Even institutional investors struggle to gain direct access to individual stocks in frontier markets in places such as Africa, so private investors should focus instead on using funds to build some exposure if they're happy with the risks (see below).
The frontiers fund universe is small (but growing) and comprises two main camps, namely index-tracking products from the big investment banks or actively managed niche funds run by managers such as Dr Feriani and Mr Mobius.
Deutsche Bank's db x-trackers unit offers an exchange-traded fund (ETF) that tracks the S&P variant of the frontiers universe: S&P SELECT FRONTIER ETF (ticker XSFR).
The Royal Bank of Scotland offers access to the MSCI index through its Frontiers Market Tracker RB18. Both these index-tracking products are much cheaper in terms of management and dealing costs than their actively managed peers, but unsurprisingly most fund managers think that their extra active management expertise is worth the extra cost. "Passive products, such as ETFs, are not available for certain markets, but more importantly, frontier market indices have limited scope and are not fully representative of the trends driving economic growth," says Mr Blachut. "We believe that the most interesting investment prospects in frontier markets can be found outside of the MSCI indices, and these are the companies that enable us to participate in the underlying economies."
IMF global growth forecasts | |||
|---|---|---|---|
| IMF Global Growth Forecasts (%) | 2010 | 2011 | 2012 |
| G7 | 2.3 | 2.3 | 2.3 |
| Emerging and developing economies | 6.3 | 6.5 | 6.6 |
| Developing Asia | 8.7 | 8.7 | 8.6 |
| Central and Eastern Europe | 2.8 | 3.4 | 4 |
| Sub Saharan Africa | 4.7 | 5.9 | 5.5 |
| Middle East and North Africa | 4.5 | 4.8 | 4.8 |
| Western hemisphere | 4 | 4 | 4.3 |
Investors looking to buy into actively managed funds are probably best off focusing on listed funds that boast a diversified basket of underlying stocks. Mr Mobius's Templeton Emerging Markets investment trust has substantial exposure to individual companies within the frontier markets space. Dr Feriani's Advance group offers the only listed fund that's entirely dedicated to frontier markets, using a fund-of-funds approach – Advance Frontier Markets Fund (AFMF) currently trades at a 10-15 per cent discount to its net asset value.
| Risk warnings |
|---|
Building a diversified basket of frontier markets with low correlation between each other (and wider markets) might be a good idea, but it shouldn’t blind investors to the obvious risks of investing in small, less liquid markets. And the same thing that's currently making frontier markets cheap – the lack of 'hot money' – can also be a big risk factor. When investors in the West decide they want out, they sell their frontier markets funds. The managers of open-ended vehicles in particular are then left needing to raise cash to finance redemptions. So they sell shares – usually starting with the biggest and most liquid. That causes frontier-market stock indices to plummet, as the heaviest-weighted companies are being clobbered. What could trigger such a rush for the exits? "For investors who take a diversified approach to frontier markets, we believe the risks are mostly external and more related to developed markets," says Dr Feriani. "For example a second leg down in the financial systems of the West or a return to recession in the West would probably limit inflows to frontier markets and would impact performance even if the actual impact on companies operating there was more muted. A collapse in commodity prices would also affect the governments' fiscal positions in a number of frontier markets." There's also a healthy dollop of political risk, although this is mostly country-specific. And emerging and frontier markets don't have a monopoly on political risk, either; it's not that long ago that governments in Europe banned short-selling, and they are still contemplating drastic reforms of banking. |
