InvestmentsMay 8 2013

Frontier markets gain exposure as economies mature

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Fund managers are betting on frontier markets as the next major growth areas despite high volatility and a run of disappointing results in recent years.

Michael Levy, portfolio manager of the Baring Frontier Markets fund, which launched at the end of April, said the sector offers promising long-term growth with low correlation to both emerging and developed economies, making it an effective diversification away from other sectors.

“Valuations in frontier market equity markets look attractive,” Mr Levy said, adding, “The frontier market index peaked in 2007 and, while 2012 was up 5 per cent and this year started good as well, we haven’t reached 2007 levels yet.”

As a result, Mr Levy believes frontier markets offer room for plenty of growth as well as an attractive dividend return, which he said is offering a 5.5 per cent yield.

“In a world where investors are seeking income, frontier markets represent a good yield,” he said.

But while frontier markets have suddenly come onto the scene as an attractive place for growth as the traditional emerging markets show signs of cooling off, events like the Rana Plaza factory collapse in Bangladesh at the end of April highlight the negative points of western investment in these economies.

My Levy said while his fund is not ethical in its strategy, it aims for firms with good business practices that should do more good than harm. “We don’t have specific ethics as part of our mandate; we are not a ‘socially aware’ fund, but we are a corporate governance aware fund,” he said, adding that this should mean better working conditions and higher standards.

Despite the promise of attractive returns, frontier markets also offer up plenty of risk and Mr Levy does not deny this, saying performance among countries in this sector can be contrasting. “Last year the difference between the top performing frontier market and the bottom performing frontier market was 90 per cent,” he said.

Before the 2008 financial crisis, frontier markets returned an average of 33 per cent pa, but since then they have had a run of volatile returns. For example, the Templeton Frontier Markets fund, launched in 2008, had positive returns of 73 per cent in 2009, then flatlines in 2010 and returned -8.1 per cent in 2011.

Mr Levy said the volatility in frontier markets and the variability between countries means it is necessary to be selective when choosing holdings for a fund in this sector. Countries like Sri Lanka, Pakistan, Bangladesh, Vietnam and the Middle Eastern states look attractive, for example, while Latin America is an area to avoid, he said.