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The Risks and Rewards of Frontier Markets Investing

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The final frontier may sound like some place only Captain James T. Kirk might boldly go, but he would not be alone. Advisors who want to invest in these nascent markets on behalf of their clients can be well rewarded with double-digit returns as long as they diversify and manage risk, noted three portfolio managers exchanging views at the 2015 Morningstar Investment Conference in Chicago. 

Each manager was bullish on these markets, which are smaller and less developed than emerging markets. Laura Geritz, portfolio manager with Wasatch Funds, considered frontier markets as those along “the old Silk Road trading countries,” including Sri Lanka, port cities in Africa and Tanzania and Vietnam. All three managers were high on Vietnam, while Taizo Ishida, portfolio manager with Matthews Asia, noted that Pakistan is one of the better frontier markets and that he “likes it better every time I go there.”

Geritz said that China was crucial in propelling the Asian frontier countries — and had ulterior motives for backing those markets in its sphere of influence.

“Look at what China is doing, trying to be a superpower and establishing a reserve currency,” she said. “And to do that, they are investing across a lot of frontier countries.” She noted China’s sovereign and development investment made up as much of 20% of Pakistan’s GDP. 

Frontier countries do well “in spite of their politics,” she said, adding that what’s occurring in many of these countries is “positive,” such as in Nigeria, which just had an election “that went our way,” and Sri Lanka, which recently voted for democracy. “Democracy is messy; it’s not linear,” she said.

Ishida added that these countries also “learn to work within” political changes.

Of the two key risks, political and currency, political is short term, noted Pradipta Chakrabortty, portfolio manager with Harding Loevner. 

“Political risk peaks right before election time,” he noted. “By and large, if the political risk and upheavals do create an opportunity, we gladly take positions in companies [in frontier markets] because of cheaper valuation. We actually like the fact that there are upheavals, which are political in nature and don’t affect the underlying fundamentals” of the companies. He added that “the headlines you see are not really material from an investment point of view. These companies in frontier countries have learned to live and survive and prosper in these environments. They are good at managing risk.”

Geritz added that as frontier management teams hold “capital dear,” the result is “better management teams” that are even “phenomenal.”

Two other positives the managers pointed out were the relative youth of frontier markets and lack of correlation to each other. Chakrabortty noted that roughly 70% of the overall frontier market population was under the age of 40, which over the next 10 years “translates from an investment point of view” to much more “job creation and massive consumption.” 

He also said these countries lack correlation, so if one is doing poorly, it doesn’t affect a nearby country. He noted that when Kenya is doing poorly, it doesn’t affect Nigeria. The internal managers focus on their countries and not on others, he added.

As a group, the managers were bullish on frontier markets over some so-called emerging markets, such as Argentina or Kuwait. Further, Isheda added that China is risky in the short term. “Try to find companies in China [to invest in],” he said. “They are trading 90 times earnings…every housewife in China [is trading daily]…and turnover is 78%, so it’s like a casino.”

Geritz admitted that while there are risks, if an investor is well diversified in the countries (and all managers believed the MSCI emerging market index was too narrow and didn’t include what they considered ‘frontier’ markets), managers and investors can be well rewarded.

She noted that large multinational companies have invested in frontier markets by setting up subsidiaries, for example, Nestle Pakistan and Nestle Nigeria, saying there are “these companies have skin in the game.”

— Check out JPMorgan’s Kelly: ‘You Gotta Get Invested’ on ThinkAdvisor.


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