Oct 7 After a year of mediocre returns from
emerging markets, many investors are searching for yield in
so-called frontier markets in hopes that low prices and
potential growth will outweigh the risks in little-developed
Often viewed as tomorrow's tigers, nations like Nigeria,
Qatar, Bangladesh or Colombia have drawn interest from asset
managers looking for well-managed companies serving a growing
middle class - a combination with strong potential for profit.
"It really is one of the most interesting asset classes,"
said Gavin Graham, chief strategy officer at INTEGRIS Pension
Management Corp in Toronto. "There are very few markets left
that are not correlated to major asset classes. With rates
having gone so low, everything moves in one direction. Frontier
Graham said every investor who owns international equities
should look at boosting exposure to frontier markets, especially
since aging emerging market stars like China, India and Brazil
have become more correlated to developed nations, nullifying
their appeal as high-growth performers.
Since the start of 2012, MSCI's Frontier Market index
has risen 20.1 percent, nearly triple the
performance of stocks in its emerging market index,
which climbed 7.0 percent.
Dividend yield is also above 4 percent, almost double the
2.5 percent for global equities, while typical price-to-earnings
ratios are lower, because share prices are relatively cheap.
Frontier companies and countries are also often far less
leveraged than those in the developed world, making rising
global interest rates less threatening.
"Typically people have been going to emerging markets before
they have looked at frontier markets, so they have really been
overlooked," said David Kunselman, senior portfolio manager at
Mississauga, Ontario-based Excel Funds Management, which
specializes in emerging markets.
HIT HARD IN LAST CRISIS
The potential rewards from frontier markets come with high
risks. During the last financial crisis, MSCI's International
Frontier market index lost about two-thirds of its value in
eight months. And it is still only worth a little more than half
of what it was in early 2008.
Excel Funds does not have a frontier fund, but it will,
Kunselman said. "We like these countries. To us, the frontier
markets are almost emerging markets, 10 years beforehand. They
are the next emerging markets."
A new fund would likely be welcomed in what is a relatively
illiquid investment sector without a lot of options. One
high-profile fund, the Templeton Frontier Markets fund
, closed to new investors in June, citing a surge in
"While the Templeton Emerging Markets Group does not see any
capacity issues within the frontier markets universe, the soft
close is a way to best manage the flows coming into the
dedicated frontier market portfolios," spokeswoman Sarah Kingdon
said in an email.
While the market may be relatively overlooked, a surge of
money may inflate prices too quickly and push investors into
second-tier companies as they look for new bargains.
FOREIGNERS WITH A CHECKBOOK
Along with some U.S. and European mutual funds in frontier
markets, a handful of exchange-traded funds (ETFs), including
the BlackRock Frontiers Investment Trust have also
invested in the sector.
While the lower costs of ETFs boost their value in developed
market assets, that may not work for frontier markets. Graham
said paying the fees for active management has paid off in
frontier markets, even with management expense ratios (MERs) at
about 2.1 percent.
"Even after those MERs, they still manage to beat the
(frontier) index" said Graham, whose book "Investing in Frontier
Markets: Opportunity, Risk and Role in an Investment Portfolio,"
co-authored with Al Emid, was released last month.
"With frontier markets, the quality of the information you
are getting is not particularly great, so you have to be based
there, or at least traveling frequently ... to kick the tires,
see the management," Graham said. "Otherwise you risk being seen
as the stupid foreigner with a checkbook."
While some investors might balk at investing in nations like
Argentina, Egypt or Pakistan, which are strife-ridden and
unstable, many asset managers see volatility rather than risk.
Thomas Vester Nielsen, frontier market portfolio manager at
Lloyd George Management (LGM), a unit of Bank of Montreal
, said the beauty of holding 40 equities in two dozen
less-developed countries is that they have no correlation with
each other. Problems in Georgia may not touch Cambodia, and
strife in Kenya is not likely to affect shares in the United
That effectively diversifies a portfolio, a welcome
development in a global market in which a default in Europe or a
monetary policy shift in the United States can drive down
equities, bonds and commodities in one afternoon.
Holdings in LGM's Frontier Markets Strategy portfolio range
from Vietnamese milk producer Vinamilk to Nigeria's Guaranty
Trust Bank and Senegalese telecom Sonatel
And given the liquidity question and volatility, a long-term
approach is critical.
"Ten years plus. This is what you consider for your
retirement funds or kids' college funds," LGM's Vester Nielsen
said. "Take a cornerstone of your portfolio and you leave it
aside with a long-time horizon, not money you depend on in the