Frontier Markets: Short-term pain for long term gain

Mark Mobius, chairman, Templeton Emerging Markets Fund, has been a strong advocate of the contribution that foreign portfolio investment can make to economic growth. As volatility returns to global equity markets, he remains upbeat. Are frontier markets in your view still a distinctive investment category? Whil

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Mark Mobius, chairman, Templeton Emerging Markets Fund, has been a strong advocate of the contribution that foreign portfolio investment can make to economic growth. As volatility returns to global equity markets, he remains upbeat.

Are frontier markets in your view still a distinctive investment category?

While considered one investment category, frontier markets in Latin America, Africa, Central and Eastern Europe, and Asia are geographically and economically diverse. A subset of emerging markets, the list is long and includes nations which appear to have little in common: Nigeria, Kenya, Saudi Arabia, Kazakhstan, Vietnam, Qatar, Ukraine, Romania and Argentina, to name a few. In terms of their economic situation, they range from wealthy Gulf oil producers with some of the highest per capita incomes in the world to some of the world’s most impoverished nations. What most of these countries do have in common, however, is a desire to introduce market mechanisms to boost economic growth and development.

The International Monetary Fund, in its World Economic Outlook in April 2015, projected that during the next five years, 19 of the 20 fastest-growing economies will be in frontier markets with the last one rounding up the 20 being India. With economic growth comes capital market growth, these markets are quickly moving from small and illiquid to large and liquid.

Would you consider them a mainstream investment option or are they only for the adventurous?

Frontier markets are not only growing faster, but also have a number of characteristics that make them safer than imagined. For example, they generally have lower debt and higher foreign exchange reserves in relation to their gross domestic product.

Many of the frontier market countries have enormous reserves of natural resources. Companies that are strong producers of commodities such as oil, iron ore, aluminium, copper, nickel, and platinum look especially interesting. Infrastructure development in emerging markets has led to continued demand for hard commodities, but demand for soft commodities such as sugar, cocoa, and select grains has also increased. Many of the frontier countries are already leading producers of oil, gas, precious metals, and other raw materials and are well positioned to benefit from the growing global demand for these resources.

In the consumer area, rising per capita incomes mean that the demand for consumer products is increasing fast. The deceleration of population growth combined with high economic growth means that per capita income is rising and demand for consumer products is increasing. The rising demand for consumer goods and services is also accompanied by a dramatic increase in the demand for infrastructure – electricity, roads, railroad, airports and so forth.

The relatively low correlation of frontier markets to global markets also provides investors with an opportunity to diversify their investment portfolios. Frontier markets have historically had low correlation with developed and emerging markets, as well as with other frontier markets. This is due in part to differences in the underlying industries and growth drivers in each country. Adding frontier markets exposure, as a component of the international portion of a portfolio, could help reduce overall volatility, provide a source of diversification.

Within the frontier market universe, that are particularly attracting your attention?

When we look at all frontier markets the most diverse and fascinating area is Africa. All of the nations in Africa, with the exception of South Africa, can be classified as frontier markets and even in the case of that country, the exposure to the rest of Africa means that many of the South African stocks qualify as frontier market targets.

Many global investors into Africa, most notably from emerging market countries such as China and India, have been seeking raw materials for their own economic development and markets for their industries. In return, African countries have been receiving vitally needed infrastructure such as transport links, power stations, schools and hospitals, which is bringing into play another great African resource – a huge and youthful population. More than a billion strong and with a median age of just twenty, the population of Africa has been seeing prospects and productivity transformed by education, mobility and access to capital resources. The effects of this virtuous circle are evident.

Beyond Africa, countries in Asia and the Middle East hold great potential. Examples include Pakistan, Vietnam, Saudi Arabia and Kuwait. In Europe, Romania looks interesting.

Are the risks over-hyped?

While it is clear that frontier markets offer investors an attractive investment opportunity, one should not forget the challenges. Some investors perceive that the frontier market growth premium is available only at the cost of heightened risk caused by factors such as political instability, low shareholder protection and corruption. We would contend that the risks inherent in most frontier markets are more salient, but similar to the political, country- and stock-specific risks in any other market, whether developed or emerging. The real difference is a lower degree of understanding and research on the part of the global investment community. We believe that research-oriented and detailed investment models allow investors a great deal of insight to better manage this information “gap”.

Market-specific risks are discounted in valuations and can be managed through a rigorous investment process. We believe that frontier markets present a strong investment case for long-term investors seeking to take advantage of this “new wave” of emerging markets.

Do you find that third-party service providers are always available for you to take advantage of perceived opportunities?

The role of local safekeeping agents (popularly known as custodians) is vital, especially when investing in less developed markets since it is paramount for foreign investors to be able to have adequate security for clients’ shares in domestic companies. The lack of these services is a deal-breaker for any foreign investor. I recall one time we wanted to invest in a telecommunication services company in Senegal for one of our Korean-domiciled funds. However, the custodian disclosed that they no longer supported the Ivory Coast as it was considered to be a restricted market, and as a consequence they did not offer services for the Senegal market. We were thus unable to move ahead with that purchase for the particular fund.

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