Investment Adventures in Emerging Markets

The Next Frontier

This post is also available in: German

In a recent interview, I was asked whether I was becoming a “frontiersman” in my quest for the next big investment opportunity. It’s true that many of my recent investment adventures have taken place in frontier markets – the smaller, less-developed cousins of the emerging markets. I view frontier markets as having tremendous potential for long-term investors, if—and this is a big “if”—you are able to be patient and show some perseverance. Just a few decades ago, China and India were considered frontier markets, and when I began my investment career Japan was considered an emerging market. So, you can see how economic progression and market development often go hand in hand.

Frontier markets could be viewed as a subset of emerging markets. Frontier markets are generally less liquid and have lower market capitalizations than emerging or developed markets. A country’s classification as “emerging” or “frontier” is generally based on criteria such as economic development, size, liquidity and market accessibility. The MSCI Frontier Markets Indices1 provide a handy benchmark for investors and have their own criteria to determine classifications, but they are not something we strictly adhere to.

As frontier country income levels rise, and frontier stock markets become more developed and easily accessible to international investors, these markets could transition to the status of emerging market.

One might make the mistake of associating frontier markets with impoverished nations, but in fact, they encompass a broad range of economic development, ranging from countries where the average citizen’s yearly income couldn’t buy a used car, to some of the wealthiest countries in the world. Frontier markets span the globe, including Panama and Argentina in Latin America, Bulgaria and Romania in Eastern Europe, Saudi Arabia and Qatar in the Middle East and Cambodia and Vietnam in Asia, to name a few. Africa is an area of particular interest to me right now. All of the nations in Africa, with the exception of South Africa, can be classified as frontier markets. Africa is a very fast-growing region—from 2001 to 2010, six of 10 the fastest-growing countries in the world were in Africa.2 So we are very excited by the growth prospects in those countries. (See my three-part series “Investing in the Cradle of Civilization” for more on Africa.)

As with all our investments, we must do our homework. We visit every country and every company we invest in. We examine the fundamentals unique to each country, and for each company we examine a history of profit/loss statements, balance sheets, and other materials to support a five-year forecast. It’s an intensive process. In particular, we look for companies that appear to have solid long-term growth prospects (supported by a youthful population and rising middle class) and good corporate governance. We also favor a culture of dividends.

Risks of Investing

As intensive as our process is, it cannot guarantee success and, of course, doesn’t eliminate the investment risks.  Unlike more developed markets, the risks in frontier markets haven’t been fully studied. That’s where my team and I really step in. Political risk is often cited as a concern in new markets, and as I’ve noted on these pages before, such risk can create volatility, but it can also lead to opportunity. For example, when there is tension in the Middle East, we’ve seen investors there flock to markets perceived as “safe havens” in the region, such as the United Arab Emirates (considered a frontier market).

Corruption is a problem found in nearly all markets, but it can be magnified in those markets where power and resources are concentrated in the hands of a few and penalties aren’t uniformly enforced. The good news, from my perspective, is that today corruption is openly discussed, which is a good first step toward achieving a more fair and equitable system.

On a recent visit to Nigeria, I sat down with a prominent government official who, instead of trying to sweep their history of corruption under the rug, candidly discussed how they are trying to clean it up. I believe many leaders in frontier markets are waking up to the fact that corruption must be squashed in order to prosper on a global scale, and are working on implementing policies to provide oversight and uphold the rule of law. It’s also important to remember that while the headlines may cast a country in a negative light, individual companies can look very attractive from an investment perspective, growing their business in their local (and even international) market. For example, I observed widespread use of cell phones in Africa, not just for basic communication, but for services such as money transfer where there may be no bank branches to serve the people. Consumers are gaining clout, and they are embracing new products and services.

Another risk often associated with frontier markets is liquidity, which can be a double-edged sword. A low investment base in an underdeveloped market can make it a challenge to buy or sell a stock on demand and at a fair market price. However, a lack of liquidity can actually be an advantage, because we can pick up stocks we see as attractive that no one else is interested in, at bargain prices. It can often take time to build a position in a particular stock (sometimes many months), but if the market ultimately recognizes the value of these companies, holding blocks of appreciated shares is, of course, quite desirable.

Sometimes we feel there might be risks that are too big to take. Our biggest concerns include capital controls and expropriation of assets. We have to be able to get our money out if we need to. So far, this hasn’t been a huge problem in most countries we invest in, but it is always something we are cognizant of.

Growth and Diversification

From my perspective, the most compelling reason to invest in frontier markets is their long-term growth potential. When you compare the growth rates of many developed nations to that of frontier markets, you find a wide discrepancy. For example, U.S. GDP in 2011 was under 2%, while a country I just mentioned, Nigeria, saw GDP of 6.9%.3  Growth in an economy should lead to growth in corporate earnings.

For an investor, frontier markets also offer the potential for diversification since we’ve found there is often little correlation between the performance of these markets and the developed markets.

There is a misconception that the fate of all frontier markets is highly dependent on commodity prices. While it’s true many are indeed rich in natural resources and have a healthy level of exports, others depend more on domestic consumption for growth. Kenya, for example, is more agriculturally oriented and domestically driven, while Nigeria is more dependent on oil exports.

Sources of growth can evolve in a positive way. For instance, to help diversify its economy, Nigeria is looking to start refining its oil to produce more value-added products for export. It is also developing more domestic industries to feed, clothe and house a growing population.

For all their growth and diversification potential, it is important to be prepared for a few inevitable growing pains and unexpected challenges in frontier markets. However, growing incomes, higher living standards and improvements in infrastructure and trade all have the potential to bring the patient investor exciting opportunities in areas like construction, transportation, banking, finance and telecommunications.

There’s still a lot of work to do in these markets, but it’s exciting to be able to witness firsthand the innovation and growth taking place on the frontier.


1. The MSCI Frontier Markets Indices provide broad representation of the equity opportunity set across 31 countries while taking investability requirements into consideration within each market. One cannot directly invest in an index.

2. Source: IMF, 2012

3. Source: CIA – World FactBook, June 2012.

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