Frontier Markets: Fund Tips Five Best New Emerging Markets

30 October 2009. Dr. Mark Mobius knows a thing or two about emerging markets. From his base in Singapore, he spends more than 250 days a year travelling to them, opened the first emerging markets fund open to US investors, and manages the Templeton Emerging Markets Investment Trust & over 35 other related funds, together the largest pool of private investor money in these markets.[br]

30 October 2009. Dr. Mark Mobius knows a thing or two about emerging markets. From his base in Singapore, he spends more than 250 days a year travelling to them, opened the first emerging markets fund open to US investors, and manages the Templeton Emerging Markets Investment Trust & over 35 other related funds, together the largest pool of private investor money in these markets.[br]

In a recent video interview with the Telegraph newspaper, Mark has said that we are now in a bull market for emerging markets (in effect, most of the countries outside North America, Europe and Japan). Average growth is 6% across emerging markets – slightly higher than the 1% or so for the G7.

However this will not be a smooth ride. It is important to note that corrections can be large and violent even in the best bull market, as evidenced by the 20% drop in Shanghai earlier this year.

What is supporting this growth? Money supply is increasing globally, and ‘derivatives’ are not dead. In fact Mark estimates that there are $600 trillion worth of derivatives in circulation. That is almost 10 times world GDP – a pretty scary thought in general. Right now they are generally supporting emerging markets, although that can flip very quickly – as we saw a year ago.

The BRIC story is still strong and provides good balance, with Brazil & Russia benefiting from growthin in commodity price rises, while China & India will increasingly become domestic consumption plays.

Most exciting though, for Mark and Templeton are what have come to be called the Frontier Markets.

The term ‘Frontier Markets‘ was first coined in 1992 by an analyst at the International Finance Corporation (IFC), Farida Khambata. The IFC is a branch of the World Bank that provides funding and other assistance to help markets, companies and projects that improve capabilities and jobs in emerging markets.

The term ’emerging markets’ had become a kind of dumping ground for everyone that wasn’t in the closed OECD club of advanced economies.

Farida was looking to distinguish between those who were close to getting to developed economy status, such as the ‘Asian Tigers’, and countries that were much further behind in their development, but who looked like they would eventually join the club. A frontier market has basic markets and regulatory framework, and is exhibiting good economic growth, but has lower market capitalization and liquidity than the more well-known and better developed emerging markets.[br]

She used the term Frontier Markets to define that second group, and developed a set of indices to track them in the Emerging Markets Database or EMDB.

The EMDB was bought by Standard and Poors (S&P) in 1999, and in 2007 they launched the first index open to investors, the Select Frontier Index with 30 companies from 11 countries. It then launched the Extended Frontier Index with 150 companies from 27 countries. That same year, MSCI Barra formed the rival Frontier Market Index, and in 2008 Deutche Bank created the first Exchange Traded Fund (ETF) for this asset class. Interest has been rising ever since.

The draw for investors is clear – it is growth. The highest rates of growth in percentage terms are exhibited at the earliest stage of growth; when a market starts to ‘take off’ but before size and development causes the Law of Diminishing Returns to set in. When we looked at the 12 Fastest Growing Economies in 2010, we noted that if you listen to the press you may think that China is the fastest growing country in the world, but it is markets like Qatar, Botswana and Azerbaijan that lead the pack in economic growth.

This doesn’t necessarily make them the best frontier markets, however, since an investor also needs markets that are open to foreigners, with regulatory support, and with some level of liquidity.

Mark tips the best Frontier Markets as being:

• Kazakhstan
  
• Romania
  
• Vietnam
  
• Nigeria
  
• Kenya

 

Within the Templeton Frontier Markets fund, not only are these countries starting to carry significant weight, but the financial sector accounts for about a quarter of the entire holding.

As we talked about when RBI called an end to the financial crisis in India, Indian banks have strong balance sheets with good capital ratios. This is true for most homegrown markets across emerging markets, including frontier markets. Banks here have tended to stick to ‘old school’ banking. Loans are assessed and granted conservatively (unless political pressure has been brought to bear, which does still happen quite often), and derivatives and securitization have been mostly avoided. Mark points out that the only banks to be impacted by the Financial Crisis in these markets were HSBC and the like – western players with a global footprint.

Traditionally these markets have been characterised as risky. The massive changes rippling through the world economic and financial systems have in reality changed that. A large fund can now diversify the risk inherent in individual companies and markets at an early stage of development.

We would argue that today the biggest risk exists in the advanced economies, addicted as they are to debt and with few triggers for growth. Investing for the future should be centered on emerging markets, with an increasing focus on frontier markets.

Keith Timimi

EconomyWatch.com