Experts say now could be a good time to look at frontier markets if you have an appetite for higher risk investments. The easiest way to get exposure is via investment trusts or funds.

Higher risks can equate to higher returns, but there is also a greater chance of losing your money. Therefore anyone with a nervous disposition may wish to stop reading now.

What are frontier markets?

Frontier markets refer to the countries less developed than the 23 countries which make up the MSCI Emerging Markets index. They include countries such as Sri Lanka, Croatia and Saudi Arabia.

Many investors might baulk at the idea of investing in these areas, where there can be political strife, hyperinflation and corruption.

‘Individually these are very risky places to invest,’ says Emily Fletcher, co-manager of BlackRock Frontiers Investment Trust (BRFI). ‘But when you put them together in a portfolio there is actually very little volatility because they are not linked in any way – what happens in Romania doesn’t affect Argentina, for example.’

‘The fortunes of countries such as Vietnam, Pakistan and Romania tend to be driven by what is going on locally. So while there is more uncertainty in the world, that doesn’t actually change anything in these markets.’

The BlackRock trust has delivered a share price return of 87% over the past five years.

Diversification benefits

Asset manager Jupiter says frontier market exposure ‘offers additional diversification benefits’ to an investor.

It is launching a new investment trust in mid-May called Jupiter Emerging & Frontier Income Trust with the aim of having a concentrated portfolio of 40 to 45 investments. Frontier markets will account for a maximum of 25% of the fund’s total assets.

For someone seeking greater exposure to these markets, we’d highlight the Charlemagne Magna New Frontiers (IE00B65LCL41) fund which has returned 89% over the past five years.

Manager Dominic Bokor-Ingram says frontier markets are a series of individual opportunities and that you can’t treat them as a whole.

‘We are looking for countries which are going through political and economic reform and then investing in companies with good corporate governance which can take advantage of the resulting economic growth.’

Where are the best opportunities?

Bokor-Ingram is finding opportunities in Argentina after a new government came to power in 2015 and implemented a radical programme of reform. His biggest holding in the country is an electricity provider, because power is key to economic expansion.

In Pakistan his favourite stock is a cement company. He says: ‘Some of the big urban centres in the country are a long way from any ports so domestic cement firms are not so susceptible to international competition. We like these domestic-focused businesses.’

Keeping abreast of the changes in these countries is key and many Frontier fund managers will travel the globe searching for opportunities, kicking the tyres of the companies they’re interested in.

Oliver Bell, manager of the T. Rowe Price Frontier Markets Equity (LU1079763535) fund, is excited about Sri Lanka. A recent trip there has left him feeling more confident about the country, where he expects the economy to grow, wages to rise and consumption to increase.

The fund, which returned 37.5% over the past 12 months, includes exposure to Vietnam where exports are growing and a middle class is emerging.

Not as risky as you think?

Surprisingly, some aspects of these markets may even be less risky than developed countries.

For example, many frontier governments and companies have very low debt levels. Historically they had high debt and banks became reluctant to lend to them; many have since endured periods of rampant hyperinflation which meant their debt was inflated away.

They also didn’t want to borrow more because of hyperinflation – not many people want to take out a loan if the interest rate is 100% or more.

Fletcher at BlackRock has been increasing her investment holdings in Kuwait; the country’s weighting in the portfolio has risen from 3% in September to around 11% today.

‘We are starting to see signs of reform and progress in the country,’ she says. ‘The market has underperformed for the past five years so we don’t think many people are looking at it, and that means there are opportunities.’

She also anticipates the fund could start investing more in Africa over the next 12 months after being ‘perma-bears’ on the continent.

The Moroccan market, for example, was up around 40% last year and the country’s government is working hard to get a handle on its debt.

In the Middle East, Fletcher is excited about Kazakhstan where the largest private bank, Halic Bank, may be about to merge with another financial giant. ‘It could make a new entity much larger than any competitors and really dominate the market,’ she says.

There are still trouble spots

Some frontier markets continue to have major problems. Issues with property rights, share ownership and badly managed economies are not uncommon, for example.

Fund managers often avoid entire regions or will change the portfolio because of local events – a country absent from a portfolio could become the biggest area of investment in 18 months’ time.

Bokor-Ingram at Charlemagne says two years ago his fund had no money in Argentina or Pakistan and today they account for 35% of the portfolio between them.

Frontier markets should never make up more than a small percentage of an investors’ portfolio but, for those willing to stomach the risk, there could be gains to be made. (HB)

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