While emerging markets were considered a niche or “exotic” investment when I started investing in the late 1980s, many investors are now familiar with them and I’m seeing more and more investors turning to emerging markets as a way to diversify their portfolios. Yet, emerging markets themselves are not a homogeneous zone. Within the emerging markets universe, we believe frontier markets as a whole have begun to take an impressive lead in terms of growth.
Frontier markets, as their name suggests, could be described as “new or younger emerging” markets. Located throughout Asia, Africa, Europe and South America, they are often in a much earlier stage of economic development than larger emerging markets and many have only recently opened to foreign investing. This helps explain their high growth potential. Newer markets typically have more room to grow and the search for growth potential amid acute global volatility is encouraging many investors to expand their horizons.
We believe the advance of many frontier market countries toward emerging market status gives them and their investors economic opportunity, although it’s important to keep in mind that the risks of investing in emerging markets are magnified in frontier markets. Access to capital markets is a key ingredient to high and sustainable private sector–led growth. Political uncertainty has meant this access has long seemed out of reach for many of these countries until recently. As these countries move ahead, their governments are taking the steps necessary in an effort to help support sustained, steady growth, making them intriguing long-term investment opportunities with attractive potential, in my opinion.
In this week’s blog, I asked my colleagues Johan Meyer, Senior Vice President of Equity Analysis in sub-Saharan Africa, and Claus Born, Senior Vice President of Emerging Markets in Latin America to share some of their thoughts on the frontier market regions of Africa and Latin America respectively.
Johan Meyer on Africa
Several African countries with developing markets appear to be potential candidates to join a second generation of emerging markets. The same crucial developments that presaged the arrival of investors in emerging markets in the 1980s are taking place in parts of sub-Saharan Africa today. Private sector growth has been increasing and financial markets have been opening up.
Frontier markets overall are an area that we firmly believe are now where emerging markets used to be 20 or so years ago.
Africa is a very interesting continent that unfortunately very few people know much about. You have a billion people on the continent and you have big countries like Nigeria, for example, with a population of over 150 million. This is a country that has been growing over the past 10 years at about 7 or 8% per year on average, in terms of GDP, and it’s one of the top 10 fastest growing economies in the world.
This is a country that generates very little electricity on its own, so most of the electricity is provided by diesel generators. You can imagine the burden that this places on consumers, on companies and on industries in this market, and what potential, what opportunity this holds if this infrastructure constraint is lifted, how this can improve the functioning of this economy. It’s amazing the economy has managed to grow so fast with this type of issue.
Some markets like Kenya are particularly interesting. Kenya is very attractive to us because it’s on the east coast of the continent, an attractive position as a centre for India’s and China’s investments and interests in Africa. We see many companies setting up their operations in Nairobi, the capital city. The United Nations has a massive base there that it uses for its operations on the rest of the continent.
Unfortunately there are countries that still suffer, like Zimbabwe. Even though we have seen massive improvements in that economy, there still needs to be some political change before we can really start to get excited about those types of markets.
Claus Born on Latin America
Across the Atlantic, many Latin American frontier nations are also attracting attention as their economies progress. These markets may not be as big as Brazil, the “B” in the BRIC (Brazil, Russia, India and China) nations, but they have been demonstrating the growth and rising wealth typically associated with more advanced emerging market economies. Many have been weathering the credit crisis currently sweeping developed markets relatively unscathed, thanks to prudent financial policies. And they have the potential to benefit from continued demand for their natural resources.
If you look across the continent starting with Brazil, the biggest country on the continent, we have seen dramatic growth with a huge discovery of oil reserves, which is driving investment opportunities. But it’s not the only country where we see change.
Look at Peru. We have had a stable economic environment for nearly two decades now and this country has huge mining resources, especially in copper and in gold. We have seen a lot of investment in this sector during the past years. Also the consumer has benefited a lot, so you really see that the country is growing if you go there year after year.
Another interesting case is Panama. Currently the enlargement of the Panama Canal is underway. The country has a unique strategic location within the Americas. It’s a nice hub to connect within the Americas and between South America and North America. So you’ve seen some companies benefit from the location, not only with the canal, but also in airline connectivity. So we see very exciting developments also in Panama.
We believe frontier markets can be attractive opportunities for three reasons:
1) Growth Potential: We’ve seen growth in many of these markets. If you look at a list of the 10 fastest growing economies during the last decade, one is China, but the other nine are frontier markets.
2) Valuations: We very much like what we consider to be the attractive valuations that we’ve found in many frontier markets during the past year.
3) Correlation: If you look at the historical correlation of frontier markets with emerging markets and with developed markets, it’s actually very low. And also the historical correlation in between the different markets is very low. If you look at what is happening in Argentina, it appears to have no impact on what is happening in Nigeria or what is happening in Vietnam. So it’s really an asset class where we think there is diversification potential.
 Source: The Economist;IMF
 Source: International Monetary Fund, World Economic Outlook Database, September 2011
Read more posts on Investment Adventures in Emerging Markets »