By John Wasik
CHICAGO Dec 14 With China, Brazil and India
hitting icy patches on their economic growth paths, investing in
even younger emerging markets looks promising.
The so-called "frontier" economies offer diversification and
profit opportunities as big global investors look for low-cost
labor and resources. Most of these 25 or so countries won't
appear on most individual investors' radar screens, though. They
range from Bangladesh to Vietnam and are expanding due to
industrialization or global demand.
Vietnam, for example, benefiting from normalized relations
with the U.S. and membership in the World Trade Organization, is
one of the only Asian countries to have grown faster than China
since 2000, according to the McKinsey Global Institute. The
country's manufacturing sector alone grew at a 9-percent annual
compounded growth rate from 2005 to 2010.
Part of the appeal of frontier markets is their growing
younger populations, which produce a "demographic dividend" that
allows for competitive labor rates. Many of these countries are
also blessed with natural resources from land to oil, which is
the case in sub-Saharan African countries like Ghana, Nigeria
and Kenya. Even established Gulf states such as Kuwait and Qatar
Commodity demand from the largest developing countries such
as China and India will focus even more attention on the
frontier countries. China has become the largest single trading
partner of African countries as well as South American nations
such as Brazil and Chile. Ultimately, China's growing middle
class and industry will tap every country for resources like
copper, iron ore, coal and other metals.
While the future opportunities are numerous, the vehicles
available to invest in frontier markets are few. There are
several single-country, exchange-traded funds available and two
index funds, but they pose a number of problems.
Two frontier index funds - Guggenheim Frontier Markets ETF
) and the iShares MSCI Frontier Index Fund - rely
upon capitalization-weighted indexes that concentrate holdings
in a handful of small countries. Some of the indexes used to
track frontier markets are too heavily skewed to a handful of
countries to be able to claim the mantle of diversification.
The FTSE Frontier 50 Index, for example, has 46 percent of
its weighing in Nigeria and Qatar. The next-largest stake is
Kenya, at 9 percent as of Oct. 31. As a result, the indexes
don't provide a broad-enough basket of country representation.
The iShares fund, for example, has nearly half of its
holdings in Kuwait and Qatar. Although those oil-rich countries
will benefit from higher petroleum demand and prices, they
concentrate risk in two countries and one region. The Guggenheim
fund, in contrast, puts more than half of its assets in Chile
and Colombia, although it owns smaller stakes in Egypt, Peru,
Argentina and Kazakhstan. Almost one half of the fund is
invested in financial and energy stocks.
Actively managed funds may offer some better opportunities.
Since the companies being eyed are thinly traded and researched
relative to global mega-caps, specialty managers might provide
The Templeton Frontier Markets A fund, led by
manager Mark Mobius, invests across 11 sectors in 10 regions
with three quarters of its holdings in emerging Africa, Europe
and the Middle East. The fund is up more than 22 percent
year-to-date through Dec. 12, compared to an 11-percent return
for the Guggenheim fund. The iShares fund, which has only been
in existence since Sept. 12, is up about 3 percent for the past
The main drawbacks of the Templeton fund are its costs.
There is a 5.75-percent sales charge for the fund's "A" shares
as well as high management expenses -- 2.15 percent annually --
and 0.3-percent so-called 12b-1 marketing and distribution fee.
("A" class shares typically carry front-end commissions.)
As with many vehicles in emerging markets, frontier fund
returns show a dramatic amount of volatility. The Templeton
fund's best year was in 2009 -- a rebound year from the debacle
of 2008 -- when it returned almost 44 percent. The fund gained
almost 19 percent in 2010 before losing nearly the same amount
Political risk will also roil the frontier markets. It may
be some time before political stability comes to nations like
Nigeria, Egypt, Pakistan and South Africa. As frontier economies
have a symbiotic relationship with developing and mature
countries, they also get a flu when their largest customers
sneeze. Nearly all of developing Africa, Southeast Asia and
South America will feel the adverse impact of a sluggish China
or United States. The stock markets in the frontier nations are
also not as robustly regulated nor as heavily traded as they are
in developed countries, so that's another caution.
Frontier markets should be part of a larger strategy to
globalize your portfolio away from northern, slower-growing,
older countries -- think Europe and Japan -- into younger
countries that are mostly in the Southern Hemisphere. This
"youth movement" may not show immediate gains, but should show
long-term rewards as resources become even-more valuable
commodities as the world's population soars.