Frontier Markets: one of the best opportunities for higher returns and diversification

by OpenFunds

400Frontier Markets have a number of attractive features for investors, particular in the current market environment of slow growth in all major economies, rich equities and bonds and low bank deposit interest rates.

But private and institutional investors tend to think of Frontier Markets as unexplored. The economies of these countries are generally in earlier stages of economic development, and their capital markets less mature than Emerging Markets. An increasing number of Frontier Markets have reached a stage of development that enables investors to participate in strong structural growth. They offer exposure to growing domestic demand, strong economic growth potential, and attractive demographics. "The political and structural stability of these countries is improving and several of them are poised to become manufacturing and production hubs as a result of technological advances combined with low labour costs", says Wolfgang Landl, Managing Partner, OpenFunds Investment Services, who became the distributor of Tundra’s funds.

They exhibit low correlation to each other and relatively low levels of liquidity and transparency. But Frontier Markets equity valuations are interesting compared with Developed and Emerging Markets.

The MSCI Frontier Markets Index was trading at a trailing P/E ratio for 2015 of 9.2, compared to 11.4 for the MSCI Emerging Markets Index and 15.3 for the MSCI World Index.
In terms of P/BV, Frontier Markets exhibit attractive valuations at 1.3, equal to the MSCI Emerging Markets Index and versus 1.9 of the MSCI World Index.
Finally the dividend yield for Frontier Markets is much higher at 4.1%, compared to 3.1% for the MSCI Emerging Markets Index and 2.7% for the MSCI World Index.

These are some of the very reasons they present opportunities for managers with proven stock picking capabilities. For investors that do not understand or feel entirely comfortable with this asset class, it is important to define what Frontier Markets are. "I believe - says Landl - that the best way is to start is by comparing the main characteristics of Frontier Markets with Emerging and Developed Markets. Generally speaking, Frontier Markets can be thought of as “a subset of Emerging Markets, and they are typically economies at the lower end of the development spectrum. They are the generally smaller, less developed and less liquid emerging market countries that are considered to be in the nascent stages of development. In essence, they represent what some emerging market countries such as Brazil, Russia, India and China were 20 to 25 years ago".

So, the ability to invest in a market is a primary criterion for the classification of a country into either the Frontier Markets or the Emerging Markets index. Another problem is that there are few passive investment vehicles providing exposure to Frontier Markets. Of the existing Frontier Market ETFs, most have been struggling to maintain a low tracking error due to bigger spreads, higher commissions, FX spreads and limited liquidity in the underlying equities.
Given the benchmark’s heavy weighting towards financials, it is a sub-optimal way to gain exposure to the attractive domestic consumer growth potential that exists in Frontier Markets.


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