In recent years frontier equity markets have emerged as a $1 trillion asset class, offering low correlation to developed world equities at the adventurous outer-reaches of emerging-market investing. The potential to generate uncorrelated beta and alpha has attracted many of the world’s largest fund managers. But the downside is under-developed market structure.
Much of that $1 trillion in market cap of stocks theoretically available for investment is illiquid; accessing it often requires foreign asset managers that may have strong coverage from the world’s largest banks to display their interest through regional banks and local brokers, raising the danger of information leakage moving prices against them as each new party is engaged along the road to seeking the other side of a trade.
Yan Gloukhovski, previously head of sales and salestrading for US- and UK-based clients at Russia’s Alfa Bank, has founded Zeroflows, a new technology platform to bring to frontier equity markets the same kind of pre-trade information discovery that developed market banks are now applying to trading in illiquid corporate bonds.
Zeroflows, launched last July, is already working with 19 different fund managers, in aggregate responsible for $35 billion of assets under management and dedicated to frontier equity markets and to small and mid-cap stocks in larger emerging equity markets.
Some of these are sizeable funds, but they face testing conditions.
“If you have a portfolio manager running a $300 million fund out of Boston, looking to invest from Botswana to Bangladesh, your trading desk is going to be severely constrained by the small number of counterparties it can deal with,” Gloukhovski says. “It probably can’t trade with 50 separate brokerages, one in each market, and instead it may have just a handful of intermediaries that in turn seek trades through other local intermediaries. It’s not just the obvious risk of information leakage hurting transaction costs when the portfolio manager wants to buy or sell that $2 million block in Sri Lanka where average daily volume is around $6 million. In fact, the bigger worry is opportunity costs from failing ever to find blocks of shares to buy or sell even when the other side of the trade might be available.”
Zeroflows did not want to add to the number of middlemen by acting as a broker, but instead to deliver to investors a safe and agnostic venue to search for information that might lead to trades.
Gloukhovski says: “We want to be an information network that lets the buy side see where liquidity on the other side might be available, and they can then go and transact against it through their existing brokers.”
The aim is to encourage a range of asset managers to post anonymous indications of interest. Gloukhovski has devoted his energies to attracting a roughly even split between marquee-name global asset managers and local asset managers, which might be small in absolute size but are often leaders in their own local markets.
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“We want asset managers to input the side of the trade they are on, just the minimal information needed to locate the potential other side of the trade," says Gloukhovski. "Finding the other side remains their biggest issue. However, once the hurdle of establishing an actionable party with intent to trade is crossed, price and size negotiations go a lot smoother. Counterparties can negotiate via their brokers as to price and size once they find the other side on our platform.”
But this is not purely a buy-side-to-buy-side portal. In frontier markets, a lot of potential stock market liquidity lies in the hands of ultra-high net-worth individuals, family offices and other corporates. Zeroflows is working on ways to broaden participation on its network to these entities by bringing local brokers that might have lines to these owners onto the platform to display indications of interest. Having signed up its first brokers in Kenya and Nigeria, Zeroflows also has commitments from firms in Sri Lanka and Bangladesh, as well as larger emerging markets such as Russia and India.
Gloukhovski says: “For asset managers that want a bird's eye view of available liquidity this offers the chance to see indications from brokers which might have a lot of local information but which global asset managers or their regional banks may not normally hear from.”
Zeroflows offers a paid subscription model rather like software as a service business. Gloukhovski can’t even say how much business has been conducted by parties meeting via the platform because such transactions are negotiated separately offline.
His is not a commission-driven business. But he sees a sizeable market opportunity.
Alongside the $1 trillion market cap of frontier equity markets stands another $8.5 trillion of market cap in small and medium-sized stocks in the bigger emerging markets. He suggests there may be as many as 4,000 funds across the world investing in these markets and at least as many local brokerages.
“We’re seeing that asset managers are trying to control counterparty risks, as well as costs and resources committed across markets, which makes it even more difficult to open lines with multitudes of local brokers. Our view is that, even if they cannot meet the cost and capacity of opening direct trading lines, asset managers should at least be able to see these local brokers’ indications of interest to trade, even if asset managers then have to sub-contract executing acting against that liquidity.”
The need for the service is suggested in the speed with which Zeroflows expanded from 10 asset managers at launch last summer to 19 by this March. Brokers are signing up too.
Gloukhovski says: “Local brokerages have been very receptive to the product. Their first question is: ‘How much do we have to pay to get on your platform?’ When I tell them initial cost is free, there is rarely a hesitation. The platform allows them to heighten their visibility in front of global asset managers without commitment of extra resources. They welcome the opportunity to share information about their inventory directly with international buy side, who are under strain to open and maintain large amounts of counterparty lines.”
Could a firm like Zeroflows alter the market in which it operates? It has launched across frontier markets in Asia, Africa and central and eastern Europe and the former CIS.
Gloukhovski says: “A lot of asset managers will tell me that when portfolio managers consider investing in a frontier market stock, their standard questions run in a set order: Is the management of the company good and trustworthy? What is the liquidity in the stock? How do its financials measure up? If funds won’t even do due diligence on stocks where the liquidity is poor, then this platform really could expand the universe of investors in this asset class.”