Frontier Markets: Strengths and Risks; Growth Prospects Are Good, But Liquidity Is One Concern

Frontier Markets: Strengths and Risks

Growth Prospects Are Good, But Liquidity Is One Concern


March 3, 2014 4:00 p.m. ET


Frontier-stock funds are a way to bet on consumer spending in countries such as Vietnam, shown here.Reuters

The recent kerfuffle in emerging markets has led some mutual-fund managers to advocate for investing in arguably even more volatile regions: “frontier” markets.

Fans of markets like Zimbabwe and Kuwait say that the economies are relatively healthy and that investors will benefit over time as companies serve the expanding populations in those countries.

Compared with opportunities in emerging markets, frontier markets offer stocks with stronger growth potential, less debt and better valuations, says Laura Geritz, the portfolio manager of Wasatch Frontier Emerging Small Countries. Because frontier markets depend more on growth in domestic consumption than on exports to developed economies, they also are less correlated with markets in either developed or emerging markets, Ms. Geritz says. About three-quarters of the Wasatch fund’s recent $1.03 billion in assets were in frontier markets, including Ghana and Vietnam.

Frontier markets “represent what emerging-market countries like Brazil, Russia, India and China were 20 to 25 years ago,” says Mark Mobius, who manages more than $40 billion in emerging-markets assets at Franklin Resources Inc. BEN -1.28% ‘s Franklin Templeton Investments.

Mr. Mobius believes “internal sources of growth” have helped frontier markets with their performance, and for this reason they remain “the most exciting investment opportunities for global equity investors.”

Shared characteristics fueling growth, he says, include “reforms and relatively low levels of consumer and sovereign indebtedness.” While consumer indebtedness has risen in some countries with the introduction of consumer financing by banks and the growth of credit cards, this has helped push up retail sales, he says. But valuations, he adds, “are expected to remain favorable and even improve.”

The MSCI Frontier Markets Index is up 3.8% in dollar terms this year through February, compared with a 3.6% drop in the MSCI Emerging Markets Index.

Many investors have small exposure to frontier markets in their portfolios without realizing it. Mr. Mobius notes, for instance, that Franklin Templeton’s general emerging-markets funds may have as much as 20% exposure to frontier markets.

Finra Concerns

Still, high risks are attached with entering these markets. Earlier this year, the Financial Industry Regulatory Authority, or Finra, added frontier funds to the list of products about which it has concerns regarding brokers’ marketing practices and suitability for investors.

“Heightened risks associated with investing in foreign or emerging markets generally are magnified in frontier markets,” Finra, the regulatory body for brokers and brokerage firms, said in its annual list of regulatory and examination priorities.


The report also warned of potential liquidity problems. “In many cases, these markets have relatively few companies and investment opportunities, and the local securities market may not be fully developed,” Finra said. “This could mean less liquidity and lower investor protection.”

However, some managers believe this is the right time to enter frontier markets, which represent a tiny percentage of mutual funds. A group of 16 frontier-markets mutual funds and exchange-traded funds identified by Morningstar Inc. recently had total assets of $4.3 billion, including $2.1 billion that flowed into the funds in the 12 months through January. Two of the three largest frontier funds, Wasatch Frontier Emerging Small Countries and the ETF iShares MSCI Frontier 100FM -1.32% were launched only in 2012.

Ms. Geritz and other managers believe a portfolio should have at least a couple of percentage points invested in frontier markets due to their role in global economic output.

Frontier countries account for 21.6% of the world’s population, 6% of its nominal GDP, and only 3.1% of world market capitalization, according to the CFA Institute Research Foundation.

Ms. Geritz favors companies affiliated with giant multinationals. Her fund’s top holding, almost 4% of assets, is Nestlé Nigeria PLC. Nestlé SA NESN.VX -1.20% indirectly owns a stake in the company. Businesses like these, she says, “have strong brand platforms, they have been in these countries for a long time, they have access to cheaper capital in markets where capital is typically very expensive, they generate good cash flows and are employers of choice in those markets.”

Illiquid Assets

But even fierce advocates of frontier-markets investing concede liquidity constraints and other risks make it harder for investors to pick those markets. One problem associated with poor liquidity is that when trading volumes are tiny, investors might not find a buyer when they decide to sell.

Another problem is when a big fund wants to buy or sell a large order of shares. The market for those shares can be so small and inefficient that the fund ends up paying more, or receiving less, than it counted on.

“Liquidity is a major problem,” says Mr. Mobius, who runs Templeton Frontier Markets,Templeton Emerging Markets Small Cap and other funds.

The Frontier Markets fund closed to new investors last June in an apparent bid to address liquidity issues, describing the move as a way to “manage the flows” coming into the frontier portfolio.

Mr. Mobius, who travels extensively to frontier markets, says that volatility is also a concern. “You have to be aware about the risk of volatility because you tend to panic if things get rough,” he says.

Beware of Hype

Spencer Stewart, co-portfolio manager of Grandeur Peak Emerging Markets Opportunities, which includes emerging and frontier markets, warns “there is a lot of hype” about frontier markets.

“They are exciting, the GDP per capita is tiny, and there is a rising middle class,” he says. But these countries have their own challenges, he adds, from potentially incapable governments to disparate social structures.

“At some point, frontier markets might become emerging markets, but there is some dart throwing,” he says. Citing Nigeria as an example, he says, “We can sit here and say there’s massive opportunity…[but] how capable the government is and how contented the civilians are throughout the evolution are two factors that will ultimately decide the country’s fate.”


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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