In the years before the credit crunch, frontier markets were all the rage. These markets, ranging from Sri Lanka and Slovenia to Nigeria and Kazakhstan, are too small to be included in emerging-market indices. And while they offer compelling long-term growth stories, they are high risk, due to political uncertainty, corporate governance problems, low liquidity and vulnerability to external shocks.
The latter in particular helps explain why the MSCI Frontier Markets Index, having soared for most of the decade, slumped by 70% between peaks in early 2009 and March 2009. Since then frontier markets have lagged behind the main MSCI emerging market index, which has more than doubled, while frontier markets are up by around 66%. But with the “fundamentals looking up” and valuations “attractive”, this could prove to be “an excellent entry point”, say Andrew Howell and Maria Gratsova of Citigroup.
That’s because – thanks to the global rebound, notably a pick-up in world trade and commodity prices – frontier growth is bouncing back. The average year-on-year change in industrial production is now flat, compared to a 20% drop a year ago. A renewed downturn in Western economies and higher global interest rates, which draw crucial capital away from emerging markets, are key risks to trade-dependent and capital-hungry frontier states, say Howell and Gratsova. But interest rates look set to stay low for some time. In any case, low valuations offset some of the near-term volatility risk. And the long-term growth outlook remains compelling.
Frontier markets are on a 17% price/book-value discount to emerging markets, while Qatar and Nigeria are on 2010 p/es of nine and five respectively. Qatar’s GDP is expected to expand by 20% this year and its gas reserves are a major plus point, says Antoine van Agtmael of Emerging Markets Management. Nigeria has just overtaken South Africa to become Africa’s biggest mobile market, yet mobile penetration is still under 50%. One way to play frontier markets is through the Aim-listed Advance Frontier Markets Fund (AFMF), which invests mostly in other FM funds. It is on a 17% discount to net asset value.