‘Frontier Markets’ Rope In Investors; Off-the-Beaten-Path Arenas Attract Fund Managers Hoping to Ride Their Years of Rapid Growth

‘Frontier Markets’ Rope In Investors

Off-the-Beaten-Path Arenas Attract Fund Managers Hoping to Ride Their Years of Rapid Growth

DAN KEELER

Updated Jan. 31, 2014 8:35 p.m. ET

Some investors are finding refuge from the recent emerging-markets turbulence in an unexpected place: even less-developed economies.

These “frontier markets” are luring money managers who are willing to delve into smaller markets with more difficult trading conditions in order to gain exposure to robust economic growth.

Because they are off the beaten path, frontier markets haven’t been swept up in the selloff that has pummeled emerging markets. Countries such as Nigeria, Pakistan and Bangladesh didn’t see much of the cash that poured into emerging markets after the financial crisis, when low-interest-rate policies in richer economies sent investors in search of better returns in the developing world.

Instead, frontier markets have seen a steady trickle of investment from fund managers hoping to ride years of rapid growth. As a result, these economies have come through relatively unscathed even as investors pull out of larger emerging markets such as Turkey and South Africa.

The MSCI Frontier Market Index is up 1.3% so far this year, compared with a 6.6% decline in the MSCI Emerging Market Index. Last year, frontier markets rose 16%, while emerging markets fell 12%.

Funds that buy frontier stocks in January drew in $244 million through Jan. 29, the most since October, according to EPFR Global. Over the same period, investors yanked $11.6 billion from emerging-market funds.

“Frontier markets are very useful diversifiers because…there are fewer links between frontier markets and the international capital markets,” says Sean Lynch, global investment strategist at Wells Fargo Private Bank, a Wells Fargo & Co. unit that manages $170 billion. “We are attracted by the long-term growth prospects and the consumption-growth story.”

Mr. Lynch recently began recommending that clients own stocks in frontier markets such as Vietnam and Nigeria.

Bets on frontier markets often take longer to pay off. One key factor: Frontier markets are thinly traded, meaning it usually takes longer to get out of a position than it would in emerging or developed markets.

Investors buying stocks in frontier markets say conditions are right for these economies to see years of steady growth. Most have young populations, an important factor in the early rise of emerging markets such as Brazil and China. Shares of consumer-products companies, and banks in particular, should benefit as more people in frontier markets make their way into the middle class, these investors say.

Emerging markets that rely heavily on China have suffered this year. But frontier markets have been less affected by the slowdown in China’s growth rate, partly because growth in domestic consumption is a more important factor in their economies’ expansion.

The International Monetary Fund predicts most large frontier markets will grow at least 5% this year, with Nigeria’s economy forecast to grow by 7.4% and Bangladesh’s by 6%. Some emerging markets are expected to see more moderate expansion, with Brazil growing at 2.5% and Turkey by 3.5%.

“If the emerging-market selloff deepens, there will be contagion, but over the past few years we’ve seen that correlation dispersing,” says Pradipta Chakrabortty, portfolio manager of Harding Loevner’s $335 million frontier emerging-markets fund, which is up 2.5% since the beginning of 2014. “We see a positive outlook for frontier markets for the next three years.”

To be sure, some investors say frontier economies could succumb to the turmoil now engulfing emerging markets. Pakistan’s stock market fell last Monday, at the start of the latest emerging-market selloff, though the country’s KSE 100 index is still up 5.3% this year.

“I wouldn’t be aggressively buying until a major selloff occurs,” says Don Scott, managing director of Global Frontiers Management, a money manager that specializes in frontier markets.

Mr. Scott owns stocks in West Africa, the Balkans and Asia.

The eye-catching performance of frontier markets in recent years has started to draw in a wider range of investors. While analysts say that has helped bolster share prices in those countries, some regulators are sounding a warning bell. In its annual letter in early January, the Financial Industry Regulatory Authority cited a lack of liquidity as a reason why financial advisers should be extremely cautious about recommending frontier-market investments to their clients.

If increased regulatory scrutiny discourages some investors, that eventually could limit rallies in these markets, market experts say.

Still, many global investors who now place wagers in these markets say they will stay put.

“Frontier-market investors are less risk-sensitive. They look at different themes, and they have a longer time horizon,” says Asha Mehta, portfolio manager at Acadian Asset Management LLC’s $250 million frontier-markets fund. Ms. Mehta is bullish on Pakistan, where she says stocks are cheap and the risk of social or political upheaval is smaller than many other investors say.