Accelerating market liberalisation, improving home economic fundamentals and a reconfiguration of the global  risk environment is shaping frontier markets (FM) as a key opportunity for troubled European asset owners. Absolute returns are within easy reach as demographic trends, rich resource endowments and new investment opportunities in agriculture, mining, and energy sectors boom.
But do frontier markets remain suitable for only those with a high risk tolerance?
The 3rd annual Investing in Frontier Market report, published by Clear Path Analysis, assesses how the balance of global growth shifting towards the developing world, is dictating investment trends. Together asset owners and managers discuss the optimum tactical asset allocation plan, which countries offer the greatest growth potential and explore the investment vehicles- hedge funds, private equity, real estate, infrastructure, commodities – that seem the most promising.
Kemal Ahmed, Portfolio Manager, Frontier & Emerging Markets, Investec Asset Management, explores the emergence of ‘Horizon Markets’ to shake-up how investors traditionally allocate to frontier equities and improve absolute returns. “We currently track an initial investable universe composed of 40 Horizon Markets with 994 stocks, a market capitalisation of $3.1trn and a daily traded value of $4.8bn. In the last 10 years, the Horizon Markets have shown higher returns and lower volatility when compared to either the MSCI EM or MSCI FM indices {..} the positive macro and microeconomic fundamentals of Horizon Markets position them for future outperformance.”
He further argues that; “A capitalisation weighted approach is not forward-looking as by their nature capitalisation weighted indices are influenced heavily by historical performance and cannot fully reflect future potential.”
Investing in frontier is crucial to a global market strategy and as Andrew Brudenell, Senior Portfolio Manager, Frontier Markets, HSBC Global Asset Management, argues; “If you are diversified across the entire FM asset class, this has been shown to have a lower correlation with developed market equities than the EM space. It also has lower volatility, because although each individual country is quite volatile, the correlations between the countries within frontier markets themselves are very low.
Such returns, however can only be achieved if, as Brudenell states, the fund manager harnesses local expertise and knowledge, “…relating to the corporate sector, the credit default environment, what they think about the central bank governor or the political environment.”
With the Eurozone crisis persisting frontier markets are an attractive investment proposition but to what extent should there be contagion with developed markets?
Tim Drinkall, Executive Director, Morgan Stanley Investment Management argues that such an exponential growth potential cannot be missed. “For 2011 to 2015, we believe FM economies can sustain a compounded growth rate of 4.3 percent {...} At that pace, FM countries could add an estimated $1 trillion in GDP over the next five years, while their total population is expected to grow by more than 78 million over the same period. This opportunity is too significant to ignore.”
Florian Kohler, Associate Partner and Investment Manager, Swiss Investment Fund for Emerging Markets (SIFEM), argues that despite volatility infiltrating market-to-market connectivity there remains tremendous investment opportunities.
“An example of this is with China and Vietnam where a lot of money was going into China in the mid-2000s {..}. It was harder to find deals in China, so investment started to go into Vietnam and in terms of private equity we started to see a lot of opportunities to diversify out of China.”
Contrastingly, John Oliphant, Principal Officer & Head: Investment & Actuarial, Government Employees Pension Fund (GEPF) is exploring the use of limited-life funds, “…or open ended funds where the investor has the opportunity to entertain exit strategies at the right time as opposed to being forced due to limited life of a fund. This is a debate we are having internally as we start to deploy capital into the African continent” as a solution to drawbacks of market contagion.
To obtain a full copy of the Clear Path Analysis report on Investing in Frontier Markets visit https://www.clearpathanalysis.com/reports/investing-in-frontier-markets-2012/
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