Wednesday 9 January 2013

Frontier Markets are the new BRICs

“In essence, [frontier markets] represent what emerging market countries like Brazil, Russia, India and China were 20 years ago.” (Mark Mobius)

Pre-emerging markets are countries that have stock markets and form a subset of all Emerging Markets. They are often thought of as poor, under-developed countries but the reality is quite different. The less-established ‘Frontier Markets’ incorporate 25 countries across the globe, spanning Africa, the Gulf States, South America, Europe and Asia. These markets are typically pursued by investors seeking high, long term return and low correlations with more developed markets. As with the BRIC countries, these frontier markets are expected to continue to grow faster than the developed economies in 2013.

The 'African Lion'

Sub Saharan Africa economies are seeing rapid expansion with a growing entrepreneurial middle class, increasing political and economical stability, as well as a large resource base. While their growth and circumstances differ from so-called Asian Tiger economies of the past, taking into account the level of growth and resource wealth, perhaps these ‘African Lion’ economies will be another future success story. Nigeria, Kenya and Botswana are just a few of the African frontier markets to keep an eye on in 2013 and which should, to a degree, have a knock on affect on the rest of the continent. Botswana, for example, has relative control over its resources particularly its diamonds, while Nigeria and Kenya have an easier path to development due to their direct access to the sea and thus the ability to trade their resources without having to rely on a neighbour.

At the other end of the frontier market scale are the Gulf States. They are very wealthy due to their oil reserves but are still considered frontier markets because of heavy restrictions on foreign investments. If these are eased, the risks of investing in frontier markets like Saudi Arabia early could result in a large upside. As Allan Conway, Head of Emerging Market Equities at Schroders notes, countries like this will in fact, “leapfrog straight from a frontier market to a developed one.” Savvy investors will know that to benefit from the potential upside, they will certainly need to invest in the Gulf States before this leapfrogging occurs.

“The rapid advance of many frontier market countries toward emerging market status gives their investors economic opportunity for three main reasons: growth potential, valuations and correlation.”
(Mark Mobius)

Besides Gulf States, frontier markets also appear in other surprising areas, such as Europe. Croatia was outlined by Bloomberg as number 12 on its top 14 most exciting frontier markets of 2012. “Its stock market is cheap and inflation is low, however so is growth and more importantly their currency is highly volatile.” It is clear that there is no geographically binding factor compared with the Asian Tigers, but like the BRIC countries, perhaps the odds are in their favour now or in the not too distant future.

Risk vs. Reward

There are obvious reasons to be cautious about investing in frontier markets – by their very nature they are characterised by instability and poor liquidity. Pension funds for example, due to their risk adverse nature, would be understandably wary when it comes to investing in economically and politically fragile countries. However this has not stopped other investors recognising the opportunities for growth. Mark Mobius, Executive Chairman of Templeton Emerging Markets Group commented on his Emerging Markets blog post that “despite the psychology of risk aversion that has seized financial markets since the euro zone crisis erupted, money has been pouring not only into emerging equity markets but even into the newer and smaller frontier markets.” It is clear that for some, these risks are worth taking in order to benefit from the potential returns on offer.

Predictions are very hard to make, especially in the case of Africa when one must consider its hugely varied demographic withheld in colonial boundaries and its recent history particularly surrounding the reliance on aid and rise of dictators in a number of countries. However in my opinion, the risks – when carefully assessed – are worth taking in terms of the potential gains from investing in frontier markets, as was the case with investing in the BRIC economies a few decades ago. With countries like Qatar possibly to soon make the leap from frontier to developed market and the predicted growth of Sub Saharan Africa, frontier markets will attract significant investment. This will hopefully improve stability, further reducing risk. However in time the development of these markets may result in a decline in gains, so the prime time to act and invest may be with us sooner than we think.


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