kazakh financials. "Since the restructuring of the Kazakh banking sector there have been pockets of value," agreed Bates.

"Kazkommertsbank KKGB.KZ, long viewed as a top tier bank, has nine eurobonds outstanding, all of which are currently trading at sub-par levels."

Source: Reuters

(Editing by Sinead Cruise and David Cowell)