Eight things you should know about frontier market investment

  

Frontier markets are described as new or younger emerging markets. Most African countries can be classed as frontier markets. One person that knows all about frontier markets is Mark Mobius, executive chairman of Templeton Emerging Markets Group. For more than 30 years he has been scouring for investment opportunities in lesser-known countries. In a recent article, Mobius shared some general thoughts about investment in frontier markets. Here are the highlights:

Mark Mobius

1. Patience and perseverance According to Mobius, investments in frontier markets hold significant potential for long-term investors, but it requires patience and perseverance. “Just a few decades ago, China and India were considered frontier markets, and when I began my investment career Japan was considered an emerging market. So, you can see how economic progression and market development often go hand in hand.”

2. Frontier markets are not necessarily poor countries A country’s classification as a frontier market is based on a range of criteria such as economic development, size, liquidity and market accessibility.

“One might make the mistake of associating frontier markets with impoverished nations, but in fact, they encompass a broad range of economic development, ranging from countries where the average citizen’s yearly income couldn’t buy a used car, to some of the wealthiest countries in the world,” says Mobius.

He notes that frontier markets can be found across the globe and includes countries such as Panama, Argentina, Bulgaria, Romania, Saudi Arabia, Qatar, Cambodia and Vietnam. All the countries in Africa, with the exception of South Africa, can be classified as frontier markets. “Africa is a very fast-growing region – from 2001 to 2010, six of 10 the fastest-growing countries in the world were in Africa. So we are very excited by the growth prospects in those countries.”

3. Do your homework Mobius says it is essential to do one’s homework before investing in frontier markets. “We visit every country and every company we invest in. We examine the fundamentals unique to each country, and for each company we examine a history of profit/loss statements, balance sheets, and other materials to support a five-year forecast. It’s an intensive process. In particular, we look for companies that appear to have solid long-term growth prospects (supported by a youthful population and rising middle class) and good corporate governance. We also favour a culture of dividends.”

4. Corruption remains a problem in frontier markets, but the situation is improving Mobius says that from his experience, corruption is today discussed more openly.

“On a recent visit to Nigeria, I sat down with a prominent government official who, instead of trying to sweep their history of corruption under the rug, candidly discussed how they are trying to clean it up. I believe many leaders in frontier markets are waking up to the fact that corruption must be squashed in order to prosper on a global scale, and are working on implementing policies to provide oversight and uphold the rule of law. It’s also important to remember that while the headlines may cast a country in a negative light, individual companies can look very attractive from an investment perspective, growing their business in their local (and even international) market,” he says.

5. Liquidity – a challenge but also an advantage Liquidity – the degree of how easy it is for an investor to get his/her money out of an investment – is often a risk when investing in frontier stock markets. However, according to Mobius this can be a double-edged sword.

“A low investment base in an underdeveloped market can make it a challenge to buy or sell a stock on demand and at a fair market price. However, a lack of liquidity can actually be an advantage, because we can pick up stocks we see as attractive that no one else is interested in, at bargain prices. It can often take time to build a position in a particular stock (sometimes many months), but if the market ultimately recognises the value of these companies, holding blocks of appreciated shares is, of course, quite desirable,” he explains.

6. When the risks are too large Mobius says that sometimes there are risks that are too big to take. “Our biggest concerns include capital controls and expropriation of assets. We have to be able to get our money out if we need to. So far, this hasn’t been a huge problem in most countries we invest in, but it is always something we are cognisant of.”

7. Not all about commodities “There is a misconception that the fate of all frontier markets is highly dependent on commodity prices. While it’s true many are indeed rich in natural resources and have a healthy level of exports, others depend more on domestic consumption for growth. Kenya, for example, is more agriculturally oriented and domestically driven, while Nigeria is more dependent on oil exports. Sources of growth can evolve in a positive way. For instance, to help diversify its economy, Nigeria is looking to start refining its oil to produce more value-added products for export. It is also developing more domestic industries to feed, clothe and house a growing population,” says Mobius.

8. Long-term growth potential “The most compelling reason to invest in frontier markets is their long-term growth potential,” says Mobius. “When you compare the growth rates of many developed nations to that of frontier markets, you find a wide discrepancy. For example, US GDP in 2011 was under 2%, while … Nigeria saw GDP of 6.9%. Growth in an economy should lead to growth in corporate earnings.”



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