Frontier markets have enjoyed strong growth of late, but investors need to consider more than just the headline figures before investing. Pádraig Floyd investigates.
Frontier markets have demonstrated strong recent growth, putting better known markets in the shade.
The MSCI Frontier Markets index is up more than 13% year to date and more than 18% on a 12-month basis (as of 23 October), but despite double digit performance, frontier markets are not to everyone’s tastes. Like the Spanish Inquisition, frontier markets’ two main weapons are fear and surprise, and many institutional investors greatly fear getting caught with their pants down.
Although some use hurdles to delineate whether a market has made it a far as earning frontier status, such as an equity market capitalisation of 40% to 60% of GDP, in truth, frontier markets come in all shapes and sizes. As a result, different investors will look at them in different ways, so make sure you read the small print.
The MSCI index uses market liquidity and the size of the index, but does not take into account economic criteria, the speed of growth or accessibility.
This is important, because the strength of the performance might be attributed to two markets which are now excluded – Qatar and the United Arab Emirates (UAE). These are two of the richest economies in the world – in 2013 Qatar had the third highest GDP per capita according to the World Bank, after Luxembourg and Norway – and, until recently, they listed as frontier markets.
It is therefore important that investors take this into account and don’t get caught up in the overall figures, says Dominic Bokor- Ingram, portfolio adviser at Charlemagne Capital, as “the outperformance in the last couple of years in frontier versus emerging isn’t nearly as big as it looks on the face of it”.
Despite this, there are huge opportunities to be had from investing in frontier markets. Demographics is the driving force, with the leading economies – sub- Saharan Africa, in particular Nigeria and areas of south east Asia, most notably Vietnam – have rapidly growing younger populations ready to feed a growth in the economy firstly as workers, then consumers.
Jobs are moving there because established emerging and emerged markets such as China and Korea have hit the middle-income trap which eats into their margins and so they seek to move their production offshore.
Vietnam is now making many of the shoes Chinese producers used to export, on behalf of those Chinese firms. The middleincome trap has already seen production for US companies move to Mexico which offers the kinds of margins that used to be available in Asia.
“The projected earnings growth is 32% for 2014 and 16.5% for 2015, versus about 8% in the emerging markets,” says Bokor- Ingram. “Frontier markets are cheaper today than emerging with much higher growth prospects.”