The Big Theme
Investing in frontier markets could feel like feeding your cash to the lions. Tormented by corporate corruption, political unrest and illiquidity, these nations are about the riskiest regions you can buy into. But if you're armed with a long-term time horizon or a generous stack of cash, being daring enough to dabble now could pay off in the long run.
If you're looking to take the ultimate risk for the ultimate reward, forget Brazil, Russia, India and China (the BRICs), where it may be too late to join the party. But a £1,000 investment in frontier markets today could burgeon to £5,000 in 10 years estimates Tim Cockerill, head of collective investment research at Rowan Dartington. This is owing to the staggering growth potential of the underdeveloped sovereign markets incorporated in these portfolios. Frontier market countries are economies comparable to what today's emerging markets looked like 15 years ago. Teetering on the edge of becoming major global economic players, they include Bangladesh, Kazakhstan, Nigeria and the United Arab Emirates.
It's fair to say these are countries better known for their struggles than their strengths. But one thing they have on their side which other nations don't is demographics. Populations are possibly the only dead cert when it comes to frontier markets. Home to more than 30 per cent of the world's population, these countries have young and rapidly increasing populations. This means strong workforces, high productivity and a rapidly developing consumer class. Bloated elderly communities sapping the life out of public finances is an alien concept in these young-blooded nations, with the average age in Nigeria currently 17.9, less than half the UK average age of 40.2 years. Of course, there's a lot that can go wrong, but this is a permutation that reeks of economic expansion that will be enhanced, not hindered by demography.
Out of Africa
Fund managers are salivating over African countries in particular. In a recent review by the International Monetary Fund (IMF), it was the only region to have its outlook revised up for 2013 - owing to thriving oil and metal industries as well as tremendous agricultural potential. And 'home grown' financial services and telecoms companies continue to satisfy the inexorable appetite of the growing consumer class who are 'under-banked' and starting to guzzle mobile phones at a rate of knots. Vast numbers of companies are severely undervalued - presenting a golden window of opportunity for fund managers to snap up bargain stocks.
Described as the gem of Sub-Saharan Africa, Nigeria is the darling of the frontier markets. Boasting 7-8 per cent annual gross domestic product (GDP) growth, it's larger-than-most £260bn economy means investments have an extra level of liquidity. Thriving banking, cement, telecoms and consumer staples sectors aside, brewing is a mega industry in Nigeria, with beer sales growing at 1.3 times GDP and currently Guinness's biggest market. Andrew Brudenell, manager of the HSBC GIF Frontier Markets fund, said: "Nigeria is our favourite market in Sub-Saharan Africa and is an area we have been adding to. It has cheap valuations and a number of advantageous macroeconomic factors, resulting in what we believe is a positive outlook. The telecommunications sector there, seen in companies for example such as Safaricom, has long-term investment potential given its ties to mobile banking, a rapidly growing sector."
Egypt is another favourite among analysts. Silk Investments, which invests in frontier markets, points out that its stock market has returned almost 60 per cent so far this year, with investors reassured that the political situation there is now much more stable following last year's Arab Spring.
But not all frontier markets boast such sparkling prospects. Eastern Europe looks much rockier - having suffered as a result of being lumped as victims of Europe's troubles along with peripheral Europe, according to Sam Vecht, manager of the BlackRock frontier markets investment trust. The share price of Halyk Bank of Kazakhstan has plummeted 60 per cent since 2010, for example.
And some fund managers don't like frontier markets as an investment idea full-stop. Mats Arthursson, senior investment manager at Arbuthnot Latham, says he's only allocated a bare minimum to the region because of the high risks. He says if you are going to invest, you should pick funds that deviate from the index because they tend to avoid the Arab Gulf States, which he argues are inferior investments because, although their equity markets are underdeveloped and often highly restricted, their economies are more developed, meaning they don't "fit" well with other frontier market nations.
Liquidity is a real threat you can't ignore in these frontier economies, either. This is because they're small - and often smaller than you might anticipate. To give you an idea, General Motors has bigger revenue ($135.59bn) than Bangladesh's GDP ($104.92bn) and Microsoft's revenue at $62.48bn, exceeds Croatia's national output which currently stands at $60.59bn. And you should also be on watch for currency risk - and here timing is critical to not falling casualty to losses. Currency risk varies between countries - Nigeria has the least currency risk because the bulk of its export earnings come from oil, demand for which will remain very strong for years to come, according to Tim Cockerill, head of research at Rowan Dartington.
Should I invest?
If you're an older investor with less than £50,000 to invest you'd be "mad" to take the plunge into frontier markets, warn advisers. This is because to have a chance of making a good return you need at least a decade - if not longer - of investment time ahead of you. But for young investors starting up a pension fund or long-term savings vehicle frontier markets could be one of the best buys around. Mark Dampier, head of research at Hargreaves Lansdown, says: "If you're in your 20s and putting, say, £50 a month into a pension, why not invest it all in frontier markets and see what happens?"
But he's far more prudent when it comes to older investors' exposure, though - recommending a maximum of 2-3 per cent allocation and a 'see what happens' attitude.
Graham Stock, chief strategist at Insparo Asset Management, has 20 per cent of his liquid net worth invested in Insparo's frontier funds and he says some of his colleagues are up to 60 per cent invested. But he says before you invest you need to do proper background checks on managers because "lazy" ones are highly dangerous in a market where an extra level of scrupulousness is needed to decode the opaque and often dishonest reporting of companies' financial credentials.
"Experienced fund managers with backgrounds in a range of other markets should be a prerequisite if you're going to invest," he said. He also warns that doing your own stock-picking could be dangerous - even if you're an experienced investor.
BlackRock Frontiers Investment Trust
Stand-out funds are few and far between in the frontier market investment sphere, but BlackRock's Frontiers Investment Trust is the option most asset managers and advisers are watching with beady eyes. Since its launch in 2010 its performance has been less than impressive, but don't let that put you off if you're set on frontiers as an investment idea.
Weary sounding from a long-haul flight from India, manager Sam Vecht explains why the fund is 25 basis points (plus a 10 per cent performance fee) more expensive than its emerging markets fund, which has a total expense ratio (TER) of 1 per cent.
"We pool a huge amount of resources into checking out the countries and companies we're investing in - everything in our portfolio we've visited in person. We can't always trust what the companies tell us so we have to make absolutely sure we've got the full picture by carrying out the necessary due diligence."
And Mr Vecht also argues frontier markets have less volatility than emerging markets because what happens in other countries is irrelevant to them. "The Frontier Markets index has only moved more than 2 per cent in a day, three times," he claims.
The fund is overweight in financials (28.3 per cent), industrials (13.4 per cent) and consumer staples (13.6 per cent) and is most invested in Nigeria (15.9 per cent), Qatar (12.9 per cent) and United Arab Emirates (10 per cent).
The names of Mr Vecht's top company picks will be alien to most UK investors - but he assures this is no cause for concern as his turnover of stock has been exceptionally low. His favourite buy is Al Mouwasat - Saudi Arabia's top hospital operating company. This is a company that has got rich quick - cashing in on a sudden surge in diabetes among people, many of whom for the first time have the resources to over indulge themselves. Having held it since inception in 2010 when he bought it for a third of the price he'd have paid in an emerging market, it's currently valued at 12 times earnings.
A plus point of investing in this fund is investors have the right to sell shares at NAV in 2015, so you don't have to worry about trading at discounts or premiums. Funds like this do look exciting, but unless you've got at least £50,000 to invest or are a very young investor with a long time horizon ahead of you, the advice is to avoid funds like this.
10 largest equity investments in the BlackRock Frontiers Investment Trust
|Al Mouwasat||Saudi Arabia||Health|
|Commercial Bank Qatar||Qatar||Financial|
|First Bank Nigeria||Nigeria||Financial|
|Qatar Electricity & Water||Qatar||Utility|
|Source: BlackRock as at 30 September 2012|
Frontier market funds
|Group/Investment||Annual Report Net Expense Ratio||1 Year Return (Cumulative)||3 Year Return (Cumulative)||5 Year Return (Cumulative)|
|Fidelity Emerg Eur Middle East & Africa||1.78||11.63||24.84|
|Templeton Frontier Markets A (acc) USD||2.59||14.86||11.85|
|Advance Frontier Markets||n/s||0.41||13||2.19|
|Schroder ISF Frontier Markets Equity A||2.21||12.86|
|Source: Morningstar on 13 Nov 2012|
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